Source: Core Labs
Oil prices are highly cyclical, and when they crash Wall Street invariably loses its mind and sell off great oil stocks along with the bad. Take for example Core Labs (CLB), which, while not nearly as badly punished as some energy stocks, is still down sharply since the crude crash began in mid 2014.
CLB Total Return Price data by YCharts
Find out three reasons that Wall Street is dead wrong about Core Labs. More importantly, learn why this particular oil services stock is set to deliver potentially market crushing total returns over the next decade, no matter when oil prices recover.
Unique business model
"Core converted over $0.24 of every 2015 revenue dollar into free cash flow, again leading all oilfield service companies. Also in the fourth quarter of 2015, Core once again produced oil industry leading return on invested capital for the 26th consecutive quarter, topping an ROIC of 40%." - David Demshur, President and CEO
Core Labs is the ultimate wide moat business thanks to its 80 year age that has allowed it to create the best expertise and global database of oil field characteristics in the industry. To oil companies, knowing where to drill, how to drill, and most importantly, how to optimize production in the most price effective manner is worth its weight in black gold.
This, combined with Core Labs' low cost business model allows the company to generate staggering amounts of free cash flow. In fact, as the quote from Core's CEO from the company's latest conference call illustrates, Core had a 24% free cash flow margin last year and is the most profitable publically traded oil service company in the world.
What's more important for investors however, is the fact that Core Labs' services are so vital to oil and gas firms that its actual business is far less variable than the industry at large.
Relatively stable and consistent growth
"For the full year, revenues were $798 million, so down 27% but on a constant currency basis down only 23%, and a nice outcome considering the global rig count was down almost 35% over the same period." -- Chris Hill - Chief Accounting Officer
CLB Revenue (Annual) data by YCharts
No oil stock is completely immune from the volatility and cyclicality of energy prices however as you can see Core Labs' revenue, earnings per share, and free cash flow per share growth has an astounding record of consistency.
In fact, over the past two decades the company has managed to grow sales, EPS, and FCF per share at a compound annual growth rate of 10.3%, 14.8%, and 27.8%, respectively.
This has rewarded long-term investors over the past 20 years with 20% CAGR total returns, even after accounting for the last two year's price drop. That's compared to the S&P 500's total returns (which account for dividend reinvestment) of 8.2%.
What is Core Labs secret to such mind blowing returns? And more importantly can investors expect such outperformance to continue in the years ahead? While I can't promise Warren Buffet like returns like that, there is one secret weapon Core Labs has that is likely to help the stock keep beating the market over the next five to ten years.
Strong history of consistent investor profit sharing
"For the full year, we used our free cash flow and borrowings under our credit facility to pay $94.2 million in dividends and $159.7 million in share repurchases." -- Chris Hill
CLB Stock Buyback (Annual) data by YCharts
Over the years Core Labs has put its massive free cash flow to good use by reducing its share count by an impressive 3.5% CAGR. This strategy increases free cash flow per share and is what has allowed it to not only keep growing its dividend strongly over the past few years, but also preserve its payout at a time when so many other energy stocks are slashing theirs.
However, dividend growth investors always need to consider how safe a payout is going forward. After all, since Core Labs took on $75 million in net debt in 2015 its the dividend may be at risk if the company's free cash flow payout ratio or leverage ratio is unsustainable.
Fortunately with a Q4 2015, and trailing 12 month FCF payout ratio of 53%, and 49%, respectively Core is likely to able to preserve its dividend even should oil prices fail to recover this year.
In addition the company's interest coverage ratio of 13 means that it should have no trouble servicing its debts with operating cash flows. Management has also wisely chosen to maintain rather than grow the dividend until oil prices recover, as well as divert more free cash flow towards paying down debt.
Bottom line
Core Labs, with its long-term focused, shareholder friendly management, unique, wide moat free cash flow minting business model, and strong balance sheet, is one of the best situated energy stocks you can own to profit from an inevitable recover in oil prices.
