Core Laboratories Reports In Line Second Quarter Revenue

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Core Laboratories N.V. reported second-quarter revenue relatively in line with Street expectations, and excluding foreign-exchange effects, EPS were $1.35, versus the consensus of $1.34. We believe third- and fourth-quarter guidance was roughly what investors expected. Combining first-half results and third- and fourth-quarter guidance implies 2014 EPS of roughly $5.85 to $5.93. If the market has concerns with margins or growth opportunities, we would use any material weakness in the share price through this week and next as an opportunity to be more aggressive on the stock.

Investors are focused as much on the long-term growth rates for Core Labs as they are the near-term EPS performance, particularly given the growing recognition of the “rocks to fluids” transition the business is undergoing and the relative exposures to exploration versus production and recovery-focused spending. We view the exposure to shifts in E&P spending trends as a bit more concerning in the near term given how important the North American unconventional basins are to Core Labs’ growth and what the shift away from core analysis says about how E&Ps view the value proposition of the information once the sweet spots have been established.

We believe this issue would be less concerning for the market if the company’s fluids business (focused on driving recovery rates higher from older basins) were larger and able to offset weakness in legacy unconventional basins. The company remains confident about the potential contribution from newer unconventional plays in North America, but we believe investors are quite skeptical at this point and we doubt that third-quarter results will change the market’s view that much. In our view, however, fourth-quarter results, increasingly easy growth and margin comparisons, and 2015 commentary are more likely to shift sentiment to the upside, particularly given that the Street is now modeling only modest revenue growth for the next six quarters.

Reservoir description margins have been affected by low activity in four of the last five quarters, but management believes the long-term deepwater opportunity will lead to increasing reservoir description margins. In particular, we anticipate robust growth from reservoir fluid projects given the value Core Labs’ analysis provides in maximizing daily rates and ultimate recovery. Deepwater projects will continue to carry a tendency to push to the right given E&Ps’ growing focus on minimizing cost issues and driving returns higher.

The company’s operating margin guidance provides confidence that the new high-margin perforating charge and gun systems technologies will more than compensate for the current price erosion the more basic technology charges are experiencing. We fully expect the new technologies will have traction in the second half of the year, and we believe the new potentially disruptive perforating technology could become one of Core Labs’ growth engines; however, it is still too early to identify the actual market size, and said market size will clearly depend on E&P appetite for well count increases and stage count increases in the North American shale markets.

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