Core Laboratories NV (NYSE:CLB)
2013 Credit Suisse Energy Summit Conference Call
February 6, 2013 16:30 ET
David Demshur - Chief Executive Officer
Dick Bergmark - Chief Financial Officer
Okay. Now I have to tell you guys that next year we are banning ties, no one is allowed to or tied to present at least in the oilfield service track for next year, so be aware. We’re also going to limit you to three slides like we use to do so we’re going to be in here and we’re going to be punitive. Okay, next step we’ve got Core Laboratories, Dick Bergmark is the CFO, David Demshur is the CEO and has been the CEO ever since this was carved out of Western Atlas years ago. Core Lab is one of the, the most unique companies in the industry; it’s also been one of the best performing stocks over the last 10 or 15 years. It is a stunning niche that they have carved out and they have made what used to be an R&D type business into a fabulous iterative business Ergo with logo and I’m going to let Dave tell you all about.
David Demshur - Chief Executive Officer
Well Jim we’d like to thank you and the Credit Suisse team for having us here today. We’d like to update you on the progress of Core Laboratories many of you know we reported fourth quarter earnings last Thursday, we had quarterly records for revenue, operating income, EPS and most importantly for us free cash flow and so it’s quite a good end to the year. So, we’re going to look at some technology today that Core Lab is using to help our clients do two things; number one to help our clients produce more oil and gas everyday but more importantly to produce more oil and gas over the life of the play. On average the petroleum field produces about 40% of its reserves naturally. Our mission is to optimize the reservoir so we can squeeze out those incremental barrels. So when we talk about reservoir optimization our mission is to get that recovery rate from 40%, 41% on average up into the 43%, 44%, 45% range, I’m not sure our project at the end of the technical presentation where we think we can yield an additional 1 billion barrels of oil from a field that’s offshore in the Middle East.
We have three segments by which we report our earnings that is reservoir description, production enhancement and reservoir management. The presentation today we’ll look at the value proposition our clients get and using Core Lab, we’ll look at the client curve analysis because our mission is to alter that decline curve, remember we can’t alter the laws of physics and thermodynamics but we can use those laws to alter the decline curve. And then we’re going to look at some new Core Lab technology as it led to our record fourth quarter of this year and then Dick is going to talk about the three financial tenants by which we’re on the company is maximizing our free cash flow, maximum return on invested capital and most importantly returning excess capital towards shareholders and over the last 11 years we’ve returned almost $1.4 billion to our shareholders.
Okay, looking at the value proposition and using Core Laboratories when our clients are exploring, appraising and developing, they are spending money. They start to get a return when they start producing the wellbore and remember our mission is two-fold. Number one, increasing production on a daily basis so we have a quicker return, but moreover and more importantly we are looking for them to produce those incremental barrels, this becomes more and more important as the petroleum provinces around the world age as many of you know we are peak oil guys back in 2002 February of 2002 we predicted that the globe would reach its maximum ability to produce crude oil at around 88 to 89 million barrels a day in the year 2008 and we think that’s exactly what happened. So, we think we are on that plateau right now and we use a 2.5% global decline curve rate net per year, so we need to add 2.25 million barrels just to stay even with that production.
We think that can happen for the next two or three years but ultimately we will see production go into a decline. So, our mission is to optimize the fields that are out there of the 4000 fields of size producing around the world today we are in above 11 to 1200 of those fields. So, when we look at the budgets that we address since these are producing fields these are budgets tied to production enhancement and production and when we look at the capital budget pyramid these budgets tend to be a lot more stable and up here in the frontier in exploration area. When we look at our revenue mix for Core Lab we are now fully 80% derived from crude oil related plays and 20% from natural gas.
Now in the natural gas site what I want you to do is cut that in half, so 10% of the company revenue is related to these large LNG developments that we’re now seeing in East Africa, Eastern Mediterranean, the Gorgon project, offshore Western Australia and the other 10% is a mixture of unconventional gas and conventional gas. So, our predictions are we will become more oily and less gassy over the next four to five years. Okay, when we look at the way the revenue breaks down reservoir description still the largest part of our business but you know this as if you toward our laboratories we take rocks so the core samples and fluid samples those three fluids being the crude oil, the natural gas and the water in the reservoir and we use those to describe the reservoir system. So, I want you to think about this as being a very oily, very international business, very much is benefiting from deepwater developments.
If we look at the amount of oil produced offshore which is 30%, it represents 40% of our revenue, 5% of the world’s oil is produced out of the - 7% of the world’s oil is produced out of deepwater that represents 20% of our revenue. So, you can see offshore and deepwater very important drives for our revenue. Okay, well this is a laboratory-based business, I want you to think about this as a field-based business, production enhancement we’re going to the well-site we’re going to do something there, we’re there going to deliver perforating gun systems where we’re going to deliver technologies that can diagnose how well a stimulation event occurred. And then reservoir management small part of our business but I want you to think global very large projects. So, I suppose if you look at individual wells these guys will put together datasets over in entire basins in some places entire countries.
Okay, so this will tie in very nicely with the Kosmos presentation that just took place because what we’re going to do is investigate some of the best producing reservoirs in the world that are being exploited today and these are the turbidite flows that have occurred in the South Atlantic Margin, you might know the Kizomba field, the giant field being produced by Exxon. More recently we’ve had successes with Kosmos off of Ghana and the way these fields are formed we have debris flows that originate up on an intercontinental shelf and these debris flows pour down the face of these shelves winnowing out all the clay material in concentrating all the course grade material. So, statistically the best reservoirs in the world are turbidite flows. And right now Kosmos does benefit from that because these are the reservoirs that they are indeed developing. So, when we look at the South Atlantic Margin why are these so prevalent. Well when we breakup Pangea the first thing you’re going to start to form are carbonates in early basins you’re going to cover those with a salt layer so you get a large Aptian Salt Basin development in the south part of this South Atlantic Margin, this has been followed by just 100s and 100s of tons of sediments being dumped on top of this salt and that’s where these plays originate from.
So, as we look at the spread of this over the last 130 million years you can see these are mere images of each other. So, when we look at the buildup offshore Brazil were porous blocks control reservoir development, the salt layer and its movement control trapping and here are our reference our stacked sand reservoirs from those large debris flows off of the continental shelf. Now some of you have recently been in our lab where we’ve had 1100 meter core come in where we’ve split six of these reservoirs, so you have really a great complex where you can drill a well and penetrate six reservoir zones. So, here this is a very target rich environment, good news for offshore Angola in the pre-salt because we had a discovery by Maersk in late last year and another discovery like Cobalt in the same area.
Go a little further to the north in the pre-salt you had a discovery offshore Gabon. Now we’ve always known that offshore Gabon produced pre-salt oil on post-salt reservoirs from faulting. And now we know the petroleum system is there and tracking mechanisms work there as well. So, decades of work ahead in the South Atlantic Margins for Core Lab. So, when we go back and we look at this and actually this is taken from a SPE paper on the Kizomba field and it shows the origin of these again these large turbidite flows where we try to look engaged the most stacked reservoirs as possible. Now fortunately off of both West Africa and East Africa in some of these cases you may have as many as eternities stacked up on top of each other. So, great productivity coming from these reservoirs and the recoverability from these reservoirs should be a little higher than 40% right now and much higher 2 or 3 or 400 basis points when we get done working some magic with these clients.
Okay, when we look at the buildup of these we can see that these plays not only occur off of West Africa, they probably occur off of northern parts of South America right where Kosmos is going to be looking. So, their exploration strategy is very good from a geological standpoint. Okay, so looking at the way that we are going to describe of this reservoir enhancement production and look at the management of that is the way that the company was built. So, what we’re going to try to do is here is the decline curve, we want to use the laws in physics, in thermodynamics to make it look like this, so we want to alter this decline curve and capture this incremental amount of oil.
First off we want to describe the reservoir because really what our business is three-phase fluid flow-through porous media, so we need to understand the porous media being the rocks and those three phases of flow those being either natural gas crude oil or water. And we’ll go ahead and drill a well down through with this sequence and when we look at rocks we look at trying to describe the storage capacity or its porosity, its permeability or its flow capacity log calibration you see a lot of people in our building, why is that, because they are learning to use measured petrophysical data to calibrate wireline laws. We look at reservoir types, we know sandstones, we have lime stones, we now have shale reservoirs and then we look at frac profiles, we are not a pressure pumper, but we use a lot of rock mechanics data to predict how that reservoir should act under hydraulic stress. And many of you that have visited to our facilities this is a deepwater core from the Gulf of Mexico where we have a geologist describing it from a macro scale, we all see the scanning electron microscope where we can look at it on a sub micro scale so we are describing those rocks. Okay, the economic drivers though are the fluids, so when we look at the fluid makeup in these reservoirs they occur like is in a reservoir because of the density differences, natural gas being lighter than oil and oil being lighter than water.
This has been a real big driver over the last five to seven years for us because we now generate more revenue from analyzing the fluids than we do from the rocks moreover our margins in this business is better. So that’s why for the 9th consecutive quarter year-over-year you’ve seen margins go up in reservoir description. And so stay-tuned because with our guidance for the first quarter we believe we’ll make that 10 quarters in a row, so we look at things like fluid phases when we produce this fluid is it going to be a gas or liquid at this surface. I’ve mentioned a day by Brian in the Kosmos presentation we also have to value that crude oil, some crude oils are not all created alike, usually the amount of distillate related in that crude oil is to determine the value of that crude oil, so the higher the distillate content or gasoline or diesel, jet fuel the more valuable that crude oil is worth. We can use these datasets then the value that crude oil that you are going to develop. Moreover over the history of a well, over the history of a field the crude oil that you produce over time changes, all is you have to do is go back to the 100 days the Macondo flowed. If you remember the first day when you saw that TV camera down there it was flowing a very, very black oil.
And on to the last day that it flowed it was a very, very light grading material, what you saw was that reservoir went through its entire life in about 100 days. Our mission is to make sure that last some 25 or 30 years. So, we are always monitoring what kind of petroleum that we are producing from that reservoir because it differs every day. Okay, so when we look at trying to determine flow assurance remember some of these wellheads are in 7, 8, 9000 feet of water where we have temperatures at zero degree C maybe lower, recovery factors you guys are experts now you know that’s 40%, our mission is to get that higher and fluid compatibility remember we’re just not taking fluids out of this reservoir sequence we are going to be pumping all kind of fluids in there and I’m going to get a miscible gas flood here in just a bit. Okay, so we’ve described that reservoir system, let’s go to the well-site now and help our clients save money and make more money by employing some Core Lab technology, you are all familiar with the Bakken play, we drill a vertical well down into several areas of the Bakken and we turn that drill bit down to the site and we can drill a lateral that might be 9, 10, 11,000 feet in length. Now this used to be a costly endeavor to complete and stimulate this wellbore because we had to use a rig and drill pipe to put in some of the completion tools. Well our guys came up with a pretty clever idea that was a – that enabled the operator to get rid of the rig and operate on coil tubing. So we immediately save your money from going to coil tubing. Moreover when we’re dropping down of the e perforating guns, we use to do one gun at a time now our HTD Blast and HTD Blast XL can drop down as many as 24 guns in one go.
And what we do here is we pulse the mud and what that does is activate our HTD Blast system. So essentially what that does is it tells the perforating charges and detonators when to start their mission. So we blast through the casing with our High Efficiency Reservoir Optimizing perforating charges that then touches a another firing pin and in three minutes we’re going to have another gun firing off so you have three minutes to move your coil tubing and then three more minutes and it’s going to go again. So every stage is now taking three minutes not one day. And now we can go upwards to 24 of these stages in one go.
All right, once we have successfully perforated that this wellbore needs to be stimulated bring in our fracture diagnostics guys so when their pressure pumping discrepant either be ceramics or sand in the gel or slick water we put tracers in that and one is a solid tracer and one is a liquid tracer and when this formation breaks down and fractures occur I want you to remember in this stage we have a SpectraChem tracer which is a liquid and a Zero Wash tracer which is a solid. We go to the next stage and we use two different tracers.
And we go to the next stage and we use two other different tracers and so on and so forth until we get all of the entire wellbore perforated and stimulated, okay then we’re going to go back in with our SpectraScan tool and we’re going to start looking for a tracers. So our SpectraScan tool comes in and we’re going to be able to tell the operator to a high degree of certainty which of his perforations were stimulated. So when the tool does start to send information back we can tell good stimulation, good frac stimulation actually this is drawn up perfectly it never happens like this only one out of every three wellbores actually goes as predicted.
So, we’re able to then tell him how to remediate that wellbore and when we’re flowing the wellbore to the surface remember our liquid tracer is going to come to the surface so we can quantitatively measure how much of that gel or slick water is cleaned up and ultimately but we want our frac field to look like is this. So when we see more pad drilling we’re going to see more setup like this. Now on our Thursday call we talked about the need for more stages, more closely spaced stages because as we show these fracs going off in branches that we now know that, that doesn’t happen these are mono linear fractures and so you only have one fracture so you need more stages more closely packed together and on pad drilling those wells can be closer. So, more on that over the next couple of quarters but we might see exact number of same wells drilled in the United States in this year versus last but many more stages.
You get higher flow rates greater recovery rates. Okay and then thirdly so we’re getting a large reservoir management project this is a field offshore Middle East with 40 billion barrels in place and what we’re going to use is some proprietary technology that Core Lab has well we are going to flow miscible gases through those rocks using their fluids and what we’re going to do is put that at pressure in temperature and we’re going to put it in a giant CAT scan why because we’re going to dope this miscible gas with iododecane, iododecane, i not absorbs X-Rays. So in a giant CAT scan we’ll see this well here is the CAT scan here is the heating blanket and it’s under pressure.
But when we look at that image this is what we see. So we’ve doped a number of what we’ve injected in here look at what we see, we see a fracture right down the middle of that core. Now this would not be a good candidate for a miscible gas flood because you don’t want it inject gas into a fractured carbonate reservoir just ask PEMEX or Cantarell. So you need to be very careful when you do that. Another part of the field though this is a great candidate, what we see here is the concentration of oil in this core as I would move it as we inject miscible gas we start to move the oil out and you can see the red color which is gas increase.
So in this large project we believe that we’re going to help our client be able to produce about 250 bps more oil from an oilfield that has 40 billion barrels in place. So right now the field is being produced exactly correctly and I could remember being on this field in 1989 when we first took some of the core samples that we continue to work on today some 24 years later and then injecting regular gas it’s being produced but what we’ve come up with we’ve been able to determine that a miscible gas that is of nitrogen, CO2 heavy and light hydrocarbon gases and water will yield an additional flow from the field of 250 bps or about a billion barrels.
One problem, no source of CO2 in the Middle East, how do we solve that we build a refinery complex with an ammonia plant and a chemical plant that will give us a pure enough stream of CO2 that we can inject into that, million barrel refinery going to cost you about $10 billion to $11 billion to $12 billion but think about the return they build the refinery people going to say oh look they want to refine a product no the price here is the CO2. So, you spend $12 billion in a refinery and you get a billion barrels of oil back, billion barrels of oil at $150 or $200 a barrel big bickies. So, this is a project that right now is in a pilot project stage and we believe that we can still improve these results even more.
So when you think about Core Lab think about a company driven by technology that we leverage through our international network we’ve not been very acquisitive over the last decade on internal pipeline to generate new set services and technologies has been quite strong. 70 offices in 50 countries we’ve got six advanced technology centers in Houston, Calgary, Aberdeen, Rotterdam, Abu Dhabi and Kuala Lumpur and those support regional facilities all over the globe what’s been good for Core Lab certainly the South Atlantic margin North Africa the Middle East Asia Pacific and the unconventional place in North America.
So when you think about Core Lab I want you to think about a company that helps its clients produce more oil and gas every day but more importantly more oil and gas or more like of that project and what that enables our clients to do is generate higher cash flow that they can reinvest back into their projects.
Now I’m going to turn it over the best wingman in the business and Dick is going to talk about those three financial tenants. Dick?
Dick Bergmark - Chief Financial Officer
Thanks, Dave. That’s new financial slides here for you just want to introduce the company for those who may not know us. We’ve been on the New York Stock Exchange since 1998 we went on the year next in Amsterdam just last year it’s broaden our potential shareholder base we’re pleased we have done that. Market cap right now is about $5 billion 47 million shares outstanding and we gave guidance for revenues this year to use the midpoint about a $1.50 million that’s the size of the company. I feel back in 1995 when the market capital is about a $120 million so you grow pretty well the shares compounded average annual grow since our IPO about 3X over the S&P 500 about 2.5X over the oil service group.
And we want to talk about why we focus on that we are a public company that’s our duty we think there is some pretty important tenants on how you run a company to drive those types of returns and I’ve got some slides on each one of these points but what we want to talk about is how well does a company employ their capital so how we call a capital investment efficiencies how much revenue do you generate from your CapEx dollars and earnings conversion how much of your net income actually turns into free cash and then how much return on invested capital do you earn to the investment in your projects. And the reason why I focus on this is they’re all building blocks to return on invested capital.
Most of us know that valuations on companies are tightly tied correlated to return on invested capital. Okay, let’s look at the first one how much revenue we’re generating from our CapEx dollars. So for Core Lab over the last decade for every dollar of CapEx that we spent we generated about $3 in fresh revenue in the next year and they are the numbers public filings. For the OSX it’s about a $1.60 and I pulled out a driller, these are the service companies with a new OSX. So let’s put that in graph form so you can see what that means for total shareholder return which is on the bottom axis this is over a 10 year period on a left hand axis to Y axis you’re seeing the incremental revenue growth each year. We got two guys who are pretty acquisitive over that time period so the revenue growth really wasn’t based on CapEx so let’s redraw the map and this is one of those where it’s a quadrant chart you want to be in that upper right hand corner.
So those companies who do a good job of generating revenues from CapEx also give a good return to their owners. Okay, what’s this earnings conversion in a free cash and that said how much of your net income turns into free cash. Interesting over last 10 year average for Core Lab our free cash has been higher than our net income. About the OSX over that time period less than $0.50 for every dollar of net income, okay what that mean to you as shareholders, what it means is those companies who manage their balance sheets, their fund flow statement not just the revenue lines generate higher returns for their owners over that time period.
Okay speaking of free cash these are our results the absolute millions of dollars of free cash we generated cycle to cycle and it’s also the period that we began our share repurchase program back in 2002. Now here is that net income number so 7 out of the last 11 years our free cash flow has been higher than our net income and this year it’s pretty close as you can see. Now what do we’ve done with that money this is the same dollar amounts I just rescaled it, this is showing where we spent that free cash, the yellow bars represents our efforts to reduce our diluted share count, so think that is buying back our shares, the red bars are these three special dividends that we did a few years ago and then the blue bars represent now our quarterly dividends.
So, over this time period we’ve given back $1.4 billion to our owners and this is a company that we paid $40 million for back in 1994 in pretty good return. So, remember our focus is on return on invested capital those are building blocks for it, why is it important it’s those companies who do have high returns generate high returns for you guys so here we are against the OSX pretty large difference they don’t seem to focus on this but they should because it impacts your return and that’s a great correlation. So, what that mean on the stock price here we go over that same time period 2002 to today those who do focus on it it’s interesting the only one of the big four who does focus on it these guys and they actually have outperformed that group over that 10 year period.
So for Core Lab can we continue this our thought is yes the business model carries on we’ll continue to develop new products and services, we’ll put them out internationally through that fixed cost platform that’s already paid for, we should generate high levels of free cash if we execute well and we’re going to give it back to you and our view is that’s all designed to continue to give you a great return. Jim, that’s it.
We are out of time. Thank you very much.
David Demshur - Chief Executive Officer
[No Q&A session for this event]
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