CE Franklin: Undervalued Oilfield Supplier

 |  About: National Oilwell Varco, Inc. (NOV)
by: Yoseph West

While oil prices have recovered significantly, a few companies in the oil & gas industry are still undervalued. CE Franklin Ltd. (CFK) is one of them.

CFK is a leading distributor of general oilfield supplies to the oil and gas industry in Canada. It operates 49 branches situated in towns and cities that serve particular oil and gas fields of the western Canadian sedimentary basin.

For me, CFK, as an investment, fits into the old school value investment approach. It doesn't have any particularly exciting growth prospects but it does have a strong balance sheet and reliable margins. The idea is to pick up a stock like this, during economic downturns as prices and earnings are depressed and hold through until recovery.

While I picked up this stock in August and have seen a reasonable return (~15%), I believe there's more upside to be seen.

Let's start off with the key numbers.

Mkt Cap P/E P-to-B P-to-S Current Ratio ROIC (5 yr)
CFK 114.28 19.24 0.83 0.27 2.69 15.58%
Click to enlarge

The numbers suggest CFK is currently trading below book value and has a solid current ratio. However, in this scenario, these numbers need further consideration. The most liquid of CFK's current assets is the accounts receivable. The issue is that if CFK closed tomorrow, its unlikely that the entire accounts receivable would be recovered. For me, cash is king.

Assuming 75% of accounts receivable and of the value of inventory could be recovered, we end up with a respectable current ratio of approximately 1.95. While this is good, it lowers our book value to $64m (I chose not to include the $20m of Goodwill), which is lower than current market value.

I would like to note this is a conservative approach to evaluating CFK's balance sheet and doesn't consider subsidiaries of the company which could unlock further value.

Nevertheless, assuming a book value of $64m, a margin of safety, at current prices, will have to be found in the valuation of CFK's earnings for this company to be a viable investment.

Adjusting Earnings

Again, I've adjusted operating earnings using the approach recommended in Greenwald's Value Investing to determine the intrinsic value.

From 2005-2008, CFK averaged an operating (Earnings Before Interest & Tax) margin of 5.5%. I applied this same margin to 2009 to normalize the company's depressed earnings, as the oil & gas industry is cyclical.

The company has performed reliably over the years. Specifically, its costs have been steady and as a result, the margin of the adjusted income has stayed around 6%.

Earnings Power Value

I applied a 15% discount rate to the Earnings Power Value as that is the minimum annual return I hope to achieve from an investment.

Moving down to the Total EPV, we can determine that if we were to purchase shares of CFK at a price of $8.81 (Mkt Cap of $154.92m), we can reasonably expect to achieve a 15% return on the investment.

Currently, CFK is trading at $6.50. And it's here that we find a margin of safety. Using the $8.81 figure, we can safely assume that we have a margin of safety of at least 26%.

Considering the above information, I believe CFK's price will continue to rise and would make a good investment.

Disclosure: Long CFK

Note: This is just my opinion. I'm not a professional in the financial world. Please conduct your own due diligence in any decisions to purchase, sell, or otherwise trade any stocks.