RPC, MOCON Have Limited Downside

Includes: MOCO, RES
by: Contrary Wise

The run up in stock prices over the past few months has reduced the number of stocks available at prices with limited downside risk. Two companies that currently fit this criterion are RPC Inc. (NYSE:RES) and MOCON (NASDAQ:MOCO). RPC inc. is a holding company for several oilfield services companies. MOCON manufactures and provides services in the test, measurement and analytical instrumentation market.

RPC Inc.

RPC Inc., headquartered in Atlanta, Georgia, provides oilfield services and equipment to oil and gas companies engaged in the exploration, production and development of oil and gas properties. The company has been aggregated into two reportable business segments - Technical Services and Support Services. Technical Services segment performs value-added completion, production and maintenance services directly to a customer's well. Support Services that primarily provide equipment for customer use or services to assist customer operations. RPC has historically operated in several countries outside of the United States, although international revenues have never accounted for more than 10 percent of total revenues.

Unconventional drilling activity, which requires more of RPC's services, has grown steadily over the past several years and was 70 percent of total wells drilled during 2011. This in conjunction with an increase in U.S. domestic oilfield activity largely accounts for the increase in revenues from $1,096m in 2010 to $1,809m in 2011. The company estimates that 45 percent of 2011 revenues were related to drilling and production activities for oil, and 55 percent were related to drilling and production activities for natural gas. In the Technical Services segment, pressure pumping services accounted for approximately 55 percent of 2011 revenues. In the Support Services Rental tools accounted for approximately six percent of 2011 revenues. In 2011, only one customer, Chesapeake Energy Corporation at approximately 12 percent of revenues, accounted for more than 10 percent of the company's revenues.

The growth in revenues has resulted in a doubling of net operating profit after taxes from 2010 to 2011. Free cash flow has been negative, and increasingly so for both years. This however is offset by an increase in return on invested capital from ~ 24% in 2010 to ~ 38% in 2011. In order to achieve higher growth rates the company is in effect reinvesting its cash flow and then some. As long as the return on new invested capital is greater than its weighted average cost of capital (~9%), this strategy will result in greater value over the long run. In 2011 negative cash flow was largely driven by increase in equipment purchases. The company believes that this equipment will produce high financial returns in the future.

Since a large percentage of U.S. drilling is directed towards natural gas, the low price of natural gas has negative implications for the company's activities in the near term. This has however been offset by the rising price of oil and increased activity in U.S. domestic shale resources, which produce oil and petroleum liquids. The Company expects consolidated revenues to increase and financial performance to improve in 2012 compared to 2011.

Assuming that return on invested capital (~ $1.2b) will come in at about 30% for 2012 and no change in the weighted average cost of capital (WACC), a worst case valuation for this stock puts its value at around $7. This assumes that in subsequent years, return on invested capital will just match the weighted average cost of capital and thus no value is created. Based on past performance, this is an extremely unlikely scenario. A very conservative valuation that projects the spread between return on invested capital and WACC at 5% and the company continuing to grow its net operating profit after taxes at a rate of 1% from a base value of ~ $350m (beyond 2012) gives the stock a value of ~$9.

The company has returned value to shareholders in the form of regular dividends over the last five years including 2009. A significant portion of the stock's value depends on the management's ability to reinvest capital at a rate of return exceeding its cost. From the most recent 10-K:

RPC's executive officers, directors and their affiliates hold directly or through indirect beneficial ownership, in the aggregate, approximately 71 percent of RPC's outstanding shares of common stock.

Management thus has a strong incentive to create value for its public stockholders.


MOCON is a small company located in Minnesota. The company designs, manufactures, markets and services products to detect, measure and monitor gases and chemical compounds. It also provides consulting services. The company's products are used for the detection, measurement and analysis of vapors and gases in niche markets ranging from foods and beverages to oil and gas exploration and industrial safety. I wrote about this company in an Instablog about two years back. This is an update on its financial performance and on a recent development.

MOCON continues to remain in a strong financial position. 2011 revenues came in at $37.3m with gross profit margin at 62.8%. The company recently entered into an agreement to acquire PBI-Dansensor A/S (Dansensor), a Danish company, for approximately $20,000,000. Dansensor is a manufacturer of specialized instrumentation for Modified Atmosphere Packaging (MAP) of foods, beverages, pharmaceuticals and other perishable items. If this acquisition is completed, it will be the largest acquisition in the company's history. The company historically has had no debt but will be incurring ~ $15m of debt to complete the acquisition.

The company is currently trading at around $16, after having seen its price spike up to more than $20 about a month back. A conservative valuation assumption, that leaves the company saddled with debt without an increase in revenue (other than organic growth), as a result of the acquisition, gives the stock a value of $16-$17. This assumes that net operating profit after taxes increases at a rate of about 1% from a base value of $3.6m. The company has paid quarterly cash dividends without interruption or decline since 1988. It recently raised its dividend by 5% over its previous quarterly rate of 10 cents per share.

Besides the risks associated with integrating the acquisition, a volatile stock price and its ability to protect its intellectual property are some of the other risks associated with owning this stock. However, at current prices the risk/reward opportunity for MOCON seems favorable.

Disclosure: I am long MOCO and short RES puts.