CLB

Core Labs is an oil services firm that has technologies to help oil companies get more energy out of their finds (reservoirs). I have just started reading about them but so far I am very impressed. I just wished I had heard of them a couple of years ago -- its been a great stock so far.

This is getting habit forming isn't it? After CME, ILMN, FLIR, GOOG, TECH, FDS, etc., I presume anyone reading would think I don't care about valuation nor fundamentals because I just chase the biggest winners. One look at DFR, UEPS and TSRA (average cost is $26) should help convince people its not true.

Anyway, I just keep trying to find stocks that meet my criteria and if it turns out that I miss a lot of appreciation there isn't much I can do about it. Just to recap -- here is what I am looking for in 3 easy steps:

1. must be a beneficiary of a powerful secular trend that should allow them to grow faster than the average stock even during slow economic times.

2. The company should be the cream of the crop -- one of the best scenarios is a company that sells the highest value added service/product in an industry that customers cannot do without. Examples would include Google, NVT, TECH, CME and maybe ILMN. Other possibilities are companies with large market shares (FLIR has 40% of commercial infrared) or specialized niches such as TSRA, UEPS, etc.

The company should be either very profitable or on its way there based on a strong competitive position. The company should produce lots of free cash flow -- which should be a similar or higher amount as reported net income. Last, management must act rationally and in a shareholder's best interest -- their cash flow should be intelligently allocated towards good cap ex projects, acquisitions that make economic sense and or returning the money back to shareholders through dividends and share buybacks.

3. stock's valuation should be reasonable -- the more attractive the better relative to what the firm is likely to earn in a few years. The stock might appear expensive on several measures but it could still be cheap relative to what future earnings will be -- so FLIR looks expensive at current 30x 08 estimates of $2 but they might earn $6 in 2013 and sell for $150+ in 2012 (5 years out) -- that would be a pretty good return relative to most other stocks (of course it may not work out that well either so we would have to risk adjust that $150).

So how does CLB do on the 3 steps:

1. energy is a great secular theme now -- basically both supply and demand are being impacted to create rising prices. Demand is from strong global economic growth. Supply is impacted by aging fields and the difficulty finding new fields that are large enough to meet rising demand.

2. CLB provides reservoir description services which help oil companies understand precisely the shape and chemical make up (oil, natural gas, water) of the reservoir. Oil companies use this info to determine how to use their drilling equipment to extract more oil/natural gas from the reservoir -- about an extra 5-10% of the volume in the reservoir. Boosting production of existing wells is a high return and low risk investment so this fits the high value add of the industry. They have over 20% operating margins with incremental margins of 50% (the margin on the revenue growth for the period) so they meet the profitability test. As mostly a service company with some technology products too they have low capital needs so lots of free cash flow. Management has bought back between 1/4 and 1/3 of the shares outstanding over the last few years -- their stated policy is to return all free cash flow to shareholders through buybacks.

3. valuation -- its expensive vs. history and vs. other oil services companies at 22X 08 estimates. The stock is up about $30 since July. I expect revenues to continue growing the low teens and for operating margins to continue to expand each year. use fewer shares due to the buyback and EPS growth should be closer to 20%. Buying 20% growth for 22X is cheap -- but then again oil services is cyclical so they will probably only grow that fast in an up cycle. I expect energy companies to grow their spending on both finding and producing more oil for years to come -- they are not keeping up with demand yet.

Management appears to guide about 10% less than they actually end up earning so my hope is that the valuation is not as expensive as it first appears. I expect with incremental margins continuing to be well above current margin levels that those margins will be going up for some time.

For me its about position size (small until theres a pull back) and reducing my exposure to energy since this one is definitely a more volatile choice then my current energy stocks.

I'm still learning the story so I know my explanation does not do it justice but I hope to improve your understanding of this story over time.