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GEOS: Potential for the Patient Investor

July 11, 2014 | About:

Geospace Technologies Corporation (GEOS) sells technology to companies that service the Exploration & Production sector of the oil and gas industry. It specializes in cable and wireless products for seismic and reservoir management.

As the price chart below shows, it's share price has fallen away dramatically in the past year:

1404924221668.png

Naturally, we have to ask: Is this now a value play, or is it a value trap?

History

  • 1980: founding date of the unit that was later to become Geospace Technologies Corporation (2013 Annual Report);
  • 1994: unit incorporated as a company;
  • 1997: goes public as OYO Geospace, symbol OYOG;
  • 2012: OYO Corporation, the company’s former owner, sells its remaining 20% stake;
  • 2012: in the wake of OYO's exit, the company changes its name to Geospace Technologies Corporation and ticker symbol to GEOS;
  • 2012: 2-for-1 stock split through a 100% stock dividend;
  • 2012: receives two very large contracts, from a unit of Shell and from Statoil (more below).

The Business

At the time it went public, in 1997, the company functioned as a small manufacturer of components that went into the seismic data acquisition systems of its competitors.

Today, it designs, develops, and manufactures instruments and equipment for its own systems. These systems help large oil companies and their suppliers to manage seismic data and to monitor oil and gas reservoirs. Sales in the seismic segment made up $275-million of the company's $300-million in sales for fiscal 2013 (10-K Report);

Here's how oilandgasinfo.ca explains seismic exploration, Geospace's main line of business: "In a seismic survey, the geophysical contractor’s crew lays out a line (or several lines) of sensitive receivers, called geophones or “jugs,” on the ground. Then explosions or mechanical vibrations are created on the surface. The geophones record the energy that is reflected back as seismic waves from rock layers at various depths.

"Geophysicists use powerful computers to process the data from digitally recorded seismic surveys. Computer-assisted processing of the data creates a picture of the sedimentary structures below and ideally shows the location and extent of porous layers within these structures."

And here's how GEOS explains its product line (10-K Report for 2013), "We provide many of the components of seismic data recording systems, including geophones, hydrophones, multi-component sensors, seismic leader wire, geophone strings, connectors, seismic telemetry cables and other seismic related products."

Those products are used both on land and under water, with land and marine being two important categories for this company. Further, their product line breaks into traditional cable products and the newer wireless products; comparable, in a sense, to landline phones and cell phones.

Geospace operates its own R&D facilities, which have developed proprietary wireless technology, to replace cabled systems. Since seismic surveys generally take place in hostile environments, and often in severe weather, laying cable can be expensive, hazardous, and an environmental problem. Wireless, therefore, offers significant productivity improvement to the seismic industry. GEOS sells both land-based and marine wireless products. The company has also developed instruments that can be permanently placed in reservoirs, to provide ongoing data describing changes in a reservoir as oil or gas is tapped from it.

It list its competitors in its 10-K Report, "SERCEL (a division of CGGVeritas), ION Geophysical (“ION”), INOVA (a joint venture formed in 2009 between ION and Bureau of Geophysical Prospecting, a subsidiary of China National Petroleum Company) and Steward Cable (a division of Amphenol Corporation)."

It also sells non-seismic products that easily adapt to other industrial applications, including mine safety and water meter cables. However, this line has little impact on the company's revenues and income.

Ups & Downs

In 2012, Geospace received two major orders for permanent reservoir monitoring systems: one for $18-million from Shell Brasil Petróleo Ltda and one from Statoil (Norway's state oil company) for $167-million.

Revenue and income from big projects such as these are recognized using the percentage-of-completion method of accounting. In other words, revenue and income are booked over time, with completion of specific milestones in the contract.

The variation in payments from these contracts, along with sales that vary a great deal from quarter to quarter, lead to lumpy earnings reports. As GEOS notes in the 10-K report, "If we do not receive new large orders for our permanent reservoir monitoring systems prior to our expected completion of the Statoil order in mid-fiscal year 2014, we expect revenues and profits from our reservoir products to decline significantly during fiscal year 2014."

In October 2013, the company announced what it hoped would be another, very large order, of $30-million from a subsidiary of Seafloor Geophysical Solutions (SGS). That would have helped cushion revenue and earnings through 2014. However, the customer company ran into financing issues, and put the order on hold. As of early July 2014, that order remains stuck, although the GEOS says it is confident it will eventually go ahead.

Completion of the Shell and Statoil contracts, and only one order in the wings - far back in the wings - has prompted investors to exit the company. Since it does not pay a dividend, investors saw no reason to stick around while waiting for capital appreciation, or worse, to see their capital whittled away.

Owners

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Management

  • President & CEO: Walter R. Wheeler, joined the engineering team in 1997, became President/CEO at the beginning of 2014;
  • Chairman of the Board: Gary D. Owens, also joined the company in 1997; retired as President/CEO on December 31, 2013;
  • Vice President & Chief Financial Officer: Thomas T. McEntire;
  • The Board of Directors also includes a professor of geophysics, retired oil industry execs, a retired KPMG partner, and a senior lawyer;
  • ISS Governance QuickScore: 8 ("Scores indicate decile rank relative to index or region. A decile score of 1 indicates lower governance risk, while a 10 indicates higher governance risk.") The company receives red flags for Board Composition, Board Practices, Takeover Defences, Voting Formalities, and Equity Risk Mitigation.

GEOS by the Numbers

GEOS key statistics

Financial Strength

Geospace, which had $44-million in cash and no debt at the end of the last quarter, scores 7/10 for Financial Strength and 8/10 for Profitability & Growth at GuruFocus:

GEOS financials

But, we also need to consider how the company might fare if it fails to land another elephant. Looking at all but the last segment of the following chart shows us what the company was capable of in the preceding years (red=book value per share, blue=EBITDA per share, green=revenue per share):

1405109549960.png

Management has successfully grown the top line and the bottom line through the past decade, albeit unevenly.

Valuation

Several factors combine to make valuation of GEOS challenging, not the least of which are the temporary bump provided by the Shell and Statoil contracts, and uncertainty over the SGS contract.

As a starting point, this is what the Discounted Cash Flow valuation looks like working from an EPS of $3.00 per share (about 10% above the 2012 figure), and projecting 10-year growth at 12% (these are somewhat arbitrary assumptions, designed to illustrate a more conservative perspective than provided by the default settings):

GEOS discounted cash flow

$50.41 is close to where the price stood before taking an 8% beating on July 10, 2014. In other words, this valuation ends up reasonably near the current market price.

It does not make any provision for future elephants, just good steady growth through sales and rentals of its existing products.

Outlook

For the near future, GEOS seems unlikely to gather much steam. While the company does not offer guidance, it has indicated it expects soft market conditions for the time being. And, as Tyler Crowe points out in The 5 Worst-Performing Energy Stocks of 2014, "Geospace's biggest problem isn't the company itself, but rather its customers. As a specialist in seismic data equipment, it is subject to the capital expenditure budgets of oil companies, especially Big Oil companies that do a significant amount of seismic work offshore. These companies have been scaling back their capital budgets this past year, and one of the things that goes first is seismic studies related to exploration."

As Crowe also notes, Big Oil might postpone its exploration activities in the short term, but in the longer term, will have no choice but to go out looking for new pools of oil and gas. When that happens, we might expect significant jumps to both revenue and earnings per share.

The possibility of more big contracts still exists, and the odds remain reasonable that the $30 million SGS contract will get off the ground.

While the company waits for a return to big exploration spending and/or big new contracts, it has the security of $44-million in cash, being debt-free, and a non-dividend payer.

Conclusions

Geospace Technologies Corporation shares once sat comfortably above the $100 level. And, its reasonably possible they will again, if one or both of the circumstances noted above transpires.

Given this combination of potential and existing weaknesses, GEOS seems best-suited to watch lists. If it does land the on-again, off-again $30-million contract, venturesome buyers might enter between the time the deal is confirmed and when its revenue and income are first recognized.

All in all, it appears there is potential for the patient investor.

About the author:

Robert Abbott
Robert F. Abbott has been investing his family’s accounts since 1995, and in 2010 added options, mainly covered calls and collars with long stocks. He’s currently exploring two potential routes to an income portfolio: First, to combine dividend challengers, contenders, and champions with covered calls, and second, to combine more volatile stocks with collars.

As a writer and publisher, Abbott explores how the middle class has come to own big business through pension funds and mutual funds, what management guru Peter Drucker called the Unseen Revolution. In Big Macs & Our Pensions: Who Gets McDonald's Profits?, the first of a series of booklets on this subject, he looks at the ownership of McDonald’s and what that means for middle class retirement income.

In an eclectic career, Robert Abbott was a radio news writer and announcer, a newsletter writer and publisher, a farmer, a telephone operator, and a construction worker. When not working, he has been a busy volunteer, which includes more than a decade of leadership roles at the Airdrie Festival of Lights, one of North America’s leading holiday light displays. He lives in Airdrie, Alberta, Canada.

Visit Robert Abbott's Website


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