Lufkin Industries Up as Oil Prices Surge

Yesterday, as I was looking through the list of the top percentage gainers on the NASDAQ, I came across Lufkin Industries (LUFK). (By the end of the day, Lufkin was no longer on the list as other stocks had started to move sharply higher!)

Lufkin Industries (LUFK) closed at $90.82, up $7.92 or 9.55% on the day. I would like to share with you my rationale behind my purchase of shares in this stock and why LUFKIN INDS (LUFK) IS RATED A BUY.

First of all, what does this company actually do?

According to the Yahoo "Profile" on Lufkin, the company

..and its subsidiaries engage in the manufacture and sale of oil field pumping units, power transmission products, and highway trailers. It operates through three segments: Oil Field, Power Transmission, and Trailer. The Oil Field segment manufactures and services artificial reciprocating rod lift equipment and related products. It also transports and repairs pumping units; and refurbishes used pumping units. In addition, this segment designs, manufactures, installs, and services computer control equipment and analytical services for pumping units, as well as operates an iron foundry to produce castings for new pumping units. The Power Transmission segment designs, manufactures, and services speed increasing and reducing gearboxes for industrial applications. It also manufactures capital spares for customers in conjunction with the production of new gearboxes, as well as produces parts for after-market service. In addition, this segment provides on and off-site repair and service for its own products, and also those manufactured by other companies. The Trailer segment manufactures and services various highway trailers for the freight-hauling market. It provides general-purpose dry-freight vans, flat-bed style trailers, and dumps, as well as replacement parts.

Well, as the day went on it appeared that maybe buying an oil-related stock wasn't quite as brilliant as I thought it might be, with oil posting a very large drop in price yesterday on top of Tuesday's huge dip.

But maybe this dip in prices is short-lived? As Steve Mufson of the Washington Post related:

Today prices got another push downward because the Energy Department’s Energy Information Administration reported that U.S. commercial inventories of crude oil and petroleum products climbed by 7 million barrels last week. One reason: an increase in oil imports, perhaps partly as a result of slightly higher Saudi oil output last month (it takes 45 days for oil to get to the United States from Saudi Arabia). The EIA data also showed that U.S. gasoline demand was down 375,000 barrels a day from the same week a year earlier, continuing a trend of gradually declining U.S. fuel consumption. That comes a day after Mastercard reported that last week’s purchases of gasoline fell 5.2 percent last week compared to a year earlier. It was the twelfth consecutive weekly decline reported by Mastercard.

That doesn’t mean high oil prices are over. U.S. commercial oil inventories are still down 55 million barrels from last year this time.

“We’re at no place to be sitting back in a comfortable recline here,” said Ed Crandell, an oil analyst at Lehman Brothers. The economy could also pick up. Hurricanes could take out some production in the Gulf of Mexico.

But if there is fizz in the price of oil (and it must seem like champagne to those producing it), the realities of supply and demand should ultimately correct that price, just as happened with the recent housing bubble and other bubbles in the past. Just don't ask me when.

In any case, oil production is far more profitable at even $100/barrel then the $60/barrel price it was at the start of 2007.

Take a look at this graph to see the meteoric rise in oil prices:

And this graph doesn't even show the last few months as oil prices soared towards $150/barrel!

Anyhow, let's get back to Lufkin (LUFK). If you are a regular reader of my blog, you know that I am very interested in the latest quarterly results.

How did Lufkin do in the latest quarter?

It was yesterday's announcement of its second quarter 2008 results that drove the stock higher! For the quarter ended June 30, 2008, sales increased 30.6% to $174.5 million from $133.6 million in the same quarter last year. Net earnings came in at $21.2 million, or $1.44/share, up from $17.1 million, or $1.17/share the prior year. The company beat expectations of $1.36/share according to analysts polled by Thomson Financial. To top it off, the company also raised guidance for the full 2008 year to earnings of $5.50 to $5.70, up from prior guidance of $5.10 to $5.30/share. This exceeded analysts' current expectations of $5.28/share according to Thomson Financial.

It is this combination of strong financial results that exceed expectations and the company's raising of guidance that really got my attention!

As John Glick, the company's President commented:

The high demand from the North American market, coupled with a change in buying practices that resulted in larger quantity orders from U.S. customers…resulted in very strong new orders during the quarter.

The article continued:

The flood of new orders more than tripled the company's oil-field-unit backlog, which stood at $170.9 million, compared with $55.8 million a year ago.

Somehow, I am not a big believer that this correction in the oil price will result in any real significant and long-term decline in the price of oil. But I could well be wrong and terribly out of synch with this purchase. Time will tell.

How has this company done long-term?

Reviewing the Morningstar.com "5-Yr Restated" reveals a picture of steady growth from 2003 to 2006, and then in 2007 the company appeared to stall a bit as revenue, which had increased from $262 million in 2003 to $605 million in 2006, dipped to $597 million in 2007 and to $596 million in the trailing twelve months [TTM].

Similarly earnings have increased sharply from $0.73/share in 2003 to $4.83/share in 2006 and $4.92/share in 2007, but then have dipped to $4.81/share in the TTM.

But it was the recent quarterly result that suggested the company was 'back on track' financially and heading to steady growth that led me to overlook this 'blemish' on the record.

The company has been paying dividends and increasing them from $.36/share in 2003 to $.88/share in 2007 and $.92/share in the TTM.

Outstanding shares have been very stable with 13 million in 2003 increasing about 12% to 15 million in the TTM. During this same period, revenue was up over 100% and earnings increased more like 500%. Not much of a 'dilution' of results from my perspective.

Free cash flow has increased from $8 million in 2005 to $71 million in 2007 and $54 million in the TTM.

The balance sheet appears solid with $103 million in cash and $205 million in other current assets, easily covering the $72.5 million in current liabilities, working out to a current ratio of 4.25. The company has a relatively small amount of easily-covered long-term liabilities listed at $48 million.

The balance sheet appears solid to me!

What about some valuation numbers?

Reviewing the Yahoo "Key Statistics" on Lufkin, we can see that this is actually a small cap stock with a market capitalization of only $1.34 billion. The trailing p/e is a moderate 18.90, with a more reasonable forward p/e of 15.01 (fye 31-Dec-09) estimated. In my honest opinion, the PEG ratio works out to an acceptable, level of 1.53 based on "five year expected" earnings. With the recent earnings report, estimates should be moved higher and the PEG should fall back well under 1.5.

Looking at some other statistics, according to the Fidelity.com eresearch website, the company is reasonably valued in terms of the Price/Sales ratio relative to its peers. The Price/Sales [TTM] works out to a 2.05, much lower than the industry average reported by Fidelity at 3.62.

(Several years back I read a great article on Price/Sales ratios and how they might be used in terms of relative value compared to similar companies. I would encourage you to read the Smart Money article by Paul Sturm on this topic.)

Fidelity suggests that the company might not be as profitable as its peers as it came in with a Return on Equity [TTM] ratio of 19.06%, below the industry average of 27.91%.

Finishing up with Yahoo, there are 14.78 million shares outstanding with 14.05 million of them that float. Currently, as of 6/25/08, Yahoo reports that there are 1.2 million shares out short representing 8.6% of the float or 6.9 trading days of volume. With the great earnings report, we may well have been observing a bit of a 'squeeze' with the short-sellers scrambling to cover their negative 'bets.'

As I have noted above, the company pays a small dividend with a forward rate of $1/share yielding 1.2%. The last stock split was 4/20/05 when the company had a 2:1 stock split.

What does the chart look like?

If we take a look at the 'point & figure' chart on Lufkin, we can see that the company has been relatively flat between 2007 and early 2008 trading between $50 and $72. In March, 2008, the stock broke through resistance at the $58 level and has now moved strongly higher, peaking at $94 before closing at $90.40 today.

Summary:

I had the opportunity to buy a stock to add to my portfolio today. This was based not on my assessment that it was time to buy, but literally from a signal generated by own account.

Lufkin made the list of top percentage gainers. Yesterday, it reported solid earnings that beat expectations and the company went ahead and raised guidance for the whole year.

Wednesday's results  put the longer-term financial picture back on a track of solid growth in revenue and earnings, stable outstanding shares, growth in dividends, and a solid balance sheet. Valuation appears reasonable.

On the downside, simultaneously with this earnings announcement has been a short-term (?) sharp decline in the price of oil. A further large decline in oil prices would undermine some of the support for a company like Lufkin that is involved in the sale of oil production equipment. Otherwise, the picture is solid, and I like the stock.

In fact, I purchased shares yesterday! I don't know if I may have struck a 'gusher' or have slipped in an oil slick - only time will tell.

I am now up to six positions and am feeling a bit more optimistic about investing today after the solid market performance and my own signal to be buying!

Disclosure:  The author owns LUFK.

 

Comments

[ANTS:]

I run a quant based stock picking system, and just to let you know you are not alone, it identified this stock as a good buy on the basis of a favorable risk/reward metric.

I run the data on all companies in an index, so I don't know what the market thinks of it. Then again, listening to the market chatter is more likely to hinder a decision to invest rather than to assist.

It will be in my portfolio today, and I'm sorry I didn't find it sooner.

2008 Jul 24 06:18 AM