Core Laboratories N.V. (CLB)

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Sheraz Mian

www.zacks.com

Amsterdam, Netherlands-based Core Laboratories is an oilfield service company that provides reservoir management and production enhancement services to the oil and gas industry on a global basis. The company operates in over 50 countries and divides its operations in three segments: Reservoir Description, Product Enhancement, and Reservoir Management

The Reservoir Description segment is responsible for analyzing core samples of reservoir rocks in order to determine the quantity and quality of hydrocarbons present. This helps determine the rates at which oil and gas can be produced from the reservoir. The Product Enhancement segment is engaged in helping operators increase oilfield recovery. Most of the company's clients in this business are located in the Middle East, N. Africa, and the Asia Pacific regions. A vast majority of Core Labs' Product Enhancement products are patented. The Reservoir Management segment serves to integrate both reservoir description and product enhancement practices in the most productive way possible. The company manages several large scale reservoir production projects using its technical proprietary analysis to ensure that every economical barrel of oil and Mcf of gas is recovered.

We are initiating coverage on Core Laboratories with a Buy recommendation and 12-month target price of $142. We believe that the recent pullback in the stock price (the stock is down about 23% in the last five weeks) provides us with an attractive entry point in this quality oilfield service name. Core Labs enjoys a dominant position in a niche market with strong growth characteristics, particularly in the international arena. The growth outlook is particularly attractive for the company's production enhancement and reservoir management businesses, given the growing maturity of the global hydrocarbon reserves. We think that the stock offers attractive upside from current levels, particularly following its recent sell off. We believe that CLB's valuation premium is justified by its market leading position, strong cash flow generation and cyclical leverage.

International operations are expected to be a key growth driver for the firm going forward. While international operations contributed approximately 53% to the company's fiscal year 2006 reported revenue, the actual contribution was even larger, close to two-thirds of the total. Since the company conducts most of its analytical work at its North American labs, this constrains it to report such receipts as domestic, though in reality many of those projects are international in nature. In order to capitalize on its international growth opportunities, the company is actively investing in high-growth markets, such as the Middle East. The recent additions of several new laboratories in places like Qatar and Abu-Dhabi are steps in that direction. These strategic additions should increase the company's market share in these lucrative markets by helping increase its capacity to handle additional clients and larger projects. The Middle East currently represents the company's third largest source of revenue.

The favorable macro backdrop for oilfield service companies in general and Core Labs in particular is characterized by peak cycle crude oil prices and rig counts. This has had a positive impact on Core Labs' operations and financial performance, as shown in the chart below. With a combination of cyclical and secular factors expected to keep commodity prices at elevated levels in the next few years, Core Labs' performance momentum should remain in place going forward. As with the oilfield service group in general, stock prices are expected to weaken in a falling oil price environment. However, the overall operating environment and the company's prospects and outlook are not expected to change materially as long as crude oil prices remain near $60 a barrel, significantly below current levels.

Given the growing maturity of the global hydrocarbon reserve base, Core Labs remains well positioned to help operators extract the incremental barrels through its Production Enhancement operating arm. This arm specializes in making products that maximize reservoir potential by ensuring efficient perforation and completion results. Their arsenal of patented products and technologies allow the company to grow market share and maintain customer loyalty through product knowledge and top quality performance. Some products that are used frequently by its customers are SuperHero, ZeroWash, SpectraScan, and SpectraChem. Usually bundled together when sold, these products allow operators to optimize well production by achieving debris-free perforation, efficient fracture stimulation and proper and effective clean-up. These are quintessential steps that must be taken to develop the reservoir to its fullest extent. We expect the company to keep bringing new products and technologies to the market and as such offers an avenue for consistent growth going forward.

Core Labs' reservoir management business represents a strong growth conduit in North America. The growing share of deep natural gas wells, often horizontally drilled, offer challenges to operators that Core Labs is well positioned to tackle. These deep well contracts also represent higher margins for Core Labs due to their complex and involved nature. Additional reservoir management opportunities have emerged from Canada's oil sands. The need for proper well pressure and heat monitoring technology has contributed to the 38% year-over-year revenue growth in the first nine-months of 2007 a trend that we expect to remain in place in the coming quarters.

Core Labs has shown the ability to generate free cash flow for the past 16 quarters. Its low capital expenditure needs and service oriented nature differentiates it from its peers who are capital intensive and devote around 10%-15% of revenues to capital expenditure needs Core only spends around 4%. This liquidity provides the company with the opportunity to buy back shares (which they have done since October 2002), acquire companies that fit their strategic profile, and expand to take on extra capacity in growing regions (like the Middle East) via increased capital expenditures.

Overall, we see growth continuing at attractive levels for Core Laboratories in the next few years. The demand for oil has generated a surge in prices that has caught the eye of every producer in the world. The need to extract as much gas and oil as possible from existing reservoirs is driving and will continue to drive the success of Core Labs. The biggest oilfield reservoirs are being depleted at a faster rate and with that, the need to maximize recoveries is becoming more apparent. The company should fair very well in this global environment and the trend doesn't seem to be slowing any time soon.

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