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Summary

  • 2013 is key year for the company.
  • Valuations ratios suggest more upside.
  • Poised to capitalize on N.A. horizontal drilling growth.

For investors looking for a small-cap oil and gas service company well positioned to take advantage of the growing rig counts in North America, C&J Energy (NYSE:CJES) is well situated but at these levels is it a buy?

2013 was not a banner year for North American Onshore drilling businesses. As 2013 provided a significant decline in rig count, this had a direct effect on the onshore oil and gas service businesses that have a strong weighting within North America.

In the section below, I will analyze aspects of C&J's past performance. From this evaluation, we will be able to see how C&J fared over the past three years regarding their 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' 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 2011 = $162 million.
  • Net income 2012 = $182 million.
  • Net income 2013 = $66 million.

Over the past three years C&J's net profits have decreased from $162 million in 2011 to $66 million in 2013.

  • Operating cash flow 2011 = $262 million.
  • Operating cash flow 2012 = $283 million.
  • Operating cash flow 2013 = $114 million.

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 decreased due to a trying 2013. C&J's operating cash has increased by 129.82%.

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 2011 = $162 million.
    • Net income 2012 = $182 million.
    • Net income 2013 = $66 million.
  • Total asset growth

    • Total assets 2011 = $538 million.
    • Total assets 2012 = $1.012 billion.
    • Total assets 2013 = $1.132 billion.
  • ROA - Return on assets

    • Return on assets 2011 = 30.28%.
    • Return on assets 2012 = 17.98%.
    • Return on assets 2013 = 5.83%.

Over the past three years, C&J's ROA has decreased from 30.28% in 2011 to 5.83% in 2013. This indicates that the company is making less money on its assets than it did in 2011.

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 2011 = $538 million.
    • Total assets 2012 = $1.012 billion.
    • Total assets 2013 = $1.132 billion.
    • Equals and increase of $594 million.
  • Total liabilities

    • Total liabilities 2011 = $143 million.
    • Total liabilities 2012 = $413 million.
    • Total liabilities 2013 = $436 million.
    • Equals and increase of $293 million

Over the past three years, C&J 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 $594 million, while the total liabilities increased by $293 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 2011 = $224 million.
    • Current assets 2012 = $250 million.
    • Current assets 2013 = $257 million.
  • Current liabilities

    • Current liabilities 2011 = $79 million.
    • Current liabilities 2012 = $105 million.
    • Current liabilities 2013 = $125 million.
  • Current ratio 2010 = 2.84.
  • Current ratio 2011 = 2.38.
  • Current ratio 2012 = 2.06.

Over the past three years, C&J's current ratio has decreased from 2.84 in 2011 to 2.06 in 2013. As these numbers are 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

  • 2011 shares outstanding = 51 million.
  • 2012 shares outstanding = 53 million.
  • 2013 shares outstanding = 55.4 million.

Over the past three years, the number of company shares have increased. The amount of common shares have increased from 51 million in 2011 to 55.4 million in 2013.

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 2011 = $333 million / $758 million = 43.93%.
  • Gross margin 2012 = $440 million / $1.112 billion = 39.58%.
  • Gross margin 2013 = $331 million / $1.070 billion = 30.93%.

Over the past three years, the gross margin has decreased. The ratio has increased from 43.93% in 2011 to 30.93% in 2013. As the margin has increased, this indicates the company has been 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 2011 = $758 million.
    • Revenue 2012 = $1.112 million.
    • Revenue 2013 = $1.070 billion.
    • Equals an increase of 41.16%.
  • Total Asset growth

    • Total assets 2011 = $538 million.
    • Total assets 2012 = $1.012 billion.
    • Total assets 2013 = $1.132 billion
    • Equals an increase of 110.4%.

Over the past three years the asset growth has increased more than the revenue. From a percentage basis, this indicates that the company is making less money on its assets.

Based on the eight different criteria above, C&J Energy Services is mixed results. The company is showing weakness due to the weak onshore market in 2013. Despite the weakness in fundamentals the stock price has increased significantly. Why?

2013 was not a write-off

In 2013 the company expanded their portfolio of products and services with two small acquisitions. The first one in April added directional drilling and related downhole tool technology, while the second in December added manufacturing of data controls for their equipment.

Internally the company added a specialty chemicals business for completion and production services, which was designed to provide some cost savings to the company.

The company is expecting to introduce several new products over the course of 2014, which should provide additional cost savings to C&J while generating third-party revenue.

The investments in these projects resulted in an additional $7.0 million in expense during Q4 of 2013 thus diminishing the fundamental results.

In the Q4 statement the company stated: "I am proud of all that we accomplished during 2013 as we demonstrated our commitment to diversification and long-term growth. Looking forward, we will continue to execute our growth strategy, transforming our company into a leading, large-scale, global provider of technologically advanced services to the oil and gas industry."

Looking forward

Over the next couple of years, natural gas prices within North America are expected to drive an increase rig counts. This increase in price is in turn expected to increase E&P onshore capex spending by ~7%.

(click to enlarge)

The second half of 2014 leading into 2015 looks to be a turnaround point for onshore drilling within North America. Led by the increasing demand for natural gas, E&P onshore capex spending within the U.S. is estimated to increase by ~8%.

With the Permian Basin expected to dominate activity, demand for growth in this region is expected to increase after a challenging 2013. The Permian Basin is expected to support an increase of ~50-70 horizontal rigs which equates to a 35% increase from 2013.

Led by independent Apache Energy (NYSE:APA), which recently announced it would spend two-thirds of its $8.5 billion capex on exploration and production by drilling more oil wells onshore in North America. Within North America Apache is also focusing on the Permian Basin in West Texas and the Anadarko Basin in Oklahoma and Texas as they expect oil and gas production to grow 5% to 8% this year. All this is designed to improve returns and show steady production growth.

Anadarko Petroleum (NYSE:APC) is the independent that is expected to "lead the pack" regarding U.S. capex spending. The company estimates that it would increased its capital budget by nearly 8%. The company also stated it would spend about 60% of this total on drilling more oil wells onshore in North America. This leads to U.S capex spending at ~$6.5 billion which is an increase of ~10% over 2013. As Anadarko is expecting to spend ~$6.5 billion in the U.S. it will be leading the revival for growth within the industry.

After a strong dip in 2013, the chart below provided by Baker Hughes indicates that North American horizontal drilling looks to be on the rise in the later half of 2014.

(click to enlarge)

Analysts at MSN Money are predicting 20.00% growth in EPS year over year for the next 5 years. This is well above the industry standard of 15.50%.

Valuation

If we use the MSN money estimation of 20.00% growth in EPS year over year for the next 5 years this will form a very attractive PEG ratio and an excellent entry point for the stock.

Current PE Ratio = 17.25 (Google Finance)

17.25 / 20.00 = 0.875

PEG Ratio = 0.875

A current PEG ratio of 0.875 based on an EPS average growth rate over the next 5 years indicates that the stock is currently slightly undervalued.

Forward P/E to create a target

As the company looks to grow with the economy and take advantage of the situation despite recent set-backs future earnings look strong. The Nasdaq has FY 2016 high earnings projected at $2.40. Combine that with a forward P/E of 16.04 this leads to a target price of 2014 price target of $38.50.

Based on the above analysis, C&J Energy Services has shown to have had a weaker 2013. I do not believe this is the beginning of a trend as last year the N.A. drilling market was quite weak. As C&J Energy Services is situated in a sector poised for growth, 2014 looks to be much stronger for the company. The current PEG ratio of 0.875 indicates that C&J Energy Services is currently just undervalued and a calculated price target in the $38.50 states there is upside from this point. For an investor looking for some small-cap exposure to the North American drilling market, C&J looks well positioned to capitalize on this.

Source: C&J Energy: An Increase In North American Drilling Will Drive This Small Cap