Given the very bullish sentiment heading into earnings, FBR Capital Markets said it is not surprised by the pullback in shares of Core Laboratories N.V. (NYSE: CLB) following the company's second quarter earnings release.
"In our opinion, the stock was priced to perfection going into the quarter, and the company did not report perfection. The second quarter earnings beat was attributable to a lower-than-expected tax rate as production enhancement margins slipped during the quarter," said Robert MacKenzie, an analyst at FBR Capital Markets.
That said, MacKenzie believes concern over production enhancement weakness is overdone, particularly because it still represents a minority of the company's earnings stream, with the majority finally getting off the ground with the resurgence of international oil-directed investment.
Given the attractive niche the company has carved out and the scarcity of attractive entry points, MacKenzie believes the 6.75 percent pullback over the last week (versus the OSX up 2.1 percent) presents one of the best buying opportunities that one can expect for this stellar growth story.
Still, MacKenzie believes that the rapidly rising rig count targeting liquids-rich, unconventional resources should continue to drive strong service intensity for Core Laboratories in its production enhancement business line.
MacKenzie said that unlike some existing dry gas plays, the science on how to optimize production from these emerging plays is far from settled, yielding copious opportunities for Core to continue its stellar growth trend. This should now start being additive to growth in the core reservoir description businesses, driving rapid earnings and cash flow growth.
Core Laboratories' reservoir description segment showed solid growth this quarter, and MacKenzie expects this growth to accelerate over the next several quarters. Reservoir description experienced year-over-year incremental operating margins of 40 percent and revenue growth of 11.5 percent.
With the development of international shales on the horizon and Core commanding an unmatched knowledge of reservoirs across the globe from Poland to Argentina, MacKenzie believes that this service line will continue experiencing rapid growth for the foreseeable future.
MacKenzie said production enhancement operating margins fell to 27.6 percent in second quarter from 28.3 percent last quarter. Weakness can be attributed to the delay of certain international field-flood diagnostic projects, as well as the service and product mix during the quarter.
MacKenzie said disruptions in the Bakken shale from flooding also negatively affected results. Looking into third quarter, a shortage of high-performance specialty steel tubulars could potentially impair production enhancement results again in third quarter. However, he is not too concerned about this short-term supply issue.
As MacKenzie anticipated, management raised its full-year 2011 earnings guidance to a range of $3.65 to $3.72 per share from previous forecast of $3.55 to $3.60 per share. Last quarter, he highlighted that Core's guidance was too conservative, as it was based on growth in the U.S. oil rig count merely offsetting declines in the natural gas rig count and as guidance seemed to imply no increase in service intensity.
Core Laboratories stock closed Friday's regular trading up 0.62 percent at $109.31 on the NYSE.