Shares of Core Labs (NYSE: CLB) are down a disappointing 17.8% this year, vastly underperforming oil prices and the red-hot stock market. That decline also came despite the fact that its financial results have improved, with revenue through the third quarter up 9.6% versus the year-ago period while earnings have rebounded 25.2% over that same time frame. Instead, what seems to be weighing on the stock is that the company promised even better results but failed to deliver because the oil market didn't recover as briskly as it anticipated.
Here's a look at what went wrong this year and why 2018 looks like it should be a better year.
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From a V to a U
At the beginning of the year, Core Labs stated that its "third quarter  results established the bottom of the expected 'V-shaped' recovery that will continue into 2017." Driving that view was its belief that the global oil market had flipped from a glut to being undersupplied, which should have quickly drained off the excess oil inventories that had been clogging up storage terminals around the world. As those inventories burned off, it would fuel a "rally in energy prices throughout 2017." Core Labs thought that this would ultimately result in a rapid rise in oilfield activities, including a bottoming out of international and offshore drilling activities by the middle of the year, which would fuel significantly higher revenue and profits for the company.
Unfortunately, market conditions didn't play out as Core Labs anticipated. That's because shale drillers in the U.S. initially unleashed a flood of new oil, which at one point pushed crude back into the low $40s. While oil has recovered significantly since then and is up about 10% for the year, the initial slump in crude prices caused oil companies to tap the brakes on their drilling activities. As a result, Core Labs' quarterly results often came in toward the low end or under its guidance range:
In addition to the issue with oil prices, Core Labs noted that the oilfield services market was experiencing shortages of labor and equipment, which it expected would last through the end of the year. Due to this, drillers in the U.S. weren't completing as many wells as expected, which had an impact on Core Labs since it doesn't recognize revenue until drillers complete the wells. Furthermore, the company noted that many drillers in the U.S. had changed their business models from spending everything that came in on new wells to returning some of that capital to shareholders. Meanwhile, the pickup in international and offshore drilling activities isn't expected to materialize until early next year given the timing of recent project approvals.
The potential for an acceleration in 2018
While Core Labs' results didn't improve quite as dramatically as the company anticipated this year, there's reason to think that 2018 could see a more pronounced recovery. For starters, OPEC recently extended its production reduction agreement through the end of next year, which should further drain the market's excess inventories and likely push prices higher. That should incentivize oil companies to ramp up investments in longer-term projects. In fact, we've already seen several large offshore and international projects get the green light toward the end of this year for work staring in 2018, which Core Labs noted would boost its results next year.
In addition to that, the industry's shift from growing production at all costs toward increasing returns is right up Core Labs' alley. The company noted that it would benefit from this change because clients will employ its higher-tech solutions to maximize their profits. Those services carry higher margins for Core Labs and will therefore provide a greater boost to its bottom line.
The signs point to a better year
Core Labs was decidedly bullish heading into 2017, with it anticipating a significant recovery in its financial results. While results did improve this year, it wasn't quite as dramatic as the company expected. However, this year's slowly developing oil market recovery could lead to a much stronger rebound next year, which might finally bring the long-anticipated recovery in Core's financial results. That potential upside is why investors might want to consider buying shares of this oil-services stock before that rebound takes hold.
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