Oil prices have bounced around quite a bit over the past few years, which has held back the anticipated recovery in the oilfield services market. Instead of the "V-shaped" rebound that oil reservoir specialist Core Labs (CLB) anticipated, the chart has looked more like a "W." As a result, Core's earnings and cash flow have fluctuated quite a bit. So much so, that the company hasn't always generated enough cash to cover its dividend. That has put pressure on its stock price, causing the yield to rise as investors and analysts have begun to question the payout's long-term sustainability.
Core's dividend yield recently topped 5.5%, and touched the highest level in the company's history. Because of that, it was a top subject of discussion on the second-quarter conference call. While Core's management team acknowledged investors' concerns, they also made it clear that maintaining the payout remains a top priority.
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Taking steps to preserve the payout
CEO David Demshur pointed out on the call that Core generated more than $10 million in free cash flow during the quarter -- its 71st straight quarter of generating positive free cash. That's quite a streak, given that the oil industry operates in the red more often than not. Demshur also noted that the company "returned approximately $25 million back to our shareholders via our quarterly dividend." In other words, it paid out about $15 million more than it generated.
That's not the first time the company's free cash flow fell well short of its dividend outlay. An analyst on the call noted that operating cash flow was about 40% less than the dividend through the first half of the year.
Demshur tried to allay those concerns, stating: "Core has no plans on cutting our dividend as we view it as important to our investor base." He then ran through several reasons why the company believes it can maintain its payout.
With the emergence of international markets pushing Core Lab revenue and operating margins, Core is confident that the company's asset light model will allow Core's future cash flow to more than cover our dividend. And to further bolster free cash, the company has embarked on a North American cost cutting plan. We are continuing to streamline businesses ... to review operating structures to right-size costs for current market conditions. In addition, as was the case in the second quarter, the company will continue to review divestment opportunities of non-core non-strategic low margin businesses.
Overall, Demshur pointed out three reasons why investors should feel confident about the company's ability to continue paying its current dividend:
- International markets are improving.
- It's cutting costs to boost margins.
- It's selling non-core assets to boost profitability and bridge the gap.
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Drilling even deeper into the dividend
Despite those assurances, the dividend's sustainability came up again later in the call when an analyst asked what would drive the improvement in free cash flow in the second half. CFO Chris Hill addressed this by stating:
As we go into the second half of the year, we continue to talk about and believe that free cash flow is going to improve and it's driven by this international activity and the growth from our Reservoir Description group and the expansion of those margins ... we are confident that as we get deeper into this international recovery, that's going to be reflected in our free cash flow generation.
Core Lab's outlook backs that view. The company forecasts that its revenue will rise from $169 million in Q2 to a range of $171 million to $175 million in Q3. It also expects its operating margin to expand from 17% to 18%, which should boost EPS from $0.46 to between $0.48 and $0.52. That growth should drive free cash flow expansion.
Meanwhile, the company is even more optimistic about its longer-term outlook. That's because oil companies have approved an increasing number of major projects in the past year, which should boost reservoir description revenue. COO Larry Bruno stated that "during the darker days of the downturn [2015-2016], Reservoir Description was running at about $100 million per quarter run rate." However, he noted that the company saw a "lift-off from that, getting us now into the $105 million, $106 million and moving in the right direction."
Demshure then provided a glimpse of what could be ahead for the segment. "So if you look at 2014, you had revenues running in the $130 million a quarter," he said. "We would expect that once you start to pile up these FIDs [final investment decisions] over four or five years, we could again approach those levels in 2021, 2022."
Operating margins, likewise, could also regain their former heights in the high 20% range, according to Demshur. That's because the company now has better product offerings and an improved cost structure than it had at the peak in 2014.
An intriguing option for yield-seeking investors
Shares of Core Labs have tumbled in recent years due to the slower-than-expected recovery in the oilfield services market, which has pushed its dividend yield up to enticing levels. While the company isn't currently producing enough free cash to cover that payout, it firmly believes that this is a temporary issue. Because of that, Core Labs looks like an attractive stock for yield-seeking investors to consider buying.
