By
Oil & Gas
360
:
How is value measured? Analysts talk and write about a stock
because the company creates value. Does "value" mean "cheap?" Buy
low, sell high. That formula is not working with Facebook (
FB
) at the moment. That's more like buy high, short sell, but we
recognize that it is early for FB and its "friends." Yahoo (
YHOO
) went public in April 1996 at $24.50. At year-end 1996, Yahoo's
market capitalization was $16.9 billion. On January 3, 2000, Yahoo
reached its share price zenith, $118.75, valuing the company at
$126.8 billion. Today YHOO has a market capitalization of $18.5
billion. We are doomed to failure if we fail to learn the lessons
of the past, or willfully ignore history. FB, which started its
public life as a $110 billion company, could be in for a very bumpy
ride. Today, FB's market capitalization is $67 billion.
Turning back to equities, what exactly is "value?" Does paying
more for a Lexus and less for a Toyota (
TM
) mean that the "parent company" is cheap? Inferior? Lexus' tagline
is "the pursuit of perfection." On May 16, 2012 Lexus announced a
voluntary safety recall of certain 2013 model year GS 350 F sport
RWD vehicles.
Click here
for the news release. Toyota vehicles have experienced mechanical
issues forcing the car maker into multiple recalls. In this
example, expensive and less expensive cancel each other out.
Blue versus Pinstripes
The Los Angeles Dodgers baseball team was purchased in March
2012 for $2.18 billion, including the assumption of debt. The New
York Yankees are "rumored" to be entertaining "for sale" offers.
George Steinbrenner bought the team in 1973 for $8.8 million. In
2011, Forbes valued the Yankees at $1.7 billion, or 66 times
operating income.
Click here
for the Forbes list. The Dodgers value of $2.18 billion represents
the same 2011 66 times price-to-operating-income ratio as the
Yankees. The Dodgers have won six world championships, the Yankees
27. Which team has more value and which team is more
valuable
? The new owners of the Dodgers could, through strategic execution
of their business model, luck, and perseverance have a chance of
creating an organization that is every bit as valuable as the
Yankees. The Yankees could, if they fail to draft, over-spend for
free agents, or fall on years of bad luck, be less valuable than
they are today.
Land Drillers
Value versus valuable. Is the ratio of Stock Price to Cash Flow
[P/CFPS] the "best" methodology for determining a company's value
or if it is valuable? If it is, then Nabors Industries (
NBR
) offers excellent "value." Helmerich & Payne (
HP
) could be considered valuable.
Nabors is the largest onshore rig operator, with 501 land
drilling rigs. The company trades at an estimated best estimate
(Bloomberg aggregation) 2012 forward P/CFPS ratio of 2.3 times. The
second largest onshore drilling operator in the U.S., (with 330
marketable rigs) is Patterson UTI Energy (PTEN). This stock trades
with a 2.8 times forward P/CFPS ratio. Helmerich & Payne (
HP
) trades with the highest forward P/CFPS ratio of 5.1 times, among
the "pure" drillers, which we define as those companies having
revenues generated from drilling 70% or more. For example,
Chesapeake Energy (CHK) owns rigs, but by our definition, we do not
classify CHK as a "drilling" company. H&P (a side question
here: what would Hewlett Packard pay Helmerich & Payne to have
the HP ticker?) owns 270 land rigs in the U.S. and as of April 26,
2012 "the Company is scheduled to complete another 34 new
H&P-designed and operated FlexRigs under long-term contracts
with customers. Upon completion of these commitments, the company's
global fleet is expected to have a total of 330 land rigs,
including 293 FlexRigs." The addition of 34 more rigs represents a
12.6% "growth rate." In the pure drilling category Union Drilling
(UDRL) has a P/CFPS ratio of 1.9 times. Investors, it would seem,
are willing to pay more for H&P than any of the pure drilling
companies. But does that mean H&P isn't a value or that Union
Drilling isn't valuable?
In terms of business model, H&P has taken a different, or
rather differentiated, approach to the land drilling market. The
Company introduced the concept of the FlexRig to increase
efficiency, reduce mobilization times (and downtime) and ultimately
to reduce the number of days it takes to drill a well. The modular
design and other operational features of the FlexRig enables
E&P companies to not only reduce the total cost of drilling,
but also to drill more wells for the same amount of capital
spending. In a commodity business where the generic business
strategy is to be the low-cost producer, that is a compelling value
(valuable) proposition.
And the proof is on the financial statements. H&P has the
highest dayrate charge per day, per rig. H&P isn't just about
top-line growth. The company also earns the best per day, per rig
margin. If the P/CFPS ratio is an indicator of what is valuable,
then H&P's dayrate and margins are implied to be valuable to
the institutional investor.
Click here
to review the onshore drilling company dayrate and margin
comparison charts.
Competitors have worked to build their version of the FlexRig,
but H&P has been able to continue innovating improvements to
its rig design, maintaining its competitive advantage and higher
profit margins. That is what makes H&P a more valuable company
in the eyes of investors.
The Cost of Capital
Another key factor in assessing value is a company's Weighted
Average Cost of Capital [WACC], which forms the "hurdle rate" for
generating an economic return. Both Nabors (9.98%) and Patterson
UTI (13.37%) have a lower WACC than H&P (14.48%), implying that
those companies have an easier time generating positive returns.
But, the WACC ignores financial risk, something anathema in a
cyclical industry. Nabors and Patterson have a low WACC because
their management teams have assumed greater financial risk by
levering-up their balance sheets. For example, the debt-to-market
capitalization ratios for Nabors and Patterson are 119% and 20%,
respectively, as compared to H&P's conservative 7%. This isn't
the entire story.
(Click to enlarge)
Core Laboratories - A Case Study in What is
Valuable
This brings the final thought to Core Laboratories (CLB). "Too
expensive" is the usual thought we hear from investors when they
evaluate the company's P/CFPS ratio. On May 25, 2012, Core Lab
enjoyed a 25.6 times forward 2012 P/CFPS ratio. "Enjoyed" is
appropriate here. As we noted back on April 17, 2012, CLB derives
much of its business from big, global and oily projects. And those
big, global and oil-weighted projects are genuinely valuable to the
large oil companies, including the national oil companies that are
developing them.
Click here
to read that April 17, 2012 note.
(Click to enlarge)
(Click to enlarge)
Using an average 5-year P/CFPS ratio suggests that Weatherford
(WFT) (compared to Core Lab) has been a value buy for the last five
years, but year-to-date 2012 the stock has lost 11% of its "value"
for its shareholders. For service companies, capital intensity, or
the amount of capital spending required to generate $1 in cash
flow, is a key metric in our view and provides an indication of
growth potential and profitability. Weatherford must invest $0.64
to generate $1 of cash flow. On the other hand, it's all about the
Roosevelts for Core Lab -- the company generates a $1 for every
$0.11 cents of spending, just more than a dime. This is better than
the value menu at Taco Bell (YUM)!
Given Core Lab's low capital intensity and propensity to
generate large amounts of cash with low investment requirements, it
stands to reason that the market rewards the company with an
above-average P/CFPS ratio. The company does pay an annual dividend
of $1.12/share, a 0.80% yield. Not eye-popping, but Core is one of
11 of the 20 companies in the above chart that pays a dividend.
Additionally, on July 7, 2010 and July 13, 2009 the company issued
a $0.55 and $0.32 special dividends, respectively.
We also note that the company has an active share repurchase
program. From the activation of the share repurchase program in
1995 through December 31, 2011, CLB repurchased 33,123,122 shares
for an aggregate purchase price of approximately $788.0 million, or
an average price of $23.79 per share and canceled 27,537,600 shares
at a cost of $466.2 million. At December 31, 2011, CLB held
1,408,334 shares in treasury and has the authority to repurchase
11,145,344 additional shares under the current stock repurchase
program.
Like H&P, Core Lab took the innovative and differentiated
path to its business strategy. One of the keys to Core Lab's
profitability and strong record of growth is the company's
competitive advantage -- its data library. To our knowledge, Core
Lab has the most comprehensive data library and reservoir samples
of any other similar company in the world, which provides the
company the ability to provide greater insight than its competitors
into how to extract more value from existing oil fields. Given that
all the "easy" oil has already been found and the typical
conventional reservoir only produces 10% on average of the
estimated original oil in place, it makes sense that oil companies
are highly likely to increasingly turn their attention to the kind
of services and technologies that will enable them to increase
recovery factors from existing fields. Those are the offerings at
the core of Core Lab's service lines.
Investors have to ask just how durable this competitive
advantage is. After decades, none of Core Lab's competitors have
been able to duplicate the company's data set, so it is either
impossible or prohibitively expensive to replicate.
Free Cash Flow in a Cash Intensive Business
We analyzed each company's valuation based on a trailing twelve
month [TTM] of unlevered free cash flow. We calculate unlevered
free cash flow per share as TTM EBITDA less TTM capital
expenditures all divided by shares outstanding. The ratio we will
refer to now is a Price/TTM Unlevered Free Cash Flow [P/TMUFCF]
ratio.
The more cash it takes to generate a dollar of cash flow, then
the more likely it is that the company will trade at a high
P/TMUFCF ratio. The most important part of this equation is Free
Cash Flow. Using our earlier drilling company example, H&P's
P/TMUFCF ratio at May 25, 2012 is 21.8 times. Nabors and Patterson
are nil, meaning neither company generates free cash flow. The
value versus valuable point is clearer here, as PTEN and NBR may be
value buys, but H&P is clearly valuable.
Core Laboratories generates TMUFCF of $5.27 per share. Four
companies produced better figures: National Oilwell Varco (NOV),
CARBO Ceramics (CRR), Oil States International (OIS), and Diamond
Offshore (DO). The four companies generated free cash flow per
share of $7.64, $6.11, $6.09, and $5.40, respectively.
Although companies like Lufkin Industries (LUFK) and FMC
Technologies (FMC) have P/CFPS ratios that are lower than Core Lab,
and thus present a "value" option, look closer at each company's
P/TMUFCF ratio. For the 12 months ended March 31, 2012, Lufkin
generated free cash flow of $1.65 per share, or $3.62 less than
Core Lab. For FMC, the company generated $1.56 of free cash flow
per share during the previous 12 months. The resulting P/TMUFCF for
Lufkin is 36.8 times, or 101% higher than its P/CFPS of 18.3 times;
the comparison is similar for FMC: P/TMUFCF of 26.8 times versus
P/CFPS of 17.4 times.
Core Laboratories trades at a P/TMUFCF of 25.6 times.
(Click to enlarge)
Our earlier question of how "value" is measured is especially
timely when the energy sector looks poised to enter another down
cycle. All of the aforementioned names have enjoyed higher stock
price valuations in times past. Our question in this note has to do
with what is valuable. Each time a name is thought to be a "value"
perhaps there is a good reason for it -- operating execution is not
as it once was or current market conditions are working against a
particular set of assets.
Core Lab's focus on services that increase a client company's
production outflows, resulting in an increase in a well's or
field's ultimate recovery and value, is, we believe, valuable and
the name, a "value".
Disclosure:
I am long [[CLB]].
Disclaimer: Oil & Gas 360® did not receive compensation
for the publishing of this company note. Professionals associated
with Oil & Gas 360® hold a long investment position in Core
Lab, but do not intend to buy or sell company shares over the
next five business days. Although Core Lab pays Oil & Gas
360® a monthly fee to be a profiled company on the website, Oil
& Gas 360® reserves the right to publish notes and
observations on any company that is sees fit to distribute.
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