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As I mentioned in a previous post, I think a disciplined investor should focus on earnings and intrinsic values rather than market quotes. So it is because of their recently reported earnings that I am disappointed with Dawson Geophysical (NASD: DWSN). After last quarter, I estimated full year proforma earnings for Dawson prior to adding their 15th crew. I expected that after having a full quarter with 15 crews that I would once again have to revise my estimates upward. It turns out that the opposite is true.

Below is a table representing the last four quarters that Dawson has reported. Starting this quarter, I have begun tracking revenue per crew and channel count as I believe these will be important metrics going forward.

My proforma from last quarter had modeled revenue at $296 million or $74 million per quarter. This represents revenue per crew of $5.29 million per quarter, assuming 14 crews. I had even backed off on the revenue per crew based on the company’s indications that revenue included some non-recurring third party revenue. They gave the same guidance this quarter. Their 15th crew was operational for the entire first quarter, but revenue per crew came in at $5.17 million. This may still be too high going forward.Margins deteriorated over my projections as well, though I’m wondering if this may be a seasonal phenomenon. Gross margins for the quarter were 25.1% verses my model of 26%. Net margins were 9.7% verses my model of 10.6%. Hopefully as Dawson’s recently added crews gain more experience, their efficiency will improve and margins will climb a bit. The biggest concern for me is that I expected more growth relative to last quarter, and that growth was limited.

Estimated Full Year Earnings

Looking forward, I’m estimating $5.1 million per crew per quarter. Gross margins in this projection will be 25%. Net margins could slip further due to higher depreciation expenses, so here I model 9.4% net margins, down from 9.7% in their first quarter. I’m still estimating that $24 million of their capital expenditures are for maintaining their business and the remainder is for new growth, largely an investment in increased channel count. It will be interesting to see how these investments increase revenue per crew going forward.

Despite increases in revenue and crew count, my starting owner earnings number declined from $3.81 per share last quarter to $3.64 per share this quarter.

Valuation

For my valuation, I start with owner earnings as calculated above, assume a five year growth rate, and then a sale based on a price to earnings growth rate (PEG) of 1.50 at the end of five years. I discount these cash flows back at 10%.

I think the most likely scenario is a 9% growth rate for the next five years. At a 1.5 PEG ratio, this results in a sale P/E ratio of 13.5 times. Discounting these cash flows back at 10% results in an intrinsic value of $60 per share.

It is possible that a crew or two may be added in the next five years as well. If this occurs, growth will be closer to 15%. Assuming a 15% growth rate and a reversion based on a P/E of 22.5, the intrinsic value is $114.

Conclusion

My expectations for Dawson have obviously diminished, but crew growth could still cause this stock to leap higher. I cannot envision a contraction in demand at this point, given the demand for oil and natural gas. I will likely hold on to my shares and watch to see if all the investment Dawson has made in new equipment over the past several years translates in to additional revenue.

Disclosure: Author is long Dawson.

Source: Dawson Geophysical Q1 08 Analysis and Valuation