The oil market downturn has been a heavy weight on oilfield service companies. Drilling activities have all but dried up in some spots, which drove down revenue and profitability for service providers. That said, while the industry downturn has had an adverse impact on both Core Labs (NYSE: CLB) and Oil States (NYSE: OIS), Core has managed to remain profitable throughout, which is why its stock hasn't sunk as deeply as Oil States over the past few years. There are a few reasons for this, which in my opinion, makes Core the better buy versus Oil States.
Drilling down into what these companies do
Oil States International is a typical oilfield service company. It focuses on manufacturing products for deepwater production facilities and making certain equipment for onshore drilling in addition to providing well completion and land drilling services. That said, one problem with this focus is that these activities are highly competitive and dominated by industry giants like Halliburton (NYSE: HAL). This competition has driven down industrywide margins, with smaller scale producers like Oil State feeling the brunt of the impact. For example, its well site services segment lost money last year while earnings in its offshore and manufactured products segment fell 36%. Contrast that with Halliburton, for example, which remained profitable in both its completion and production and its drilling and evaluation segments. Though, like Oil States, Halliburton reported a net loss for the full year when factoring in other costs.
Core Labs, on the other hand, makes its money quite differently from most other service companies. That's because its focus is on providing high-margin analysis-based services to producers. While those margins have come down a bit during the downturn, Core Labs remained profitable last year. Further, the company generated $121 million in free cash flow, which equated to a sector-leading 20% of its revenue.
Margins and capex will make a significant difference
As market conditions improve both Oil States and Core Labs should see their margins rise, which would drive improved profitability and cash flow. Though, Core expects its results to experience a "V-shaped" recovery given its operating leverage, which should lead to accelerated margin expansion as its revenue improves. Further, given the proprietary nature of Core Labs' services, its margins should remain above what Oil States can capture from its services because it doesn't face the same intense competition. Because of that, Core Labs will continue to generate a higher percentage of free cash flow per dollar of revenue, which will provide it with more money to allocate on behalf of investors, including paying dividends and repurchasing stock. Meanwhile, Oil States' best option to improve its margins is to make acquisitions that increase its scale so it can better compete with larger rivals.
Another benefit of Core Labs' data-focused business model is that the company doesn't need to invest capital in buying high-cost equipment like drilling rigs. That's a significant contributor to its ability to produce more excess cash than rivals. Oil States, on the other hand, needs to invest in new equipment so it can keep up with the competition given that rigs and other equipment wear out. That said, because of its smaller scale operations, it's a step behind Halliburton, which can make its own equipment. In fact, Halliburton's CEO calls its manufacturing center a "powerful competitive differentiator" since the company can be "nimble and build equipment when needed with short lead times" while rivals like Oil States need to order from another vendor and then wait their turn.
Just a better business model
While Core Labs and Oil States are both oilfield services companies, Core is in a class of its own. The company's focus on providing proprietary services enables it to earn higher margins, which has kept it in the black during the downturn and should allow it to generate even better margins and stronger cash flow as conditions improve. Those factors have the potential to fuel higher returns for shareholders over the long-term, which in my opinion, makes it the better buy versus Oil States.
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