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For investors looking for a small-cap company in a sector poised for extensive growth, Dril-Quip Inc. (DRQ) is a growth-oriented, offshore oil and gas service company with many catalysts that will increase shareholder value.

Dril-Quip, Inc. is one of the world's leading manufacturers of precision-engineered offshore drilling and production equipment that is well suited for use in deepwater, harsh environments and severe service applications. The Company designs and manufactures subsea, surface and offshore rig equipment for use by oil and gas companies in offshore areas throughout the world. Dril-Quip also provides installation and reconditioning services as well as rental running tools for use with its products.

Over the next four years, it is estimated that global growth in the offshore E&P sector will increase at an 8% to 10% compound annual growth rate. With spending estimates in the range of $250 billion on the development of their offshore reserves, Brazil is leading the way. Second to Brazil in E&P spending is Norway, which is anticipating $220 billion to be spent on the development of the North Sea, Norwegian Sea, and the Barents Sea while estimates are that U.S. Gulf Of Mexico E&P spending is expected to be around $190 billion over the next four years. Just within these three regions, estimates total $760 billion in E&P spending over the next four years. From a global point of view this bodes well for Dril-Quip.

In the section below, I will analyze aspects of Dril-Quip's past performance. From this evaluation, we will be able to see Dril-Quip's profitability, debt and capital, and operating efficiency. Based on this information, we will look for strengths and weaknesses in the company's fundamentals. This should give us an understanding of how the company has fared over the past few years and will give us an idea of what to expect in the future

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 = $102 million
  • Net income 2011 = $95 million
  • Net income 2012 = $119 million
  • Net income 2013 TTM = $143 million

Over the past three years Dril-Quip's net profits have increased from $102 million in 2010, to $143 million in 2013 TTM. This represents a 40.19% increase.

DRQ Net Income TTM Chart

DRQ Net Income TTM data by YCharts

  • Operating income 2010 = $139 million
  • Operating income 2011 = $130 million
  • Operating income 2012 = $162 million
  • Operating income 2013 TTM = $189 million

Operating income 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 Dril-Quip's operating income has increased from $139 million to $189 million in 2013 TTM. This represents an increase of 45.38%.

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 = $102 million
    • Net income 2011 = $95 million
    • Net income 2012 = $119 million
    • Net income 2013 TTM = $143 million
  • Total asset growth

    • Total assets 2010 = $949 million
    • Total assets 2011 = $1.086 billion.
    • Total assets 2012 = $1.231 billion.
    • Total assets 2013 TTM = $1.296 billion.
  • ROA - Return on assets

    • Return on assets 2010 = 10.75%.
    • Return on assets 2011 = 8.75%
    • Return on assets 2012 = 9.67%.
    • Return on assets 2013 TTM = 11.03%

Over the past three years Dril-Quip's ROA has increased from 10.75% in 2010 to 11.03% in 2013 TTM. This indicates that the company is generating significantly more income on its assets than it did in 2010.

ROE - Return on Equity = Net Income / Shareholders' Equity

As shareholders' equity is measured as a firm's total assets minus its total liabilities, ROE reveals the amount of net income returned as a percentage of shareholders' equity. The return on equity measures a company's profitability by revealing how much profit it generates with the amount shareholders have invested.

  • 2010 - $102 million / $828 million = 12.32%
  • 2011 - $95 million / $925million = 10.27%
  • 2012 - $119 million / $1.066 billion = 11.16%
  • 2013 TTM - $143 million / $1.138 billion = 12.57%

Much like the ROA, the ROE is showing increasing profitability. Since 2010 the ROE has increased from 12.32% to 12.57%. As the ROE has increased over the past four years, this reveals that there has been an increase in how much profit has been generated compared to the amount that shareholders have invested, thus indicating an increase in shareholder value.

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 = $949 million
    • Total assets 2011 = $1.086 billion.
    • Total assets 2012 = $1.231 billion.
    • Total assets 2013 TTM = $1.296 billion.
    • Equals an increase of $347 million
  • Total liabilities

    • Total liabilities 2010 = $121 million
    • Total liabilities 2011 = $161 million
    • Total liabilities 2012 = $165 million
    • Total liabilities 2013 TTM = $158 million
    • Equals an increase of $37 million

Over the past three and a half years, Drip-Quip's total assets have increased by $347 million, while the total liabilities have increased by $37 million. This indicates that the company's assets have increased more than the liabilities thus adding shareholder value.

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 = $688 million
    • Current assets 2011 = $799 million
    • Current assets 2012 = $924 million
    • Current assets 2013 TTM = $987 million
  • Current liabilities

    • Current liabilities 2010 = $111 billion
    • Current liabilities 2011 = $151 billion
    • Current liabilities 2012 = $155 billion
    • Current liabilities 2013 TTM = $148 billion
  • Current ratio 2010 = 6.20
  • Current ratio 2011 = 5.29
  • Current ratio 2012 = 5.96
  • Current ratio 2013 TTM = 6.67

DRQ Current Ratio Chart

DRQ Current Ratio data by YCharts

Over the past three and a half years, Dril-Quip's current ratio has been increasing. As the current ratio is well above 1, this indicates that Drip-Quip would be able to pay off its obligations if they came due at this point.

Common Shares Outstanding

  • 2010 shares outstanding = 40 million.
  • 2011 shares outstanding = 40 million.
  • 2012 shares outstanding = 41 million
  • 2013 TTM shares outstanding = 41 million

Over the past three and a half years, the number of company shares has increased from 40 million to 41 million.

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 = $244 million / $566 million = 43.11%.
  • Gross margin 2011 = $239 million / $601 million = 39.77%.
  • Gross margin 2012 = $281 million / $733 million = 38.34%.
  • Gross margin 2013 TTM = $309 million / $795 million = 38.88%.

Over the past four years, Dril-Quip's gross margin has dropped slightly. The ratio has decreased from 43.11% in 2010 to 38.88% in 2013 TTM.

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 = $566 million
    • Revenue 2011 = $601 million
    • Revenue 2012 = $733 million
    • Revenue 2013 TTM = $795 million
    • Equals an increase of 40.46%.
  • Total Asset growth

    • Total assets 2010 = $949 million
    • Total assets 2011 = $1.086 billion.
    • Total assets 2012 = $1.231 billion.
    • Total assets 2013 TTM = $1.296 billion
    • Equals an increase of 36.56%.

Over the past three and a half years the revenue growth has increased by 40.46% while the assets have increased by 36.56%. This is an indication that the company from a percentage point of view has been more efficient at generating revenue.

Based on the information above we can see that Dril-Quip has produced very strong results from a fundamental point of view. Revenues over the past three and a half years, have increased by 40.46%, the ROA and ROE have both been indicating an increase in profitability, while a current ratio of 6.67 indicates that the company is very financially stable. The only blemish on the company is that the gross margin has dropped from 43.11% to 38.88%. Based on the results above we can see that the company has produced very strong results.

A Takeover from GE?

Because of Dril-Quip's strong management creating excellent fundamentals through vertical integration, Dril-Quip has been the focus of many takeover conversations. Over the past month or so, rumors have increased substantially regarding a takeover from GE Oil and Gas (GE). GE Oil and Gas has had a history of takeovers, since 2007, the company has made more than $14 billion in corporate acquisitions. Some of GE's most recent acquisitions have been Dresser Inc. in which they spent $3 billion, Wellstream for $1.2 billion and most recently Lufkin Industries which they spent $3.3 billion. As Dril-Quip is a well run company in sector with poised for significant growth, Dril-Quip is a company that has been the focus of many takeover conversations.

Analysts' Estimates

Analysts at MSN Money are estimating an EPS for FY 2013 at $4.11 while moderate growth is expected to continue into 2014 as EPS estimates increase to $5.23.

Bloomberg Businessweek supports this idea as it expects the company's revenues to be around $877 million for FY 2013 and increase to $1.0 billion for FY 2014.

Valuations

Currently, Dril-Quip's stock has a P/B of 4.17, which is above the industry average of 2.31, A P/S of 5.98 is above the industry average of 2.31 while a P/CF of 43.1 is well above the industry average of 12.25. Even though the ratios are indicating the stock is currently trading at the high end of the spectrum.

Price Targets

  • Finviz has a price target for Dril-Quip at $117.73
  • In August, Howard Weil gave the company an "Overweight" rating with a target of $130.

Conclusion

Because of Dril-Quip's strong management creating excellent fundamentals through vertical integration, Dril-Quip has been the focus of many takeover conversations. These takeover conversations along with strong fundamentals and a sector poised for growth have all increased the price of Dril-Quip. As the valuations above indicate that the stock is trading at the high end of the spectrum, I still believe that a pullback to the trend line would create an opportunity to invest in a company that has many catalysts to increase shareholder value.

Source: Dril-Quip: Management, Fundamentals And Takeover Talk Equal Value