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Over the past couple of years, the Oil and Gas equipment service industry has been evolving rapidly. With the introduction of new fracking techniques, increased safety regulations and domestic construction demands showing no signs of slowing down, these factors have given the industry a boost. One of the companies looking to situated well in the sector and looking to capitalize on this growth is Tesco Corporation (TESO).

Tesco Corporation is a company who operates in four divisions serving drilling contractors and the oil and natural gas industry. The company specializes in Top Drives, Tubular Services, Casing Drilling and Research and Engineering.

In the article below, I will look at the Tesco Corporation's past profitability, debt and capital, and operating efficiency. Based on this information, we will get to see the company's sales, returns, margins, liabilities, assets, returns and turnovers. We will get an understanding of how the company has grown over the past few years, thus keeping up with industry trends and what to expect in the future.

All numbers sourced from Company Webpage and Morningstar.

Profitability

Profitability is a class of financial metrics used to assess a business's ability to generate earnings compared with expenses and other relevant costs incurred during a specific period of time. In this section, we will look at four tests of profitability. They are: net Income, operating cash flow, return on assets, and quality of earnings. From these four metrics, we will establish if the company is making money, and gauge the quality of the reported profits.

  • Net Income 2010 = $7 million.
  • Net Income 2011 = $27 million.
  • Net Income 2012 = $48 million.

Over the past three years Tesco Corporation's net profits have increased from $7 million in 2010 to $48 million in 2012. This signifies a increase of 585.71% in earnings over the past 3 years.

  • Operating Cash Flow 2010 = $15 million.
  • Operating Cash Flow 2011 = $43 million.
  • Operating Cash Flow 2012 = $78 billion.

Operating cash flow is the cash generated from the operations of a company, generally defined as revenue less all operating expenses, but calculated through a series of adjustments to net income.

Over the past three years, the company's operating cash flow has also increased. Tesco Corporation's operating cash has increased by 420.00%.

ROA - Return On Assets = Net Income/Total Assets

ROA is an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment."

  • Net income growth

    • Net Income 2010 = $7 million.
    • Net Income 2011 = $27 million.
    • Net Income 2012 = $48 million.
  • Total asset growth

    • Total Assets 2010 = $455 million.
    • Total Assets 2011 = $549 million.
    • Total Assets 2012 = $573 million.
  • ROA - Return on assets

    • Return On Assets 2010 = 1.54%.
    • Return On Assets 2011 = 4.92%.
    • Return On Assets 2012 = 8.38%.

Over the past three years, Tesco Corporation's ROA has increased from 1.54% in 2010 to 8.38% in 2012 TTM. This indicates that the company is making more money on its assets than it did in 2010.

Quality Of Earnings

Quality of Earnings is the amount of earnings attributable to higher sales or lower costs rather than artificial profits created by accounting anomalies such as inflation of inventory. To ensure there are no artificial profits being processed, the operating cash flow must exceed the net income.

2010

  • Operating Cash Flow 2010 = $15 million.
  • Net Income 2010 = $7 million.

2011

  • Operating Cash Flow 2011 = $43 million.
  • Net Income 2011 = $27 million.

2012

  • Operating Cash Flow 2012 = $78 billion.
  • Net Income 2012 = $48 million.

Over the past three years, the operating cash flow has been higher than the net income. This indicates that the company is not artificially creating profits by accounting anomalies such as inflation of inventory.

Debt And Capital

The Debt and Capital section establishes if the company is sinking into debt or digging its way out. It will also determine if the company is growing organically or raising cash by selling off stock.

Total Liabilities To Total Assets, Or TL/A ratio

TL/A ratio is a metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt.

  • Total Assets

    • Total Assets 2010 = $455 million.
    • Total Assets 2011 = $549 million.
    • Total Assets 2012 TTM = $573 million
    • Equals and increase of $118 million
  • Total Liabilities

    • Total Liabilities 2010 = $79 million.
    • Total Liabilities 2011 = $136 million.
    • Total Liabilities 2012 TTM = $119 million.
    • Equals and increase of $40 million

Over the past three years, Tesco has acquired more total assets than total liabilities. This indicates that the company has not been financing its assets through debt. Over the past three years, the company's total assets increased by $118 million, while the total liabilities increased by $40 million.

Working Capital

Working Capital is a general and quick measure of liquidity of a firm. It represents the margin of safety or cushion available to the creditors. It is an index of the firm's financial stability. It is also an index of technical solvency and an index of the strength of working capital.

Current Ratio = Current Assets/Current liabilities

  • Current Assets

    • Current Assets 2010 = $226 million.
    • Current Assets 2011 = $294 million.
    • Current Assets 2012 = $319 million.
  • Current liabilities

    • Current liabilities 2010 = $73 million.
    • Current liabilities 2011 = $126 million.
    • Current liabilities 2012 = $103 million.
  • Current Ratio 2010 = 3.10.
  • Current Ratio 2011 = 2.33.
  • Current Ratio 2012 TTM = 3.10.

Over the past three years, Tesco Corporation's current ratio has remained the same. In 2011 the ratio dropped to 2.33 indicating that the company had less of the ability to pay off its short-term obligations than it did in 2010 but the ratio jumped back up to 3.10 in 2012 TTM. As the most recent number is well above 1, this signifies strength and indicates that the company would be able to pay off its obligations if they came due at this point.

Common Shares Outstanding

  • 2010 Shares Outstanding = 38 million.
  • 2011 Shares Outstanding = 39 million.
  • 2012 Current Shares Outstanding = 39 million.

Over the past three years, the number of company shares have remained relatively the same. As the shares have remained the same this indicates that the company is not issuing shares to raise capital.

Operating Efficiency

Operating Efficiency is a market condition that exists when participants can execute transactions and receive services at a price that equates fairly to the actual costs required to provide them. An operationally efficient market allows investors to make transactions that move the market further toward the overall goal of prudent capital allocation without being chiseled down by excessive frictional costs, which would reduce the risk/reward profile of the transaction.

Gross Margin: Gross Income/Sales

The gross profit margin is a measurement of a company's manufacturing and distribution efficiency during the production process. The gross profit tells an investor the percentage of revenue/sales left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors and industry is more efficient. Investors tend to pay more for businesses that have higher efficiency ratings than their competitors, as these businesses should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).

  • Gross Margin 2010 = $72 million / $379 million = 19.00%.
  • Gross Margin 2011 = $104 million / $513 million = 20.27%.
  • Gross Margin 2012 = $125 million / $579 million = 21.59%.

Over the past three years, the gross margin has increased. The ratio has increased from 19.00% in 2010 to 21.59% in 2012.. As the margin has increased, this indicates the company has become more efficient.

Asset Turnover

The formula for the asset turnover ratio evaluates how well a company is utilizing its assets to produce revenue. The numerator of the asset turnover ratio formula shows revenue found on a company's income statement and the denominator shows total assets, which are found on a company's balance sheet. Total assets should be averaged over the period of time that is being evaluated.

  • Revenue growth

    • Revenue 2010 = $379 million.
    • Revenue 2011 = $513 million.
    • Revenue 2012 = $579 million.
    • Equals an increase of 52.77%.
  • Total Asset growth

    • Total Assets 2010 = $455 million.
    • Total Assets 2011 = $549 million.
    • Total Assets 2012 = $573 million.
    • Equals an increase of 25.93%.

As the revenue growth exceeded the asset growth on a percentage basis, this indicates that the company is making money on its assets.

Based on the nine different criteria above, Overall Tesco Corporation is showing excellent results. Based on the above criteria,Tesco Corporation is showing that it is a solid company and has been able to take advantage of the growth in the industry over the past couple of years.

Analysts at Bloomberg Businessweek are estimating the growth to continue for Tesco Corporation over the next few years. They are estimating Tesco Corporation's revenue to grow to $531 million for FY 2012 and subside a bit in for FY 2013 and report earnings at $501 million. They are also estimating Tesco Corporation to have an EPS at $1.04 for FY 2012 and $0.98 in FY 2013.

On January 31st, 2013, TheStreet issued a "buy" rating for Tesco Corporation. The rating of "buy" was on the basis of: significant earnings per share improvement, net income growth, a very low debt-to-equity ratio and a significant increase in net operating cash flow.

Valuation

B. Annual growth rate

(A / P) ^ (1 / T) - 1 = R

(0.98 / 0.19) ^ (1 / 4) - 1 = R

R = 50.70%

Earnings per share average growth rate over the 2 past years and estimated 2 years forward = 50.70%

Current PE Ratio = 10.54 (Google Finance)

10.54 / 50.7 = 0.21

PEG Ratio = 0.21

A current PEG ratio of 0.21 based on an EPS average growth rate from 2010 to 2013 indicates that based on the next few years estimates the stock is currently at undervalued.

Based on the information above, Tesco Corporation is in an industry that is poised for growth over next few years. Tesco Corporation has indicated strong financial strength over the past 3 years and looks to continue it its strength and growth in profitability for the next couple of years. Based on the PEG ratio of 0.21 Tesco Corporation looks to be undervalued at this point. Based on the information above, this looks to be an excellent opportunity to invest in a company with a strong balance sheet and excellent growth opportunities moving forward.

Source: Tesco Corporation: A Small Cap To Add To Your Portfolio