Core Laboratories Is Back to Reasonable

 | May 14, 2014 | 11:00 AM EDT
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Core Laboratories (CLB), an oil-servicing company engaged in the development of intellectual capital and patented technologies, revised downward its revenue guidance and earnings yesterday. Core Labs lowered full-year earnings guidance from a range of $6.00 to $6.25 a share to a range of $5.80 to $6.00. Revenue for the second quarter is now estimated to be between $265 million and $270 million, lower than the previous estimate but still above last year's second-quarter results. Analyst consensus puts estimates at $288 million.

The bulk of this disappointment was due to analyst expectations, even though management did have to revise downward its own estimates too. At one point on Monday, shares of Core Labs were down by almost 20%. Such a steep drop is, I believe, part of a larger trend in which growth stocks such as Core Labs are falling out of favor. In this climate, such a downward revision was great excuse for investors to dump this high-growth stock.

Why did management have to reduce earnings estimates? In short, Core Labs saw less sampling and analysis activity in some of the older North American shale plays such as the Eagle Ford, Bakken and Marcellus. As these three shales mature, demand to understand the geology and flow rates decreases. Interestingly, sampling and analysis activity seems to be picking up in "second wave" shale plays such as the Wolfcamp, South Central Oklahoma and Tuscaloosa Marine shales. However, increases there were apparently not enough to offset the decline in "first wave" shale plays.

It seems as if upstream operators are a bit more hesitant to pour capital into the newer shale plays than into the older ones. While these newer plays, particularly the Wolfcamp and Tuscaloosa, may turn out to be just as great as the Eagle Ford and Bakken, the upstream producers seem reluctant to add yet more capacity to the market.

Management will probably need to adjust to the concept that these first shale plays are beginning to mature and that exploration and appraisal demands may not be as great as they were. Core Labs has a variety of geographies and revenue sources, including deep-water. In the long run, there should be little doubt that Core Labs can adapt to the needs of its customers and maintain a competitive advantage through its patented technologies. 

From a purely valuation perspective, Core Labs just got a lot more reasonable. The company's price-to-earnings ratio has averaged 25x over the past 15 years. Monday's steep decline brought the stock down to just over 27x earnings, much closer to its average valuation.

Overall, Core Labs is still a growth company that has powerful, secular forces behind it. Over time, the "service intensity" of oil extraction has been increasing, and Core Labs is a greater beneficiary of that than anyone else is. Management can develop more heavily in other areas if development of the older North American shale plays levels off.

There are some very powerful, secular forces at work in favor of Core Labs. Trading close to its historic average, Core Labs is fairly valued and can be picked up here. The company's overall record of high returns on capital employed and dividend growth are unmatched. This downward revision is a hiccup, but in the long run, Core Labs has a great story behind it.

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