Core Laboratories Stock Upgraded: What You Need to Know

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Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

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Cheap oil does no favors to companies in the oil and gas industry -- as investors in Core Laboratories (NYSE: CLB) can attest. Since the start of this year, oil reservoir description and "production enhancement" company Core Labs has lost 24% of its stock market value -- a loss twice as large as the 12% decline in oil prices since January.

But there's good news, too: According to Swiss megabanker Credit Suisse (a continental neighbor to Dutch-based Core Labs), the sell-off in Core Laboratories stock is giving investors an opportunity to pick up shares on the cheap. Credit Suisse thinks now's the time to buy -- and here are three reasons why.

1. Core Labs' business improves

Core Labs reported its fiscal Q2 2017 earnings last month, and the news was a welcome surprise. Sales climbed 11% year over year and profits were up a very strong 34% at $0.51 per share, beating analyst estimates. Furthermore, Core issued new guidance saying it expects to book between $165.5 million and $170 million in revenue in the current fiscal third quarter. If that's how things turn out, it will equal 17% growth year over year.

Profits for the quarter are expected to range from $0.54 to $0.56 per share -- as much as a 47% improvement. So you see, not only are Core's numbers going up, but if estimates hold true, then the rate of acceleration in revenue and earnings growth is also improving.

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2. Core Labs' cash suffers

Now, on the other hand, free cash flow suffered a bit last quarter. Core generated $18.7 million in cash from operations, which was down 32% year over year. Core also increased its capital spending in the quarter, so when all was said and done, it ended up with free cash flow (FCF)  of only $15.8 million. That worked out to a 38% decline year over year.

That being said, Credit Suisse is optimistic that Core's cash machine will get up and running again soon. In a write-up on StreetInsider.com (requires subscription) this morning, Credit Suisse argued that free cash flow this year should be at least $92 million -- roughly the same amount of cash profit Core generated over the past 12 months, and significantly ahead of the company's $72.5 million in trailing net income.

Granted, even $92 million in free cash flow only works out to a free cash flow yield (FCF divided by revenue) of 2.3%. But even so, Credit Suisse sees the fact that free cash flow remains positive, combined with the gains in sales and income (implying, eventually, free cash flow growth as well) as lending themselves to a $110 price target and an outperform rating for Core Labs stock.

3. What it means to investors

Commenting on these same trends earlier this week, my fellow Fool and oil industry aficionado Matthew DiLallo echoed this sentiment, and explained why free cash flow is important to investors: "[W]ith production on the rise ... Core's sales and earnings" should rise in tandem, and produce "even more free cash flow. Furthermore, with a minimal need for that money given the capital-light nature of its business, the company intends to use the bulk of it on share repurchases, which has the potential to supercharge returns for shareholders as the oil market recovery takes hold." 

Bonus thing: Valuing Core Labs

Precisely how much supercharging might investors expect to see at Core Labs? Analysts quoted on S&P Global Market Intelligence see Core earning perhaps $2.08 per share this year, a 42% improvement over last year. 2018 profits are projected to rise a further 33%, followed by 21% growth in 2019. Roll all that together, and we could be looking at about a 32% annualized growth rate over the next three years.

Is that enough to justify Core Laboratories' current price-to-earnings ratio of 55.6? I personally don't think so, especially given that after 2019, analysts see Core's growth petering out, and profits plateauing in 2020. But Credit Suisse still thinks the stock's a buy. Moreover, the analyst's 12-month $110 price target implies as much as a 21% profit lying in store for investors who buy today.

Check back next year to find out who was right.

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Rich Smith has no position in any of the stocks mentioned. The Motley Fool recommends Core Laboratories. The Motley Fool has a disclosure policy.