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3 Reasons I Just Bought This Oil Stock

Matthew DiLallo, The Motley Fool

Turbulence continues to plague the oil market and has caused oil prices to be quite volatile over the past year. Oil companies, as a result, aren't spending as much money to drill new wells, which is affecting the oil-field services market. And that has put pressure on the stocks of companies in the sector, including Core Labs (NYSE: CLB). Overall, the oil reservoir specialist's stock has plunged about 35% so far this year, which pushed its dividend yield up above 5.5%.

That sell-off doesn't make much sense, given the positives the company sees up ahead in the offshore drilling market. The arrival of the long-awaited rebound in that market is one of the three main reasons I recently bought more shares of Core Labs.

A closeup of the word buy formed by wooden blocks.

Image source: Getty Images.

1. Offshore is finally showing signs of life

Investment spending on offshore drilling-related activities is on track to end its five-year slide, with analysts anticipating a mid-single-digit year-over-year improvement. Driving that rebound is the increase in offshore drilling activity. This move "has been evident in the 20 FIDs (final investment decisions) approved in 2017, another 30 in 2018, and 30 or more queued up here in 2019," according to comments by CEO David Demshur on the company's second-quarter conference call.

Demshur noted that "revenue from these longer cycle projects has mainly been absent from Core's reservoir description revenue streams dating back to 2015." However, an increase in drilling activities "did bolster reservoir description revenue in the second quarter of 2019." That trend should become more pronounced in the coming years. President Lawrence Bruno noted on the call that revenue in the segment has improved from $100 million during the oil market's downturn to around $105 million in the second quarter. CEO David Demshur, meanwhile, sees revenue running back up toward the peak of $130 million by 2021 and 2022, thanks to all the projects oil companies have approved in recent years. Given those improvements, as well as the company's improved cost structure and product line, Demshur believes that Core's margins will be as good as they were in the peak of 2014 within the next year or two.

The dividend isn't going anywhere

One of the reasons Core's stock has slumped this year is that it's not generating enough free cash flow to cover its dividend. During the second quarter, for example, the company paid out about $25 million in dividends but hauled in only $10 million in free cash. That's causing investors to worry that the company might cut its dividend.

Core's management team, however, put those concerns to rest on the second-quarter call. Demshur stated that "Core has no plans on cutting our dividend, as we [believe] it's important to our investor base." He backed that proclamation by pointing to the pickup in the offshore drilling market, which will boost the company's revenue and margin. On top of that, the company implemented a cost reduction program in its weaker North American business to improve profitability. Demshur said he's "confident that the company's asset-light model will allow Core's future cash flow to more than cover our dividend" and added that "Core will continue to return capital back to its shareholder via quarterly dividends and share repurchases as free cash flow levels increase." That statement shows the company's confidence that it will eventually produce enough free cash to more than cover the dividend.

3. The valuation looks attractive

With shares of Core Labs plunging this year, it currently trades near a historically low valuation:

CLB PE Ratio (TTM) Chart

CLB PE Ratio (TTM) data by YCharts

Shares are not only well below their average historical valuation but also approaching the lows they hit during the depths of the last two oil market downturns. That seems like an attractive entry point, given the company's view that its earnings should improve significantly in the coming years.

Getting paid well to wait for the eventual rebound

While the market is worried that Core Labs won't be able to afford its dividend much longer, the company completely disagrees. With oil companies approving an increasing number of major offshore drilling projects over the past few years, its revenue and earnings should improve significantly. As that happens, the company's shares should bounce back, especially given how cheap they are these days. That combination of upside and yield was too tempting for me to pass up, which is why I recently boosted my position in this oil stock.

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Matthew DiLallo owns shares of Core Laboratories. The Motley Fool recommends Core Laboratories. The Motley Fool has a disclosure policy.

This article was originally published on Fool.com