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David Rolfe Comments on Core Labs

- By Holly LaFon

Both of our oil service stocks corrected from recent January highs during the first quarter. Recall that from late January 2016 lows (remember fears of " $20 oil?"), SLB rallied from $61 to $87 in mid-January 2017; a +43% gain. CLB (CLB) rallied from $89 to $125 in early January 2017; a gain of +40%. (Note the stock raced to $135 in May last year, too.) The profit-taking was not too surprising after sharp stock price advances over the past year. The cause was two-fold. First, an unusually weak seasonally (winter maintenance) refinery pause. Second, the unusually large build-up of OPEC inventories before the commencement date of agreed-upon supply cuts. On the demand front, global oil-demand estimates continue to be revised upward, continuing a 7-year trend. Our thesis in these two stocks continues to play out as expected. Supply/demand continues to come into balance after the recent depression in the oil patch. Oil is back to over $50 again. Oil service activity is quite robust in North America. Oil service company pricing inflation has snapped back after recent deflation. International spending remains at depressed levels. Net, net, the oil service industry remains in the early innings of our expectation of a multi-year recovery.

We think Core Labs is at the leading edge of a multi-year rebound in the E&P capex spending cycle. Core Labs' revenues are derived from providing high-return, niche products and services for E&P companies that are looking to increase the output of already producing wells. The majority of the Company's revenues are derived from their Reservoir Description (RD) business, which is focused on studying a fluid and core samples from a client's oil or gas field, and then providing critical data sets on how to better produce from existing wells. The revenue stream of this business tend to be much less cyclical compared to most of the industry, as Core Labs' RD services represent a small fraction of the client's production budget, yet produces sizable returns. The Company's more activity-driven business - Production Enhancement - grew 15% sequentially, and has begun to see the benefits of increased E&P spending, as clients work through a large backlog of uncompleted wells, particularly in unconventional North American basins. We expect this business to lead the return to growth in the short term, while Core Labs' steadier, high-margin, Reservoir Description business should drive growth longer-term, particularly as international E&P spending begins rebounding later this year and into 2018.

From David Rolfe (Trades, Portfolio)'s Wedgewood Partners first-quarter 2017 shareholder letter.
This article first appeared on GuruFocus.