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.


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