TGC Industries Hires More Crews and Hints at a Strong Turnaround

TGC Industries (TGE), a seismic data acquisition company, recently reported that it was adding three more ‘crews’ in the U.S. and Canada for a total of eleven ‘crews’ by the middle of the current quarter. This is a strong turnaround from the four to six crews it has operated in the last four quarters, which in turn as explained below translates to significantly higher quarterly revenues and earnings in 2011 in the $38-42 million and 25c-35c range respectively.

Given its historical PE trading range of 10-25 and based on similar PE ranges at its peers, this translates into a price target of well over $10 in the next six to nine months. Given the current stock price in the $4.50s, this implies a more than 100% appreciation above current levels making it in my opinion one of the undiscovered ‘gems’ in the oil services industry as the global macro-economy, the price of oil and the demand for oil services improves in 2011 and beyond.

Projected Quarterly Revenues

The number of crews deployed is the primary driver for the top-line revenue reported by seismic data acquisition companies like TGE. Specifically, since TGE regularly discloses the number of crews it operates in every 10Q/10K filing, one can easily deduce that each crew deployed by TGE generates between $3.5-3.8m revenue for every quarter that it is deployed.

Since the company has already disclosed in its recent press release on January 12, 2011, that, “it deployed its seventh seismic field acquisition crew in the U.S. and its third and fourth crews in Canada”, and that “We plan to have the crews fully operational by the middle of the current quarter”, we can project that TGE will be generating approximately $33-36 million revenue in the current quarter ending March 2011 and $38-42 million revenue in the June 2011 quarter. This suggests a very strong pick-up in seismic data acquisition activity, and the projected quarterly revenues are well above both recent quarter revenues ranging from $15-30 million in the last four quarters, as well annual revenues ranging from $85-90 million in the last four years.

Projected Gross Margins

Seismic data acquisition companies like TGE are labor intensive and a large portion of their cost of goods sold (COGS) is the cost of their ‘crew’ deployment.  During lean times, while these companies adjust their labor to correspond with the market demand, they have to maintain on their payroll ‘key’ technical and operational employees to help them capitalize on new opportunities as they emerge. This leads to lower utilization rates as their ‘crew’ deployment and revenues fall, and thereby negatively impacts gross margins. Conversely, when ‘crew’ deployment rises, their labor utilization rates also rise and this leads to an increase in gross margins. This relationship was observed across a 10-year market cycle at both TGE and its peer Dawson Geophysical (DWSN), as illustrated in the chart below.

 

Fiscal Year	TGC Industries (TGE)		Dawson Geophysical (DWSN)		Price of Oil (in $)
	Annual Rev (in $ mill.)	Gross Margins (in %)	Annual Rev (in $ mill.)	Gross Margins (in %)
2000	6.5	-8%	18.5	-17%	27.40
2001	10.1	-2%	37.9	13%	23
2002	6.3	-11%	36.1	8%	22.81
2003	8.5	19%	51.6	10%	27.69
2004	20.1	21%	69.3	20%	37.41
2005	30.9	41%	116.6	22%	50.04
2006	67.8	40%	168.6	25%	58.30
2007	90.4	33%	257.8	26%	64.20
2008	86.8	36%	324.9	27%	91.48
2009	90.4	28%	244	21%	53.56
2010	91.2 rate	17%	205.3	10%	70.32

 

As illustrated, gross margins at both TGE and DWSN have moved in tandem with an increase in their annual revenues, which is based on their crew deployment. Also, as can be seen, there is a slightly looser but definite relationship also with the price of oil so that as the demand and price of oil increases, crew deployment, revenues and gross margins also rise at seismic data acquisition companies. Thus, it is highly probable that gross margins may approach 35% or higher in the current cycle at TGE in 2011 and beyond.

Valuation Calculation

Both SG&A and D&A at TGE have been fairly steady at $1.6-1.7m and $3.7-$3.9m every quarter recently and should probably stay in that range or move slightly higher. Based on these assumptions, and assuming a tax rate of 40%, the company may generate between 25c and 35c every quarter going forward in 2011. This means that the company is trading well below 5 PE going forward. Historically, the company has traded between 10 and 25 PE so that would give us at least a double based on current price in the $4.50s. Of course, this assumes no further pick-up in seismic data acquisition activity in North America.

Company Overview and Background

For those relatively unfamiliar with this industry, seismic data acquisition companies are typically hired by energy producers to help optimize drilling activity. They do this by blasting sound into the ground or underwater, as the case maybe, and the reflection of the sound echoes is then mapped using relatively sophisticated equipment and hardware to help delineate the oil and gas field boundaries. The reason why their activity is so ‘directly’ correlated with energy prices is because higher prices make it more economical to explore not just for new fields but also to explore for the remaining oil and gas pockets in mature fields.

TGE touts itself as having the latest in 2D and 3D seismic data acquisition equipment. It has been in business since 1967, and its stock has publicly traded since at least 1986. Recently, in October 2009, TGE acquired Eagle Canada, Inc., thereby expanding their reach into Canada. The acquisition however was for only $10.3 million, all of which was paid from existing cash without incurring any debt or diluting existing shareholders.

In the 10-year period ending 2010, the stock price has appreciated from 75c at end of 2000 to the $4.50s at the end of 2010, with a peak of $12.50 in 2007 (rising from <10c at the trough in 2002). Wayne Whitener, the CEO has been in that position since at least 1999. Management holds 30% of the company shares, and their goals are thereby aligned with shareholders (compared with 2% - 8% insider ownership at its peer companies).

Competitive Landscape and Peer Comparison

TGE operates only on-shore, all of its projects are in North America and it is the smallest; in comparison, its three primary ‘pure play’ competitors Dawson Geophysical (DWSN), Geokinetics (GOK), and Global Geophysical Services (GGS) are larger, operate worldwide and with the exception of DWSN they do both on-shore and underwater seismic data acquisition. There are two more publicly traded peers, ION Geophysical Corp (IO) and CGG Veritas (CGV), but a significant portion of their revenues is derived from equipment sales and so were not considered in the peer comparison table illustrated below.

	TGE	DWSN	GOK	GGS
Current Price	$4.55	$34	$9.55	$11
Prj. 2011 Annual Rev ($m)	160~	260	750	370
Market Capitalization ($m)	85	270	170	400
Price-to-Sales (PSR) Ratio	0.55	>1.0	<0.25	1.1
Debt-to-Equity Ratio	12%	0%	204%	260%
Prj. 2011 Annual Earnings	$1.00	$1.15	($1.35)	0.33
Projected PE	<5	>25	Na	35
Historical PE Ratios	10-25	8-20	Na	Na

 

Please note that the projected numbers for the three competitors are drawn from Analyst Estimates as they have adequate coverage of between 3 and 6 analysts (however, FY ending Sep 2012 numbers are used for DWSN). TGE however is smaller and is covered by only one analyst, and since the estimates have not been revised at least in the last 3 months, the numbers derived above that incorporate the press release from January 12, 2011 have been used for comparison.

As is evident from the Table, TGE trades at a steep discount based on projected 2011/12 earnings, based on both its own historical PE range and also based on peer historical PE ratios. Also, based on projected 2011/12 revenues, it trades at a much lower PSR compared to both DWSN and GGS; GOK however trades at a very low PSR as it has a high debt load and also is projecting to continue incurring very high losses even into FY 2011.  Please note that revenue and earnings growth rates were not used in the above peer comparison table, although it would be favorable to TGE; this is because historically most of the peer group has grown and contracted at comparable rates in boom and bust times, possibly because ‘barriers to entry’ based on customer relationships are sticky in this group.

Conclusion

Based on TGC Industries’ projection for business in 2011, the company stock TGE trades at a steep discount compared to both its own historical ratios as well as in comparison to its peers. Since the press release came out after the market close on January 12, 2011, the stock has gone up from $4.45 to the $4.70s.  However, as the news of three additional crews gets factored into the stock it is highly probable that it may continue the upward momentum as more fund managers add it to their holdings; and it could move towards its previous highs above $12 in the next 6-9 months, when both earnings and revenues (adjusted for outstanding shares) were much lower than what is projected by the company for 2011.

Of course, the above does not assume any further strong pick-up in oil and gas exploration activity, but if the consensus on much higher oil and gas prices going forward as the global economy improves were to be true, there would be additional upside to these estimates.