Overview, part 1

My funds are up significantly to-date, but so is the market.

The market feels overheated, so I am cautious, and looking to reduce my exposure where I can. Any securities that I had been holding as value investments may be approaching correct valuation, so I am going to have to re-evaluate.

Core Labs (CLB) is a position that has been great for my portfolio. Up until now, there has been a two-fold case for the investment – the undervaluing of its shares, and its position as THE dominant player in reservoir analysis and management. In addition, its perforating products had been selling like hotcakes to many of the shale E&P companies. However, there is evidence that growth in the latter is slowing, and recent reports of drilling rigs being pulled from dry gas areas may negatively impact these products performance. Core’s management has even stated that they did not expect the past levels of growth in these products to be sustainable.

Core is also approaching a good valuation for the shares. I would place a good target price at $140/share. However, the whole oilfield sector is due for major appreciation, as geopolitical risks show no signs of cooling down, and oil prices continue to rise, and a rising tide tends to lift all ships. Core will likely appreciate along with the likes of Halliburton and C&J.

Can I still justify my investment in CLB, with HAL and CJES sitting at such ridiculously low valuations? Especially with C&J, the latest quarterly report has just confirmed the trend of earnings growth, and indicates a speeding up of growth, as three new fleets will be deployed in 2012. This is a 50% growth in its fracking business, which itself brings in over 80% of its revenues. C&J is also set to grow its coiled tubing business this year.

Further, C&J is a 100% liquids play now. They have moved their last fleet out of dry gas regions, and enter 2012 with all of their fleets in liquids rich regions. The only problem that seems to be occurring with the trend is a delay further upstream – there have been well delays because of constriction of supply in drilling rigs. When demand is outstripping supply, is that not a good thing?

With over 25% of my portfolio in this single stock, I am reluctant to commit to it further. Especially because its shares have appreciated so much since my initial buy-in – I feel I missed out, and now must wait.

This is probably foolish, but I should not ignore the effect of this emotion – does it have merit? If not, I can safely disregard it, hold my nose, and continue to load up.

But it is true – CJES does not represent the same value proposition that it once did. Buying it at $22 a share is much different than buying it at $17.

But how can I value this company properly? Because it is also a reflexive process – CJES is fueling its growth through share issuance – does my traditional value measurement even apply?

It has a 13.66% earnings yield, and a P/E of 7.32. From a return on my equity, it gives 64%, similar to its ROA of 42%, since it carries no debt. A price to free-cash-flow 4.83, almost all of which is used for the new fleets.

To value it from a PEG ratio, I expect anywhere from a 50%-100% earnings growth this year, which would translate to a PEG .14 to .07.

But can a GARP approach make sense here? There is a reflexive influence. It inflated the market cap by about 10% last year – this year we might expect something similar. If that were to occur, at today’s prices, CJES would still have a P/E of 8.05, still leaving significant margin for safety.

And the reflexive relationship may decrease over time – as CJES’s operating cash flow increases, it can increase the proportion of capital expenditures financed by operating cash flow and decrease the amount funded by share issuance.

Well, at least three questions remain –

1. At what price would I stop being a buyer?

2. At what price would I be a seller?

3. How much of my portfolio am I comfortable with allocating to this one stock?

1. I don’t have an exact answer, but I believe that a P/E of 10, it would cease to be such a screaming value. The stock does carry some risk – perhaps regulations, but more likely the ceasing of the trend, caused by decreasing oil prices (a resolution to the Iran crisis, Saudi Arabia flooding the market, or extensive oil finds outside of CJES’s core areas). The resolution of the Keystone pipeline could provide another risk to this stock, by flooding the United States with new, potentially cheaper, oil.
A P/E of 10 would give a top buying price of $30, which is still 36% higher than today’s price. Wow.

But that is my top purchase price. I get a feeling that buying at any price higher than $25 would not be prudent. If I want to allocate any more of my portfolio to this position, it should be at prices below this. If it so happens that I get a flood of capital after the stock has appreciated, I will have to evaluate the current market at that time – maybe there will be an abundance of great values by that point (i.e. maybe a crash will occur before then).

2. To gauge this, I would normally use the valuation of a current oil service major. But with much of the sector depressed, current valuations of BHI and HAL seem too low to correctly gauge. And SLB and CLB, with P/E’s of 22.6 and 32.9, respectively, are given high valuations because of competitive advantages that I don’t believe are present in CJES.
The growth rate will slow as the company’s installed base increases, at the same time that every other oil service major is increasing their installed base.

3. I would be comfortable below a max allocation of 50%. Anything more would be too much in one basket.

So that is an analysis of two of my holdings. Since CJES is below my stop-buying price, and provides significant upside from here, I am going to stick with it, and move over some funds from the hot CLB.

But what about the rest of my holdings? I want to make my allocation to CJES much closer to 50% than it is currently. I will have to do a follow up post on some other stocks that look less compelling that I am holding.

Trolling for Ideas, Part 2: Dreamworks Animation

DWA (Dreamworks) is an interesting company. The business is entirely hits driven – the movies decide the profit. The next three that DWA has lined up are Madagascar 3 in summer 2012, The Rise of the Guardians in winter 2012, and The Croods in early 2013. Here is a quick preview of the two movies for this year: http://www.youtube.com/watch?v=f5TKd82FRnw

Judging from comments and my own intuition, I feel that Madagascar will perform roughly in line with expectations – slightly worse than the old Madagascar films, but still enough to be very profitable. I am guessing a ~$500mm worldwide gross.

Rise of the Guardians looks far more interesting. This could be a major blockbuster, which means closer to the $1 B mark on box office. If that is so, this movie alone could cause a major appreciation in stock price.

The company is also going to be booking revenues from its ongoing sales of Puss in Boots and Kung Fu Panda. I will have to do more research to see the full impact from these films.

Overall, DWA does not have any fundamental reasons to appreciate short term, but the perception is net negative. S&P is strongly bullish, but analysts have a median target of $18, slightly below its current price, and the lowest estimate sits at $12. $12? Really? The perceptions are probably more negative than the stock warrants.

The perceptions may turn more positive on general strength in the movie industry as we approach the summer. Maybe I could purchase sometime soon. I may have to wait 12-18 months for appreciation, but I strongly feel that 18 months from now, the stock will be at least 40-50% higher, on either Rise of the Guardians or The Croods.

Indeed the price seems to be on a fairly strong uptrend, breaking its long slide. So, fundamentals are positive, but will take a long time to play out. Perceptions are net negative. And the price is beginning to turn. Perhaps this is the best time to get into DWA.

The company will announce earnings later this month, where they will release results of Puss in Boots and Kung Fu Panda sales. Puss in Boots performed well, with a $522 mm box office worldwide, but it was by no means knock-out. However, with the perceptions this negative, we could be in for a nice pop on this stock.

Trolling for New Ideas, Part 1: HAL

It is a little difficult to find stocks I like at prices currently. In addition, several stocks, such as IMAX and CLB, have appreciated considerably, and I am considering taking part of my position off of the table. 

Thus I have capital, but not enough ideas. While it may be prudent to be patient, I am still going to investigate to see whether there are any speculative or fundamental ideas out there.

The most obvious idea I can see is HAL. The stock is, in my mind, the best of breed in shale fracking. In addition, HAL is one of the few service companies that can make the move to international territories as more countries become interested in exploiting their shale reserves. From this perspective, HAL looks like a better long term play than CJES, though it is not price quite as attractively.

But it is definitely in value territory. After growing 50% yoy, the stock still sits at a P/E of 11? And this is AFTER being cleared of many of the charges related to Macondo. Perhaps civil charges may be raised, perhaps punitive damages may be awarded against them, but will these affect the fundamentals? Not severely.

I would think the indemnification against BP for Halliburton’s pollution would cause perceptions to rise. Yet the stock has remained depressed. Perhaps perceptions are still negative because of the threat of punitive and civil losses…

Yet analysts are overwhelmingly positive on the stock. The low target is above the current price, and Goldman Sachs has named HAL to its conviction buy. The price has been trending up for the past two months, yet it seems to be showing resistance at the mid $37 level. 

So the underlying trend is strong, and perceptions are also strong, yet the price moves are not quite as strong. I would expect the underlying trend and perceptions to reinforce each other and propel the price upwards, but maybe there is something major that I am overlooking. I will have to watch over the next few days and see whether further declines occur. I will try to get shares in the $35 range or below.