CanElson Drilling (CDLRF), Found With GuruFocus' Industry Overview Tool

I gave GuruFocus’ New Industry Overview tool a spin. I like cheap stocks so I took the following steps:

1. Went to the GuruFocus Industry Overview page
2. Sorted on Median PE which gave me “Oil & Gas - Drilling” as the industry with the lowest PE
3. Filtered on North America only and EV / EBIT from 0 to 8
4. That left me with 3 companies: ATW, HP, and CDLRF.
5. CDLRF looked the most promising as both its GuruFocus Financial Strength and Profitability & Growth rankings were 8 out of 10.

Company profile

CanElson Drilling Inc (CDLRF, Financial) operates land-based contract drilling rigs in Canada, Mexico and the U.S. for oil and natural gas exploration and development companies. Currently, it has rigs in British Columbia, Alberta, Saskatchewan, North Dakota, Texas, and Mexico. This is a Canadian company so if you go through its financials everything is stated in Canadian dollars.

Chart trends

• The first chart shows the relationship between ETF USO which reflects WTI oil prices and CDLRF’s stock price. You can see the clear correlation.
• 
• This second graph shows the company’s revenue, net income, and PPE (property, plant, & equipment) trends these past five years.
• You can see the correlation between revenue and net income and the inverse correlation between PPE spending and net income.

Business and Industry

• This is a commodity business dependent on the price of oil. If their customers, the exploration and production (E&P) companies, can’t make a profit then they won’t extend their contracts with CDLRF.
• There are two types of contracts. The first is based on day rates. The second is based on performance contracts usually related to the depth of drilling. CDLRF's financials state that performance contracts are typically more profitable because of their experience in controlling risk.
• Their contracts typically extend beyond one year but due to the recent weakness in oil, many contracts are now below the 12 month threshold.
• As a result, the company has made cost cuts. From the 2014 Annual Report
  • We have made significant reductions to our cost structure in recent months, including a 70% reduction of our capital program, a 50% reduction of the dividend and a 20% reduction of executive and board of directors compensation, and we are now in a position to maintain the one of the strongest balance sheets in the peer group.
• The statement suggests to me that cost cuts are related to decreasing spending on equipment, salaries, and the dividend. However, nothing suggests the company is benefitting from efficiency gains as their gross margins have fallen to 27.64% TTM from a high of 37.7% in FY12.
• They listed a number of the rigs they used: AC tele-double, telescoping, and jackknife.
• I did more research and learned that rigs have minimum specifications to be able to drill Shale. 75% of the wells drilled in the U.S. are horizontal now.
• Shale rigs need a minimum of 1,000 to 1,500 horsepower. Many older rigs have between 500 and 700 horsepower.
• Rigs need to have new features that allow them to move easily. Below is a YouTube video showing a sliding rig that doesn’t need a truck to move the pad between drilling destinations. As an outsider to the industry, I found it extremely informative, and it opens my eyes on how E&P companies are using technology to improve productivity.

• [kad_youtube url="https://youtu.be/mcZJR7kyZtE" width=320 height=180 ]

  https://www.youtube.com/watch?v=mcZJR7kyZtE&feature=youtu.be

  https://youtu.be/mcZJR7kyZtE

• Given the weakness in oil prices, I was really hoping to find CDLRF’s average marginal cost of production for its customers. That would give me insight into a floor for oil prices but I didn't find anything in the financials.

Red flags

• Share count going up substantially from 26.4M (2009) to 93.3 (2014)
• As mentioned before, gross margins have fallen to 27.64% TTM from a high of 37.7% in FY12.
• 
• Insiders are selling the stock

TTM Ratios Company’s Financial Statistics (Per GuruFocus as of 7/30)

• Market Capitalization = $265.43M
• PE Ratio = 10.46
• EV / EBIT = 7.66
• Price to Tangible Book = 0.79
• Price to FCF = 9.21
• Current Ratio = 3.16
• Quick Ratio = 3.16
• Debt to Equity = 0.11
• ROIC = 8.84

Final thoughts

• I’m going to pass on CDLRF.
• The company looks ok on a backward basis but it’s a commodity business.
• With WTI Crude Prices at $48.54 as of close today, I expect the company’s earnings to trend downwards.
• Even though CLRF isn't a potential investment,I think there is opportunity in the oil sector so I was happy to have learned more about the industry by reading the company’s financials.
• How do your research methods differ? Let me know in the comments below.