In this week's Small-Cap Spotlight, Frank Curzio and Larsen Kusick take a close look at Dawson Geophysical (DWSN) - Get Report, a seismic data provider that has seen its stock surge this year. But is the stock overvalued or does this growth play have more room to run?
Curzio: Stock Still Has Upside Potential
In today's marketplace, it's important to take into account current market conditions and look at areas that are not as vulnerable to a slowdown in consumer spending, and Dawson Geophysical fits this profile. I think the stock is going higher.
Dawson provides onshore seismic data services, including processing 2-D and 3-D data, for major oil-and-gas companies that are cash rich and spending on exploration since they need to look deeper and in unconventional fields to meet growing demand.
Tough Market? Go Underground With Small-Cap Dawson
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This demand was not only evident in Dawson's 63% increase in EBITDA (earnings before interest, taxes, depreciation and amortization) from fiscal 2006 to fiscal 2007, but the company expanded its working crews to 15 from 12 over the past 12 months. Further increases in crews could be in the works, as management stated last quarter that demand for services for exploration activity by clients remains at an all-time high.
Looking at the stock price, shares have surged more than 100% on the year but have pulled back 15% from their 52-week high of $85.67 back in September. According to Capital IQ, shares are trading at 16 times next year's earnings -- or in line with the industry average. However, Dawson is expected to grow earnings by 24% over the next three years, so I believe the stock still has room to run.
Other positives for Dawson are that most of its crews are booked through 2008, and while December is usually its weakest quarter due to weather, thus far, weather across the U.S. has been warmer than usual, creating upside to estimates when Dawson reports fiscal first-quarter results early February.
As for risks, Dawson is levered to the U.S. on-shore market, and the major oil companies are shifting some capex toward international offshore projects. The offshore market is growing at a much higher rate, but based on demand for onshore seismic data, I do not view this as a concern over the next 12 to 18 months.
Also, huge demand has created additional competition, notably from Canadian crews vying for jobs in the U.S. market. Last, Dawson sees a majority of its work from the exploration of natural gas. Prices have been strong as of late, providing further evidence that next quarter has upside to estimates, but a decline in natural gas prices long-term could result in the majors spending less money on exploration projects.
Overall, I believe the reward is worth the risk. Dawson should continue to see huge growth for its services over the short- and long-term, and funding is fueled by the major oil companies, which have plenty of cash and are not levered to the weakened macro environment.
I would use this pullback as a buying opportunity and believe the stock has 20% upside potential, meaning it can trade back to its 52-week high within the next 12 months.
Kusick: A Great Pick for a Tough Market
As much as I love disagreeing with Frank in our Small-cap Spotlight columns, I have to agree with him this time.
I first noticed Dawson in the first half of 2007, when it seemed to set a fresh 52-week high nearly every week. It was one of those situations where, as an analyst, you like the company, but the stock is rocketing so fast that you can't help but think you're late to the party. (N.B.: When a stock is up 150% in less than a year and is getting major coverage in
, it's probably not a good purchase price for long-term investment.)
Fortunately for those of us looking for a good long-term idea, momentum in Dawson Geophysical finally broke in October, and shares now sit about 15% below their 52-week high. In hindsight, the strong run during 2007 had a lot to do with shares being undervalued previously.
Financial results from early in the decade up until the present show that not only has demand for Dawson's seismic data services skyrocketed, management has been very successful in expanding margins as the business scales.
Frank mentioned the company's strong EBITDA gains, but I'd also note that EBITDA margins have been on a steady uptrend for years now, reaching 24% in 2007 from 16% in 2004, and just 2.4% in 2002, according to Capital IQ.
Obviously, the steady rise in oil prices has played a part in Dawson's success, and anyone who doesn't believe oil prices will stay high for years to come may want to pass on this name. But I admit to being fully on the side of the bulls when it comes to long-term crude prices. As such, Dawson is in the "sweet spot" when it comes to providing a service that will continue to be in high demand as drillers look to find every last source of oil in North America over the next decade.
In my view, Dawson offers investors much bigger upside potential over the next year than large-cap names like
and major integrated oil companies like
I also like this pick in light of what is shaping up to be an ugly and uncertain stock market in 2008.
Investors looking for new picks right now need to be especially careful to stay away from certain sectors. Stocks connected to housing and consumer spending are virtually untouchable, and even the financial sector has very few names that are safe from the deteriorating economic outlook. From cyclicals to tech names, it's difficult to find stocks that can post gains in the current environment.
In addition to Dawson, and as a New Year bonus for our readers, I would also suggest that investors look at the larger and more geographically diverse
, the product of last year's merger between Compagnie Generale de Geophysique and Veritas DGC. This mid-cap stock trades at just 17.5 times 2008 consensus estimates despite expected earnings growth of 23%.
Unlike Dawson, CGGVeritas is not a pure services company, as about 40% of last year's sales came from its products segment (I'm not quite as bullish on equipment manufacturers). However, I am a big fan of the company's global reach, with operations on six continents.
Have a small-cap you'd like to see covered? Email Curzio and Kusick.