Last Friday, two days after I posted my comparison of Dawson Geophysical (“Dawson” and Ticker: DWSN) and TGC Industries (“TGC” and Ticker: TGE), TGC reported financial results for its first quarter of 2007. For the quarter, TGC reported earnings of $0.13 per diluted share on revenues of $18.6 million compared to year-ago earnings of $0.17 per diluted share on revenues of $14.8 million. Since reporting earnings, shares of TGC traded up by as much as 25% before pulling back a bit.
So let me get this straight….earnings decreased 25% and shares traded up 25%. Where’s the logic?
Two major factors led to the lower earnings result in the first quarter of 2007 compared to the year-ago quarter. First, bad weather in January and February resulted in five of TGC’s eight crews sitting idle for an average of 15 days. I don’t know how many weather days there were in 2006 but the weather across the nation was unquestionably more favorable in 2006. While TGC has some level of weather protection built into its contracts, the weather provisions typically don’t cover 100% of expenses or lost profits.
Second, TGC’s depreciation expense nearly doubled to $3.3 million from $1.7 million in the year-ago quarter. The higher depreciation expense comes as a result of $23.6 million in new equipment purchases in the last year. In the fourth quarter 2006 conference call, management indicated that the depreciation expense in 2007 would likely run about twice that of 2006. With regards to depreciation, it is important to note that depreciation is a non-cash expense. As such, the deprecation expense is an add-back on the cash flow statement. A cash flow statement was not made available with the press release.
In my opinion, TGC moved up after the earnings report because the negative factors noted above were already priced into TGC’s shares. Furthermore, I suspect many investors feared the weather impact was going to be greater than what was actually reported. According to Yahoo, the one analyst covering TGC had an EPS estimate of $0.10 for the quarter. TGC beat the $0.10 estimate by 30% and the market is now looking towards the more favorable spring and summer weather conditions. With the additional crews and equipment that TGC put into service in the last year, TGC is in a position to post a strong Q2 and really start to see returns on their capex spending over the last year.
Here are some of my notes from the earnings release and conference call:
While margins were down from the year ago level, gross margins, operating margins, EBITDA margins, and net profit margins were higher than the prior two quarters. I assume that the lower percentage of dynamite work in the first quarter of 2007 compared to the prior two quarters contributed to the margin improvement. Looking into 2007, management expects dynamite work to be consistent with the first quarter at 25%.
EBITDA was up from $6.4 million in the year ago quarter to $7 million in Q1. EBITDA margins were down from 43.2% in the year ago quarter to $37.4 million in the current quarter. Assuming nicer weather in the second quarter and crews operating at normal capacity, EBITDA margins should return to year-ago levels.
Management expects demand in the seismic data industry to continue for several years. All crews are booked through the second quarter with some booking well into the third and fourth quarter of 2007. For the most part, customers are unwilling to schedule work much past 2007.
60% of TGC’s business is repeat business. The high level of repeat business is a clear sign customers are happy with the results they are getting from TGC. Keep this point in mind as I will discuss it again when discussing the possibility of a buyout.
TGC’s backlog is roughly 25% dynamite and 75% vibration. TGC expects to be able to complete the shot-hole drilling associated with the dynamite work with its in-house shot hole drilling business, which should result in higher margins on the dynamite work.
The company is operating 2 crews on term contracts and 6 crews on turn-key contracts. Turn-key contracts have higher margins but less protection from bad weather conditions. If there is good weather throughout most of the quarter, this will work in TGC’s favor.
Crews are currently operating in Louisiana, South Texas, the Barnett Shale, Kansas, and Oklahoma. On the call, the CEO indicated they were preparing for work in a particular region and a crew would be moving into that region in the near future. I could not make out what region he was talking about. If someone could understand what region he mentioned please let me know.
TGC implemented a small price increase in the fourth quarter of 2006. The first quarter of 2007 saw some of that benefit. The price increase has not had a negative impact on demand.
I don’t know if anyone noticed but the CEO threw in a comment that they won a couple of nice contracts just yesterday, meaning the day before the earnings call.
In my last post, I mentioned that TGC ordered two shot-hole drill rigs, 4,000 channels and 6 vibration vehicles. The company took receipt of the 4,000 channels and the 6 vibration vehicles in the first quarter. Management expects the drill rigs to be delivered in the second quarter. Spending on the above equipment was $10 million and management expects to increase capex spending as opportunities present themselves.
TGC management takes adding a new crew very seriously. They will add crews when and if there is the right opportunity with the right client. Management needs to have 6 to 12 months of work dedicated to the new crew before they will consider adding the new crew.
At the end of the year, management will be reviewing its Opseis Eagle equipment to make a determination on whether or not they should replace the equipment in 2008. It sounds like management is likely to replace one of the Opseis Eagles in 2008 and then consolidate the Opseis equipment into one crew. Again, management will make that decision at the end of 2007.
When a caller asked TGC management if they have considered acquiring some of the one or two crew firms that were out there, management gave two reasons why they were not. First, these small operations typically have outdated equipment that dates back to 1994 and 1995. This equipment does not meet TGC’s standards. Second, management indicated that these firms don’t really have any exclusivity contracts or relationships with larger E&P companies that would make it worth their while. TGC management indicated that GeoKinetics was making some of these smaller acquisitions and they just assumed let them.
Now for a little buyout speculation that is purely speculative and based on nothing but management’s comments about being an acquirer of some of the smaller operations that are out there. TGC has six relatively new Aram ARIES and it has purchased most of its equipment in the last couple of years. Furthermore, TGC has a high percentage of repeat business. Adding new crews is difficult because of equipment lead times and a lack of skilled labor. Given the quality of TGC’s equipment and its high level of repeat business, it seems like TGC would make for a nice acquisition.
Well, that’s all I have to say about that.
Regards
Tuff
Sources
Q1 2007 Earnings Press Release
Q1 2007 Conference Call
Wednesday, April 25, 2007
Tuesday, April 17, 2007
Superseismic
Given all the hype around the seismic data acquisition industry, J.J. Fad has decided to release a new rendition of their 1988 hit Supersonic and plan to call it Superseismic.
OK…maybe I am lying about the J.J. Fad bit but the seismic data acquisition industry really has been on a tear. I have been following this industry since Bill Mann, co-advisor for The Motley Fool Hidden Gems newsletter, recommended Dawson Geophysical (“DWSN” or “Dawson”), a provider of onshore seismic data acquisition services, in the December 2005 Hidden Gems newsletter.
After Bill Mann made his Dawson recommendation and I did some due diligence, I decided to invest in one of Dawson’s competitors, TGC Industries (“TGE” or “TGC”). Subsequently, the Hidden Gems newsletter identified TGC as a Tiny Gem. A Tiny Gem is an informal recommendation that has Hidden Gem qualities but doesn’t meet all of the criteria necessary to achieve Hidden Gem status (i.e. market cap > $200 million).
If you own shares of Dawson, you likely know of TGC and vice versa, but have you really taken the time to compare the two companies? If not, that is exactly what I intend to do….but first, the basics.
The Case for Onshore
If you read my blog entry for BOOM, you know that I subscribe to the school of thought that commodities are in the midst of a long-term bull market. The last three bull markets lasted an average of 17 years and each bull market was preceded by an equally long bear market. The current bull market started in early 1999.
Since the start of the current bull market, oil and gas prices have risen substantially from their lows of the preceding bear market. While oil and gas prices are off their 2006 highs, they still remain well above historical norms. Given the shrinking supply and growing demand, prices are likely to remain elevated for quite some time. Using history as a guide, the current bull market still has roughly nine years to go (Please don’t rely on history alone when evaluating the sustainability of the current bull market).
When oil and gas prices increase, there is a point where various sources of supply become economically viable for production. That is, the selling price of oil and gas exceeds the exploration and production costs (“E&P”) associated with other sources. For instance, exploration and production cost of offshore sources are less than that of onshore sources. When per unit oil and gas prices are below the onshore per unit costs, there is little to no onshore E&P activity. On the other hand, when oil and gas prices move above the associated costs of onshore E&P and the higher prices are seemingly sustainable, there is an increase in onshore E&P activity. Today, oil and gas prices are well above the cost of onshore E&P. While I don’t know the exact inflection point, most of the information I have read indicates that oil and gas prices could be cut in half and onshore E&P would still remain a profitable endeavor.
The Case for Seismic Data Acquisition
Seismic data acquisition is the process of sending acoustic waves deep into the ground and recording the reflected energy from those waves using a recording system on the surface of the earth. The customer or contractors for the customer subsequently processes and interprets the recorded data. Through the interpretation of the data, customers are able to identify underground formations that are favorable for the accumulation of hydrocarbons; thus, decreasing the likelihood of drilling a dry or marginal well. With the rapidly rising exploration costs and daily rig rates, the cost of drilling a dry or marginal well is far greater than the cost of obtaining a seismic survey. Furthermore, seismic surveys are beneficial to customers because they help the customer increase efficiencies of reservoir location, delineation, and management.
Recent advancements in seismic equipment and computing capacity have taken seismic surveys to a whole new level. Until recently, data acquisition crews conducted surveys in a linear formation to produce a 2-D seismic survey. Today, data acquisition crews conduct surveys over a broad area and collect vast amounts of data that in-turn produces a 3-D seismic survey. The 3-D surveys provide more clarity and are far more valuable to customers.
In a way, the perfect storm has been brewing for onshore seismic data acquisition companies. High oil and gas prices have lead to an increase of onshore oil and gas E&P activity. E&P companies are developing more difficult areas characterized by rugged terrain and/or smaller reservoirs. At the same time, E&P costs from labor to daily rig rates have steadily been moving higher; thus, increasing the cost of drilling marginal or dry wells. While the demand for seismic data acquisition services has been growing, the end product has improved considerably. With the latest technologies in seismic equipment and computing capacity, customers are getting a much clearer picture of what lies beneath, which in turn makes seismic data acquisition services considerably more valuable to the customer.
While the perfect storm is brewing on the demand side for seismic data acquisition, there are sufficient barriers on the supply side to keep the number of seismic acquisition crews reasonably low. The high cost of equipment, long lead times for new equipment, and lack of experienced technicians have kept the number of crews in the field growing at a slow pace relative to demand.
The Survey
Before a survey can begin, the data acquisition company and/or the customer must design the proposed survey, obtain the necessary permits, and setup the survey field, which looks something like this. The preparation process can take several months and the permitting process seems to have the greatest potential for causing delays, outside of weather.
A typical seismic data acquisition crew consists of at least 35 technicians, several off-road vehicles, multiple vibration sources, geophones, cables, a recording system, and other equipment. The vibration source can be either large vibration vehicles or dynamite. The vibration source sends the acoustic waves deep into the ground and geophones on the earth’s surface record the reflections. Multiple geophones linked together with cables form a channel. More channels equal more data and greater efficiencies, which in turn results in superior clarity. Dawson compares the number of channels to the number of pixels in a camera. Multiple channels transmit data to a central recording vehicle.
What You Should Know
Productivity of seismic data acquisition crews will vary from one quarter to the next. The high level of fixed costs associated with the seismic data acquisition business has a magnifying affect on changes in productivity. Usually weather and/or permitting delays have the biggest impact on levels of productivity but timing of new contracts and absorption of new crews can also impact productivity. By absorption of new crews, I am referring to how resources from existing crews get shifted to the new crew in order to bring the new crew up to speed. When this happens there is frequently a negative impact on existing crews.
There are two types of contracts Dawson or TGC will enter into with a customer. A turn-key contract is a fixed fee contract for each unit of data produced. A term contract is a fixed fee contract for each unit of labor (hour, day, or month) worked. While turn-key contracts offer greater upside profit potential, the downtime provisions are usually less favorable. With term contracts, there is less upside profit potential but the revenue stream is steadier and the downtime provisions are usually more favorable.
As mentioned above, the energy source can be either vibration vehicles on the earth’s surface or dynamite placed in shot-holes in the ground. Margins are usually higher on vibration contracts than dynamite contracts. I suspect this is largely due to the quality and quantity of data acquired from dynamite work and the dependence on third party contractors for drilling the shot-holes (I am not positive on this). TGC recently made an acquisition that they hope will improve the margins on their dynamite contracts (see below).
Customers are demanding more and more channels, vibration density, and recording capacity to improve data quality and subsurface resolution. To the extent Dawson and TGC can provide higher quality data, customers are seemingly willing to pay more for the data.
Aside from managing and executing the survey data, seismic acquisition companies may have other sources of revenue such as data licensing and/or data processing.
Comparison of Operations - TGC vs Dawson
In the following comparison, information regarding equipment and financials are made based on the twelve months ended December, 31, 2006, unless noted otherwise.
History
In 1980, Supreme Industries, Inc., a manufacturer of specialized vehicles, formed Tidelands Geophysical Co., Inc. (“Tidelands”) as a wholly owned subsidiary. Tidelands Geophysical purchased the assets of a Houston based seismic, gravity and magnetic surveying company. Six years later, Supreme Industries spun off Tidelands to its shareholders and Tidelands changed its name to TGC Industries.
L. Decker Dawson founded Dawson in 1952. The company exists today in substantially the same form as it did in 1952 and Mr. Dawson continues to serve the company as Chairman of the Board of Directors.
Acquisition Survey Zones
By "Other Zones", I am referring to land-to-water transition areas, difficult terrain, and heavily cultured areas not easily accessible with a system like the Aram ARIES. TGC's Opseis Eagles are well equipped for this type of terrain.
Data Bank and/or Data Processing
Neither company maintains its own seismic data bank as they feel this would be a conflict of interest with its customers, which may include providers of multi-client data libraries. TGC has amassed gravity and magnetic data banks through participatory surveys and internally funded speculative surveys. TGC licenses the data and interpretations of that data to its customers. TGC’s data licensing revenue does not contribute significantly to overall revenues.
Unlike TGC, Dawson offers data processing services. The data processing end of the business is very competitive and more of a commodity type business. Data processing does not contribute significantly to Dawson’s revenues. Nonetheless, management recently indicated that they are gaining market share in the processing business.
Crew by Type
In the second half of 2006, TGC was operating two dynamite crews. In the first half of 2006, TGC was operating only one dynamite crew and management expects to be back to operating only one dynamite crew in 2007. Dawson operates two dynamite crews but management plans to purchase additional equipment later in 2007 that will leave only one crew operating solely as a dynamite crew.
At the end of December 2006, there were 55 seismic data acquisition crews operating in the United States.
Recent Crew Growth
TGC has not announced plans for adding any new crews in 2007. Dawson has announced plans to add one new crew sometime in April. In the past, TGC and Dawson have added crews on an ad hoc basis depending on the current level of bookings and future outlook.
When making a decision to add a new crew, management must carefully consider the associated costs, potential benefit, existing backlog, anticipated bookings, and future expectations both short and long-term. Crews are equipped with off-road vehicles, vibration sources, geophones, cables, recording systems, and other equipment. There are a minimum of 35 technicians per crew and one central recording system for capturing seismic data. The recording system alone can easily run between $4 and $5 million. Given the capital investment required to field a new crew, the decision to add a new crew is not something that is taken lightly.
Employees
Dawson did not provide an employee count in its recent 10Q filing. As such, Dawson’s employee count and crew & support employees per crew noted above are from the 10K filing for the fiscal year ending in September.
Contract Type
Neither company provides much information with regards to how their contracts breakdown by type. I talked with TGC management to get information on their breakdown and I put a call into Dawson's investor relations. I have not yet heard back from Dawson but when I do I will update the table.
Energy Sources
TGC received shipment on six new buggy mounted vibration vehicles in the first quarter of 2007. The above totals are as of 12/31/2006; therefore, the 6 new vibration vehicles are not included in TGC’s total vehicles. Including the six new vehicles, TGC has 54 vibration vehicles, which brings the number of vibration vehicles per vibration crew to 7.71. TGC also placed an order for 2 new shot hole drill rigs in early 2007 and expects to take delivery on those rigs in the second quarter of 2007.
Dawson expects to take delivery on 18 new vibration vehicles sometime in 2007. As Dawson is converting one dynamite crew to vibration and adding a new vibration crew in 2007, Dawson’s ratio of vibration vehicles to vibration crews will remain relatively constant.
In 2006, TGC purchased the assets of Highlands Industries, a contract shot-hole drilling company. Through the purchase of Highlands Industries, TGC hopes to not only reduce its dependence on third-party contractors and gain greater control over its contract scheduling but also reduce costs and increase margins of its dynamite crews.
Central Recording Systems and Channels
One of Dawson’s crews is currently utilizing a Q-Land system provided by Western Geco (“Geco”), a subsidiary of Schlumberger. The Q-Land system is an acquisition and processing system with over 30,000 channels that has been in use in the Middle East and North Africa. Dawson’s Q-Land crew is working with Geco in West Texas gathering data for a multi-client data library program.
In the most recent conference call, Dawson management indicated that the work for Geco was winding down at the moment. While Geco is compiling the results and marketing the data, Dawson will redeploy the Q-Land crew on one of its I/O System IIs. Management believes the Q-Land has tremendous opportunity in the U.S. but recognizes that it is not a system that will be used everywhere and that it is not a catch-all for all surveys.
Though Dawson does not own the Q-Land system, its experience with the system could prove advantageous in the future.
The Aram ARIES has become the recording system of choice for both TGC and Dawson. TGC put its first Aram ARIES in service in late 2004. Since then, TGC has equipped all new crews with an ARIES. In its fiscal year 2006, Dawson purchased its first two ARIES and intends to purchase two additional ARIES in fiscal 2007. One ARIES will support the 14th crew being added in 2007 and the other ARIES will replace an I/O System II already in service.
While the ARIES has become the recording system of choice, the data recorded by the I/O System IIs is the same as that of the ARIES. Furthermore, both systems use the same sensors and geophones. Nonetheless, the ARIES is a faster system with greater flexibility and a more robust operating system. My sense is that Dawson will slowly replace its I/O System IIs with ARIES, or another newer system.
The Opseis Eagles, made by Sercel, employs radio-frequency (“RF”) telemetry technology providing seismic data-gathering services to land-to-water transition areas, rivers, lakes, inaccessible terrain, deserts, and man-made barriers such as highways and cities.
Dawson’s plan to acquire two new ARIES will add 17,000 channels to its current channel count of 75,000. With a channel count of 92,000 and a crew count of 14, Dawson will have a channel count per crew of 6,571.
TGC expects to take delivery of 4,000 channels sometime in April bringing its total channel count to 36,000. With a channel count of 36,000 and a crew count of 8, TGC will have a channel count per crew of 4,500.
Capital Expenditures
Note that TGC does not budget for capital expenditures but management says they are committed to purchasing and updating equipment to take advantage of advancements in seismic technology and to provide for the addition of new crews as necessary. I expect TGC to announce a number of additional planned purchases during the year. Dawson already increased its capital spending budget for fiscal 2007. I would not be surprised to see a similar announcement later in the year.
Comparison of Financials - TGC vs Dawson
Please note that Dawson’s fiscal year ends in September and TGC’s fiscal year corresponds with the calendar year. In the comparison that follows, I am using trailing-twelve month results for both companies, with the most recent results ending 12/31/2006.
Sales (in thousands)
The growing demand for data acquisition services has prompted both companies to increase capacity and pricing. Capacity expansion has been the major contributor to the recent sales growth for both companies. TGC is growing its revenue faster than Dawson but Dawson’s sales are over two times that of TGC. Clearly it is easier to grow sales at the rate TGC has been growing sales when the starting point is lower.
Operating Margins
TGC’s operating margins have been significantly higher than that of Dawson over the last three years. Nonetheless, TGC’s operating margins decreased a bit from 2005 to 2006 while Dawson’s operating margins increased.
TGC’s dip in operating margins from 2005 to 2006 was likely driven in part by the abnormally high level of lower margin dynamite work in the second half of 2006. TGC management expects the level of dynamite work to normalize in 2007. Furthermore, management expects its acquisition of Highlands Industries to boost the margins on its dynamite work. Finally, the impact of weather on TGC in 2006 was seemingly greater than that of Dawson and greater than that of 2005.
Dawson’s margins improved nicely in 2006 over 2005 due in large part to the higher level of sales, crew productivity, and pricing.
In order to get a better understanding of margin trends and differences between the two companies, it is helpful to compare various expenses as a percent of sales.
TGC Expenses as % of Sales
Dawson Expenses as % of Sales
The difference in operating margins between the two companies is clearly a result of Dawson’s higher operating expenses as a percent of sales. As noted earlier, Dawson has 82 crew and crew support employees per crew compared to TGC’s 58.5 crew and crew support employees per crew. Furthermore, Dawson has twelve employees dedicated to data processing, which is lower margin work relative to data acquisition. The combination of Dawson’s higher headcount per crew and data processing work is likely the reason for its lower operating margins.
With regards to G&A as a percent of sales, both companies have seen a steady improvements over the last two years as sales have increased. G&A expenses are mostly fixed expenses. Thus, G&A as a percent of sales should move lower when sales are higher and vice versa. Dawson’s lower G&A as a percent of sales stems from its higher sales and somewhat offsets its higher operating expenses as a percent of sales.
TGC’s depreciation expense as a percent of sales is nearly twice that of Dawson. Both companies use the straight-line method of depreciation. TGC purchased the majority of its equipment, including several Aram ARIES, in 2005 and 2006. With the type of equipment purchased by TGC and the timing of those purchases, TGC depreciable base relative to that of Dawson is likely higher. At the same time Dawson has a number of I/O System IIs and related equipment that have been in operation for several years. Dawson’s deprecation expense as a percent of sales may be lower as a result of some of its equipment being fully depreciated. To this regard, Dawson is replacing one of its I/O System IIs with a new Aram ARIES in 2007. I wonder if Dawson will be looking to replace more of the older I/O System IIs in the next couple years.
Operating Income (in thousands>
While TGC annualized operating income growth is higher, Dawson’s operating income is nearly twice that of TGC and its growth rate was greater than that of TGC in 2006. When comparing the 2006 growth in operating income, keep in mind that depreciation as a percent of sales increased significantly for TGC but only slightly for Dawson. As such, comparing EBITDA, which removes depreciation expense from the equation, might make for a better comparison.
EBITDA (in thousands)
Removing depreciation from the equation magnifies TGC superior growth rate over the last two years. Furthermore, TGC’s decelerating growth rate and Dawson’s accelerating growth rate in 2006 compared to 2005 is a little less pronounced.
Other Income/(Expenses)
Dawson has no long-term debt and a healthy cash position. As a result of Dawson’s cash position, Dawson typically reports positive other income. In 2006, Dawson had other income of $659,000.
While TGC has a strong cash position, it has utilized commercial bank loans to fund the purchase of some of its equipment. TGC’s long-term debt including current maturities reached a high of just over $9 million at the end of 2005. As a result of TGC’s bank loans, TGC typically reports negative other income. TGC made $3.3 million in principal and $781,000 in interest payments in 2006.
Tax Rate
At different points over the last three years, both companies fully utilized their tax loss carryforwards. Nonetheless, both companies were fully taxable in 2006. I expect the tax rate for both companies to range between 37% and 39%.
Net Income (in thousands>
Earnings Per Share Diluted
With both companies utilizing all of their tax loss carryforwards over the last three years, year-over-year earnings growth and net profit margins do not provide a reliable basis for comparison. As such, investors should focus more on operating income and EBITDA.
In 2006, both companies were fully taxable; therefore, it is reasonable to compare net profit margins for 2006. TGC had superior net profit margins of 11.97% compared to Dawson’s net profit margins of 10.17% in 2006.
Dilution
In October of 2005, TGC completed a public offering of 5.79 million shares raising proceeds of $40.01 million. Proceeds from the offering were used to repurchase stock warrants, purchase a new Aram ARIES along with peripheral equipment and nine new vibration vehicles.
In March of 2005, Dawson completed a public offering of 1.8 million shares. The offering raised proceeds of $41 million which Dawson used to fund its expansion and repay borrowing on a revolving line of credit agreement.
Balance Sheet
TGC has employed a reasonable level of debt to fund its expansion. It has positive net cash of over $3.7 million and interest coverage well over 10x. TGC’s current ratio is just above 1 even with the nearly $4 million in notes payable that come due in the next twelve months and included in current liabilities. As we will see in looking at the cash flow statement, TGC will have no problem paying off the current portion of their debt with operational cash flows. In looking at days-sales-outstanding (DSOs), TGC is doing an excellent job collecting on its receivables.
Dawson’s balance sheet is exceptionally strong with over $15 million in cash and no debt. The only thing that stands out to me is Dawson’s DSOs, especially when compared to TGC. In my DSO calculation I am using ending receivables instead of average receivables. If I use average receivables the DSOs come down to about 77 days. Given Dawson’s strong balance sheet and operational cash flows, despite the relatively high DSOs, the DSOs are not a problem but obviously there is room for improvement.
Cash Flow Statement
Both companies have very strong operational cash flows. Operational cash flows are important because they allow a company to fund capital expenditures, reduce debt, pay dividends, etc. It is interesting to note that TGC’s operational cash flows are greater than that of Dawson despite the fact that Dawson has over twice the earnings of TGC. Probably the biggest difference between the two companies is the change in working capital, which is further evidence that TGC is doing a better job of managing its receivables.
Dawson and TGC put the majority of their operational cash flow to work through capital expenditures. While some of the spending is maintenance spending, the majority is expansionary spending, which bodes well for the future of both companies.
Aside from spending on new equipment, TGC used $1.8 million in cash for the purchase of Highlands Industries. As mentioned above, management expects the Highlands acquisition to improve flexibility and margins of its dynamite crew.
Dawson cashed-in on some short-term investments in 2006. I would imagine management decided to convert the short-term investments to cash in order to utilize the cash for the purchases of new equipment.
In looking at cash flows from financing activities, the only real point of interest I see is TGC’s $5 million in principal payment.
Return Ratios
My calculation of ROIC takes fully taxed operating income divided by total assets less non-interest bearing current liabilities less excess cash. I consider excess cash to be anything over 6.5% of sales.
Valuation and Valuation Ratios
By all the valuation metrics above, Dawson is trading at a premium to TGC. Dawson began trading at a premium to TGC soon after the last earnings announcements from both companies. Dawson put together a very strong quarter with earnings up over 136%. TGC on the other hand reported earnings that were down 23%. Earnings were down for TGC in the fourth quarter because the year-ago quarter had a net tax benefit of nearly $474,000 compared to $1.54 million in taxes paid. Furthermore, operating margins in the last quarter were lower than normal because of the abnormally high amount of dynamite work in the quarter and bad weather. As noted earlier, weather seemed to have a greater impact on TGC than Dawson in the last quarter and that has investors scratching their heads a bit. In looking at the location of the crews for each company, there seems to be some validity to the reasoning. Nonetheless, it is worth watching in the future.
Note that my calculation of FCF, operating cash flow less depreciation, is slightly different from the normal calculation, operating cash flow less capital expenditures. I subtract depreciation instead of capital expenditures because the majority of capital expenditures for both companies are expansionary as opposed to maintenance. By subtracting depreciation, I think it is more indicative of maintenance capex spending; thus, it provides a better estimate of the actual free cash flow.
From a price-to-earnings perspective, both companies are trading at a premium to the market. Given both Dawson’s and TGC’s growth, margins, returns, and future prospects, both companies seemingly deserve the market premium.
Conclusion
I have compiled a lot of information comparing Dawson and TGC. In summary, both companies provide customers with seismic data acquisition services as their primary source of revenue. Dawson is significantly larger than TGC in terms of crew count, employees and equipment per crew, assets, revenues, earning and market capitalization. Both companies have strong balance sheets, rapidly growing sales, and strong margins. While Dawson has a stronger balance sheet, TGC has posted higher growth rates, margins, and returns. Dawson and TGC are generating an abundance of cash from operations but TGC has done a better job in the last twelve months of managing its working capital.
In recent months, Dawson has been trading at a premium to TGC and both companies are trading at a premium to the market as a whole. I suspect Dawson and TGC will switch places many times in terms of one company trading at a premium to the other. At the same time, I expect both companies to continue to post strong growth, margins and returns, which should keep them both trading at a market premium over the next couple of years.
The benefits of seismic data acquisition services are clear. Assuming my thinking is correct in that commodities are in a long-term bull market and oil and gas prices will remain high for the next several years, onshore E&P activity will remain robust and Dawson and TGC will provide investors with above market returns.
Things to Watch
Remember I said weather can have a substantial impact on crew productivity from one quarter to the next. The weather across the nation in January and February was less than ideal for seismic data acquisition services. As such, I expect weather to have a negative impact for both companies in the quarter ending March. Furthermore both companies, and TGC in particular, are up against some tough year-ago comparisons. With the bad weather in the quarter and the tough year-ago comparisons, earnings could be a little disappointing for the March quarter. To the extent these factors have not been priced into the share of either company, a nice buying opportunity may present itself. TGC reports earnings tomorrow and shares are down about 4% on the day. I suspect the weather in the first quarter is getting priced in a bit now.
I expect both companies to report significantly higher depreciation expense in 2007. The higher depreciation expense is likely to mask the underlying growth of each company. As such, I suggest investors pay close attention to EBITDA, cash flow, and free cash flow.
TGC reports Q1 results on Thursday, April 20.
TGC will pay a 5% stock dividend on April 27. Stock dividends are different from cash dividends in that the person holding the shares at the time the dividend is paid will get the shares from the dividend. For all intensive purposes, the record date doesn't matter. When someone sells their shares after the record data and before the payment date, they are not only selling their shares but also the rights to the stock dividend.
Technical Take
Once again, downtowntrader has put together some technical analysis on both TGE and Dawson. For anyone interested in technical analysis, downtowntrader does a great job.
Disclosure
I own shares of TGC.
Sources
TGC 10K
Dawson 10K
Dawson 10Q - Q1 FY2007
Dawson Conference Call Transcript - Q1 FY2007
AP Article on Seismic
IBD Article on Dawson
Dawson Website
TGC Website
TGC New Equipment Announcement - Channels
TGC New Equipment Announcement - Vibration Equipment & Drill Rigs
TGC Acquisition of Highlands Industries
TGC Stock Offering 2005 - Pricing
TGC Stock Offering 2005 - Completion
Dawson Geophysical Company (Public, NASDAQ:DWSN)
TGC Industries, Inc. (Public, AMEX:TGE)
OK…maybe I am lying about the J.J. Fad bit but the seismic data acquisition industry really has been on a tear. I have been following this industry since Bill Mann, co-advisor for The Motley Fool Hidden Gems newsletter, recommended Dawson Geophysical (“DWSN” or “Dawson”), a provider of onshore seismic data acquisition services, in the December 2005 Hidden Gems newsletter.
After Bill Mann made his Dawson recommendation and I did some due diligence, I decided to invest in one of Dawson’s competitors, TGC Industries (“TGE” or “TGC”). Subsequently, the Hidden Gems newsletter identified TGC as a Tiny Gem. A Tiny Gem is an informal recommendation that has Hidden Gem qualities but doesn’t meet all of the criteria necessary to achieve Hidden Gem status (i.e. market cap > $200 million).
If you own shares of Dawson, you likely know of TGC and vice versa, but have you really taken the time to compare the two companies? If not, that is exactly what I intend to do….but first, the basics.
The Case for Onshore
If you read my blog entry for BOOM, you know that I subscribe to the school of thought that commodities are in the midst of a long-term bull market. The last three bull markets lasted an average of 17 years and each bull market was preceded by an equally long bear market. The current bull market started in early 1999.
Since the start of the current bull market, oil and gas prices have risen substantially from their lows of the preceding bear market. While oil and gas prices are off their 2006 highs, they still remain well above historical norms. Given the shrinking supply and growing demand, prices are likely to remain elevated for quite some time. Using history as a guide, the current bull market still has roughly nine years to go (Please don’t rely on history alone when evaluating the sustainability of the current bull market).
When oil and gas prices increase, there is a point where various sources of supply become economically viable for production. That is, the selling price of oil and gas exceeds the exploration and production costs (“E&P”) associated with other sources. For instance, exploration and production cost of offshore sources are less than that of onshore sources. When per unit oil and gas prices are below the onshore per unit costs, there is little to no onshore E&P activity. On the other hand, when oil and gas prices move above the associated costs of onshore E&P and the higher prices are seemingly sustainable, there is an increase in onshore E&P activity. Today, oil and gas prices are well above the cost of onshore E&P. While I don’t know the exact inflection point, most of the information I have read indicates that oil and gas prices could be cut in half and onshore E&P would still remain a profitable endeavor.
The Case for Seismic Data Acquisition
Seismic data acquisition is the process of sending acoustic waves deep into the ground and recording the reflected energy from those waves using a recording system on the surface of the earth. The customer or contractors for the customer subsequently processes and interprets the recorded data. Through the interpretation of the data, customers are able to identify underground formations that are favorable for the accumulation of hydrocarbons; thus, decreasing the likelihood of drilling a dry or marginal well. With the rapidly rising exploration costs and daily rig rates, the cost of drilling a dry or marginal well is far greater than the cost of obtaining a seismic survey. Furthermore, seismic surveys are beneficial to customers because they help the customer increase efficiencies of reservoir location, delineation, and management.
Recent advancements in seismic equipment and computing capacity have taken seismic surveys to a whole new level. Until recently, data acquisition crews conducted surveys in a linear formation to produce a 2-D seismic survey. Today, data acquisition crews conduct surveys over a broad area and collect vast amounts of data that in-turn produces a 3-D seismic survey. The 3-D surveys provide more clarity and are far more valuable to customers.
In a way, the perfect storm has been brewing for onshore seismic data acquisition companies. High oil and gas prices have lead to an increase of onshore oil and gas E&P activity. E&P companies are developing more difficult areas characterized by rugged terrain and/or smaller reservoirs. At the same time, E&P costs from labor to daily rig rates have steadily been moving higher; thus, increasing the cost of drilling marginal or dry wells. While the demand for seismic data acquisition services has been growing, the end product has improved considerably. With the latest technologies in seismic equipment and computing capacity, customers are getting a much clearer picture of what lies beneath, which in turn makes seismic data acquisition services considerably more valuable to the customer.
While the perfect storm is brewing on the demand side for seismic data acquisition, there are sufficient barriers on the supply side to keep the number of seismic acquisition crews reasonably low. The high cost of equipment, long lead times for new equipment, and lack of experienced technicians have kept the number of crews in the field growing at a slow pace relative to demand.
The Survey
Before a survey can begin, the data acquisition company and/or the customer must design the proposed survey, obtain the necessary permits, and setup the survey field, which looks something like this. The preparation process can take several months and the permitting process seems to have the greatest potential for causing delays, outside of weather.
A typical seismic data acquisition crew consists of at least 35 technicians, several off-road vehicles, multiple vibration sources, geophones, cables, a recording system, and other equipment. The vibration source can be either large vibration vehicles or dynamite. The vibration source sends the acoustic waves deep into the ground and geophones on the earth’s surface record the reflections. Multiple geophones linked together with cables form a channel. More channels equal more data and greater efficiencies, which in turn results in superior clarity. Dawson compares the number of channels to the number of pixels in a camera. Multiple channels transmit data to a central recording vehicle.
What You Should Know
Productivity of seismic data acquisition crews will vary from one quarter to the next. The high level of fixed costs associated with the seismic data acquisition business has a magnifying affect on changes in productivity. Usually weather and/or permitting delays have the biggest impact on levels of productivity but timing of new contracts and absorption of new crews can also impact productivity. By absorption of new crews, I am referring to how resources from existing crews get shifted to the new crew in order to bring the new crew up to speed. When this happens there is frequently a negative impact on existing crews.
There are two types of contracts Dawson or TGC will enter into with a customer. A turn-key contract is a fixed fee contract for each unit of data produced. A term contract is a fixed fee contract for each unit of labor (hour, day, or month) worked. While turn-key contracts offer greater upside profit potential, the downtime provisions are usually less favorable. With term contracts, there is less upside profit potential but the revenue stream is steadier and the downtime provisions are usually more favorable.
As mentioned above, the energy source can be either vibration vehicles on the earth’s surface or dynamite placed in shot-holes in the ground. Margins are usually higher on vibration contracts than dynamite contracts. I suspect this is largely due to the quality and quantity of data acquired from dynamite work and the dependence on third party contractors for drilling the shot-holes (I am not positive on this). TGC recently made an acquisition that they hope will improve the margins on their dynamite contracts (see below).
Customers are demanding more and more channels, vibration density, and recording capacity to improve data quality and subsurface resolution. To the extent Dawson and TGC can provide higher quality data, customers are seemingly willing to pay more for the data.
Aside from managing and executing the survey data, seismic acquisition companies may have other sources of revenue such as data licensing and/or data processing.
Comparison of Operations - TGC vs Dawson
In the following comparison, information regarding equipment and financials are made based on the twelve months ended December, 31, 2006, unless noted otherwise.
History
In 1980, Supreme Industries, Inc., a manufacturer of specialized vehicles, formed Tidelands Geophysical Co., Inc. (“Tidelands”) as a wholly owned subsidiary. Tidelands Geophysical purchased the assets of a Houston based seismic, gravity and magnetic surveying company. Six years later, Supreme Industries spun off Tidelands to its shareholders and Tidelands changed its name to TGC Industries.
L. Decker Dawson founded Dawson in 1952. The company exists today in substantially the same form as it did in 1952 and Mr. Dawson continues to serve the company as Chairman of the Board of Directors.
Acquisition Survey Zones
| TGC Industries | Dawson Geophysical | |
| Offshore | No | No |
| Onshore | Yes | Yes |
| Other Zones | Yes | ? |
By "Other Zones", I am referring to land-to-water transition areas, difficult terrain, and heavily cultured areas not easily accessible with a system like the Aram ARIES. TGC's Opseis Eagles are well equipped for this type of terrain.
Data Bank and/or Data Processing
| TGC Industries | Dawson Geophysical | |
| Seismic Data | No | No |
| Gravity Data | Yes | No |
| Magnetic Data | Yes | No |
| Data Processing | No | Yes |
Neither company maintains its own seismic data bank as they feel this would be a conflict of interest with its customers, which may include providers of multi-client data libraries. TGC has amassed gravity and magnetic data banks through participatory surveys and internally funded speculative surveys. TGC licenses the data and interpretations of that data to its customers. TGC’s data licensing revenue does not contribute significantly to overall revenues.
Unlike TGC, Dawson offers data processing services. The data processing end of the business is very competitive and more of a commodity type business. Data processing does not contribute significantly to Dawson’s revenues. Nonetheless, management recently indicated that they are gaining market share in the processing business.
Crew by Type
| TGC Industries | Dawson Geophysical | |
| Vibration Crews | 7 | 11 |
| Dynamite Crews | 1 | 2 |
| Total Crews | 8 | 13 |
In the second half of 2006, TGC was operating two dynamite crews. In the first half of 2006, TGC was operating only one dynamite crew and management expects to be back to operating only one dynamite crew in 2007. Dawson operates two dynamite crews but management plans to purchase additional equipment later in 2007 that will leave only one crew operating solely as a dynamite crew.
At the end of December 2006, there were 55 seismic data acquisition crews operating in the United States.
Recent Crew Growth
| TGC Industries | Dawson Geophysical | |
| Crews as of 12/31/2004 | 3 | 9 |
| Crews added in 2005 | 2 | 2 |
| Crews added in 2006 | 3 | 2 |
| Total Crews 12/31/2006 | 8 | 13 |
| Planned Additions for 2007 | * | 1 |
| Planned Crews 12/31/2007 | * | 14 |
TGC has not announced plans for adding any new crews in 2007. Dawson has announced plans to add one new crew sometime in April. In the past, TGC and Dawson have added crews on an ad hoc basis depending on the current level of bookings and future outlook.
When making a decision to add a new crew, management must carefully consider the associated costs, potential benefit, existing backlog, anticipated bookings, and future expectations both short and long-term. Crews are equipped with off-road vehicles, vibration sources, geophones, cables, recording systems, and other equipment. There are a minimum of 35 technicians per crew and one central recording system for capturing seismic data. The recording system alone can easily run between $4 and $5 million. Given the capital investment required to field a new crew, the decision to add a new crew is not something that is taken lightly.
Employees
| TGC Industries | Dawson Geophysical | |
| Crew & Support | 468 | 984 |
| Crew & Support/Crew | 58.5 | 82 |
| Data Processing | 0 | 12 |
| Management, Sales, Admin. | 13 | 27 |
| Total Employees | 481 | 1,023 |
Dawson did not provide an employee count in its recent 10Q filing. As such, Dawson’s employee count and crew & support employees per crew noted above are from the 10K filing for the fiscal year ending in September.
Contract Type
| TGC Industries | Dawson Geophysical | |
| 2006 | 25% Term / 75% Turnkey | NA |
| 2007/Backlog | 25% Term / 75% Turnkey | NA |
Neither company provides much information with regards to how their contracts breakdown by type. I talked with TGC management to get information on their breakdown and I put a call into Dawson's investor relations. I have not yet heard back from Dawson but when I do I will update the table.
Energy Sources
| TGC Industries | Dawson Geophysical | |
| Vibration Vehicles | 48 | 95 |
| Vibration Vehicles/Vibration Crew | 6.86 | 8.64 |
| Shot-Hole Drill Rigs | 9 | 0 |
TGC received shipment on six new buggy mounted vibration vehicles in the first quarter of 2007. The above totals are as of 12/31/2006; therefore, the 6 new vibration vehicles are not included in TGC’s total vehicles. Including the six new vehicles, TGC has 54 vibration vehicles, which brings the number of vibration vehicles per vibration crew to 7.71. TGC also placed an order for 2 new shot hole drill rigs in early 2007 and expects to take delivery on those rigs in the second quarter of 2007.
Dawson expects to take delivery on 18 new vibration vehicles sometime in 2007. As Dawson is converting one dynamite crew to vibration and adding a new vibration crew in 2007, Dawson’s ratio of vibration vehicles to vibration crews will remain relatively constant.
In 2006, TGC purchased the assets of Highlands Industries, a contract shot-hole drilling company. Through the purchase of Highlands Industries, TGC hopes to not only reduce its dependence on third-party contractors and gain greater control over its contract scheduling but also reduce costs and increase margins of its dynamite crews.
Central Recording Systems and Channels
| TGC Industries | Dawson Geophysical | |
| Aram ARIES | 6 | 2 |
| Opseis Eagles | 2 | 0 |
| IO Systems II RSR | 0 | 6 |
| IO Systems II Cable | 0 | 5 |
| Total Recording Systems | 8 | 13 |
| Recording Channels | 32,000 | 75,000 |
One of Dawson’s crews is currently utilizing a Q-Land system provided by Western Geco (“Geco”), a subsidiary of Schlumberger. The Q-Land system is an acquisition and processing system with over 30,000 channels that has been in use in the Middle East and North Africa. Dawson’s Q-Land crew is working with Geco in West Texas gathering data for a multi-client data library program.
In the most recent conference call, Dawson management indicated that the work for Geco was winding down at the moment. While Geco is compiling the results and marketing the data, Dawson will redeploy the Q-Land crew on one of its I/O System IIs. Management believes the Q-Land has tremendous opportunity in the U.S. but recognizes that it is not a system that will be used everywhere and that it is not a catch-all for all surveys.
Though Dawson does not own the Q-Land system, its experience with the system could prove advantageous in the future.
The Aram ARIES has become the recording system of choice for both TGC and Dawson. TGC put its first Aram ARIES in service in late 2004. Since then, TGC has equipped all new crews with an ARIES. In its fiscal year 2006, Dawson purchased its first two ARIES and intends to purchase two additional ARIES in fiscal 2007. One ARIES will support the 14th crew being added in 2007 and the other ARIES will replace an I/O System II already in service.
While the ARIES has become the recording system of choice, the data recorded by the I/O System IIs is the same as that of the ARIES. Furthermore, both systems use the same sensors and geophones. Nonetheless, the ARIES is a faster system with greater flexibility and a more robust operating system. My sense is that Dawson will slowly replace its I/O System IIs with ARIES, or another newer system.
The Opseis Eagles, made by Sercel, employs radio-frequency (“RF”) telemetry technology providing seismic data-gathering services to land-to-water transition areas, rivers, lakes, inaccessible terrain, deserts, and man-made barriers such as highways and cities.
Dawson’s plan to acquire two new ARIES will add 17,000 channels to its current channel count of 75,000. With a channel count of 92,000 and a crew count of 14, Dawson will have a channel count per crew of 6,571.
TGC expects to take delivery of 4,000 channels sometime in April bringing its total channel count to 36,000. With a channel count of 36,000 and a crew count of 8, TGC will have a channel count per crew of 4,500.
Capital Expenditures
| TGC Industries | Dawson Geophysical | |
| 2006 Capital Expenditures | $23.02M | $24.61M |
| 2007 Capital Budget | No capex budget | $35.1M |
| Planned Purchases | * 6 new vibration | * 2 Aram ARIES with |
| vehicles | 8,500 channels each | |
| * 2 shot-hole drill rigs | * 18 energy source units | |
| * 4,000 channels | * Other technical and operational improvements |
Note that TGC does not budget for capital expenditures but management says they are committed to purchasing and updating equipment to take advantage of advancements in seismic technology and to provide for the addition of new crews as necessary. I expect TGC to announce a number of additional planned purchases during the year. Dawson already increased its capital spending budget for fiscal 2007. I would not be surprised to see a similar announcement later in the year.
Comparison of Financials - TGC vs Dawson
Please note that Dawson’s fiscal year ends in September and TGC’s fiscal year corresponds with the calendar year. In the comparison that follows, I am using trailing-twelve month results for both companies, with the most recent results ending 12/31/2006.
Sales (in thousands)
| TGC Industries | Dawson Geophysical | |
| 2004 | $20,084 | $75,430 |
| Growth '04 to '05 | 53.61% | 73.14% |
| 2005 | $30,852 | $130,597 |
| Growth '05 to '06 | 119.63% | 42.97% |
| 2006 | $67,760 | $186,711 |
| Annualized Growth | 83.68% | 57.3% |
The growing demand for data acquisition services has prompted both companies to increase capacity and pricing. Capacity expansion has been the major contributor to the recent sales growth for both companies. TGC is growing its revenue faster than Dawson but Dawson’s sales are over two times that of TGC. Clearly it is easier to grow sales at the rate TGC has been growing sales when the starting point is lower.
Operating Margins
| TGC Industries | Dawson Geophysical | |
| 2004 | 14.90% | 11.15% |
| 2005 | 23.82% | 10.97% |
| 2006 | 21.52% | 15.95% |
TGC’s operating margins have been significantly higher than that of Dawson over the last three years. Nonetheless, TGC’s operating margins decreased a bit from 2005 to 2006 while Dawson’s operating margins increased.
TGC’s dip in operating margins from 2005 to 2006 was likely driven in part by the abnormally high level of lower margin dynamite work in the second half of 2006. TGC management expects the level of dynamite work to normalize in 2007. Furthermore, management expects its acquisition of Highlands Industries to boost the margins on its dynamite work. Finally, the impact of weather on TGC in 2006 was seemingly greater than that of Dawson and greater than that of 2005.
Dawson’s margins improved nicely in 2006 over 2005 due in large part to the higher level of sales, crew productivity, and pricing.
In order to get a better understanding of margin trends and differences between the two companies, it is helpful to compare various expenses as a percent of sales.
TGC Expenses as % of Sales
| 2006 | 2005 | 2004 | |
| Operating Expenses | 60.26% | 58.84% | 73.23% |
| G&A | 4.41% | 6.97% | 6.36% |
| Depreciation | 14.08% | 10.38% | 5.51% |
Dawson Expenses as % of Sales
| 2006 | 2005 | 2004 | |
| Operating Expenses | 73.61% | 77.92% | 78.42% |
| G&A | 2.75% | 3.69% | 3.78% |
| Depreciation | 7.70% | 7.42% | 6.65% |
The difference in operating margins between the two companies is clearly a result of Dawson’s higher operating expenses as a percent of sales. As noted earlier, Dawson has 82 crew and crew support employees per crew compared to TGC’s 58.5 crew and crew support employees per crew. Furthermore, Dawson has twelve employees dedicated to data processing, which is lower margin work relative to data acquisition. The combination of Dawson’s higher headcount per crew and data processing work is likely the reason for its lower operating margins.
With regards to G&A as a percent of sales, both companies have seen a steady improvements over the last two years as sales have increased. G&A expenses are mostly fixed expenses. Thus, G&A as a percent of sales should move lower when sales are higher and vice versa. Dawson’s lower G&A as a percent of sales stems from its higher sales and somewhat offsets its higher operating expenses as a percent of sales.
TGC’s depreciation expense as a percent of sales is nearly twice that of Dawson. Both companies use the straight-line method of depreciation. TGC purchased the majority of its equipment, including several Aram ARIES, in 2005 and 2006. With the type of equipment purchased by TGC and the timing of those purchases, TGC depreciable base relative to that of Dawson is likely higher. At the same time Dawson has a number of I/O System IIs and related equipment that have been in operation for several years. Dawson’s deprecation expense as a percent of sales may be lower as a result of some of its equipment being fully depreciated. To this regard, Dawson is replacing one of its I/O System IIs with a new Aram ARIES in 2007. I wonder if Dawson will be looking to replace more of the older I/O System IIs in the next couple years.
Operating Income (in thousands>
| TGC Industries | Dawson Geophysical | |
| 2004 | $2,993 | $8,413 |
| Growth '04 to '05 | 145.52% | 70.33% |
| 2005 | $7,349 | $14,330 |
| Growth '05 to '06 | 95.93% | 107.76% |
| 2006 | $14,400 | $29,772 |
| Annualized Growth | 119.33% | 88.12% |
While TGC annualized operating income growth is higher, Dawson’s operating income is nearly twice that of TGC and its growth rate was greater than that of TGC in 2006. When comparing the 2006 growth in operating income, keep in mind that depreciation as a percent of sales increased significantly for TGC but only slightly for Dawson. As such, comparing EBITDA, which removes depreciation expense from the equation, might make for a better comparison.
EBITDA (in thousands)
| TGC Industries | Dawson Geophysical | |
| 2004 | $4,099 | $13,428 |
| Growth '04 to '05 | 157.37% | 78.84% |
| 2005 | $10,551 | $24,015 |
| Growth '05 to '06 | 126.91% | 83.84% |
| 2006 | $23,940 | $44,148 |
| Annualized Growth | 141.66% | 81.32% |
Removing depreciation from the equation magnifies TGC superior growth rate over the last two years. Furthermore, TGC’s decelerating growth rate and Dawson’s accelerating growth rate in 2006 compared to 2005 is a little less pronounced.
Other Income/(Expenses)
Dawson has no long-term debt and a healthy cash position. As a result of Dawson’s cash position, Dawson typically reports positive other income. In 2006, Dawson had other income of $659,000.
While TGC has a strong cash position, it has utilized commercial bank loans to fund the purchase of some of its equipment. TGC’s long-term debt including current maturities reached a high of just over $9 million at the end of 2005. As a result of TGC’s bank loans, TGC typically reports negative other income. TGC made $3.3 million in principal and $781,000 in interest payments in 2006.
Tax Rate
| TGC Industries | Dawson Geophysical | |
| 2004 | 2.19% | -7.23% |
| 2005 | 11.22% | 30.76% |
| 2006 | 40.44% | 37.60% |
At different points over the last three years, both companies fully utilized their tax loss carryforwards. Nonetheless, both companies were fully taxable in 2006. I expect the tax rate for both companies to range between 37% and 39%.
Net Income (in thousands>
| TGC Industries | Dawson Geophysical | |
| 2004 | $2,868 | $9,712 |
| 2005 | $6,201 | $10,716 |
| 2006 | $8,111 | $18,990 |
Earnings Per Share Diluted
| TGC Industries | Dawson Geophysical | |
| 2004 | $0.23 | $1.71 |
| 2005 | $0.45 | $1.48 |
| 2006 | $0.51 | $2.49 |
With both companies utilizing all of their tax loss carryforwards over the last three years, year-over-year earnings growth and net profit margins do not provide a reliable basis for comparison. As such, investors should focus more on operating income and EBITDA.
In 2006, both companies were fully taxable; therefore, it is reasonable to compare net profit margins for 2006. TGC had superior net profit margins of 11.97% compared to Dawson’s net profit margins of 10.17% in 2006.
Dilution
In October of 2005, TGC completed a public offering of 5.79 million shares raising proceeds of $40.01 million. Proceeds from the offering were used to repurchase stock warrants, purchase a new Aram ARIES along with peripheral equipment and nine new vibration vehicles.
In March of 2005, Dawson completed a public offering of 1.8 million shares. The offering raised proceeds of $41 million which Dawson used to fund its expansion and repay borrowing on a revolving line of credit agreement.
Balance Sheet
| TGC Industries | Dawson Geophysical | |
| Cash & ST Investments | $9.389M | $15.275M |
| LT Debt Including Current | $5.676M | $0 |
| Net Cash | $3.712M | $15.275M |
| Net Cash/Share | $0.24 | $2.01 |
| Current Assets | $18.529M | $61.354M |
| Current Liabilities | $17.350M | $14.696M |
| Current Ratio | 1.07 | 4.17 |
| Total Assets | $56.400M | $147.139M |
| Total Liabilities | $21.356M | $21.972M |
| Stockholders Equity | $35.043M | $125.167M |
| LT Debt/Equity | 0.16 | - |
| DSO | 40.12 Days | 88.49 Days |
| DPO | 44.27 Days | 19.36 Days |
TGC has employed a reasonable level of debt to fund its expansion. It has positive net cash of over $3.7 million and interest coverage well over 10x. TGC’s current ratio is just above 1 even with the nearly $4 million in notes payable that come due in the next twelve months and included in current liabilities. As we will see in looking at the cash flow statement, TGC will have no problem paying off the current portion of their debt with operational cash flows. In looking at days-sales-outstanding (DSOs), TGC is doing an excellent job collecting on its receivables.
Dawson’s balance sheet is exceptionally strong with over $15 million in cash and no debt. The only thing that stands out to me is Dawson’s DSOs, especially when compared to TGC. In my DSO calculation I am using ending receivables instead of average receivables. If I use average receivables the DSOs come down to about 77 days. Given Dawson’s strong balance sheet and operational cash flows, despite the relatively high DSOs, the DSOs are not a problem but obviously there is room for improvement.
Cash Flow Statement
| TGC Industries | Dawson Geophysical | |
| Net Income | $8.111M | $18.990M |
| Depreciation | $9.540M | $14.376M |
| Other Adjustments | $1.330M | $6.093M |
| Change in Working Capital | $9.703M | ($18.303M) |
| Cash Flow from Ops. | $28.685M | $21.156M |
| Op. Cash Flow/Net Income | 3.54x | 1.11x |
| . | ||
| Capital Expenditures | ($21.219M) | ($24.612M) |
| Acquisitions | ($1.800M) | - |
| ST Investments | - | $9.971M |
| Other | $0.130M | $0.499M |
| Cash Flow from Investing | ($22.890M) | ($14.192M) |
| . | ||
| Principal Payment Note | ($4.957M) | - |
| Principal Payment Lease | ($0.968M) | - |
| Other | $0.021M | $0.696M |
| Dividend | ($0.001M) | - |
| Cash Flow from Financing | ($5.906M) | $0.696M |
| . | ||
| Net Change in Cash | ($0.111M) | $7.660M |
Both companies have very strong operational cash flows. Operational cash flows are important because they allow a company to fund capital expenditures, reduce debt, pay dividends, etc. It is interesting to note that TGC’s operational cash flows are greater than that of Dawson despite the fact that Dawson has over twice the earnings of TGC. Probably the biggest difference between the two companies is the change in working capital, which is further evidence that TGC is doing a better job of managing its receivables.
Dawson and TGC put the majority of their operational cash flow to work through capital expenditures. While some of the spending is maintenance spending, the majority is expansionary spending, which bodes well for the future of both companies.
Aside from spending on new equipment, TGC used $1.8 million in cash for the purchase of Highlands Industries. As mentioned above, management expects the Highlands acquisition to improve flexibility and margins of its dynamite crew.
Dawson cashed-in on some short-term investments in 2006. I would imagine management decided to convert the short-term investments to cash in order to utilize the cash for the purchases of new equipment.
In looking at cash flows from financing activities, the only real point of interest I see is TGC’s $5 million in principal payment.
Return Ratios
| TGC Industries | Dawson Geophysical | |
| ROA | 16.61% | 14.12% |
| ROE | 26.32% | 16.54% |
| ROIC | 23.52% | 14.51% |
My calculation of ROIC takes fully taxed operating income divided by total assets less non-interest bearing current liabilities less excess cash. I consider excess cash to be anything over 6.5% of sales.
Valuation and Valuation Ratios
| TGC Industries | Dawson Geophysical | |
| Share Price | $8.80 | $51.30 |
| Shares Outstanding | 15.746M | 7.583M |
| Market Cap. | $138.56M | $389.02M |
| Enterprise Value | $132.54M | $373.75M |
| PE | 17.11 | 20.57 |
| EV/EBITDA | 5.52 | 8.47 |
| Market Cap/FCF | 7.24 | 18.39 |
| PE 2007 Estimate | 16.30 | 17.16 |
| PE 2008 Estimate | NA | 14.66 |
By all the valuation metrics above, Dawson is trading at a premium to TGC. Dawson began trading at a premium to TGC soon after the last earnings announcements from both companies. Dawson put together a very strong quarter with earnings up over 136%. TGC on the other hand reported earnings that were down 23%. Earnings were down for TGC in the fourth quarter because the year-ago quarter had a net tax benefit of nearly $474,000 compared to $1.54 million in taxes paid. Furthermore, operating margins in the last quarter were lower than normal because of the abnormally high amount of dynamite work in the quarter and bad weather. As noted earlier, weather seemed to have a greater impact on TGC than Dawson in the last quarter and that has investors scratching their heads a bit. In looking at the location of the crews for each company, there seems to be some validity to the reasoning. Nonetheless, it is worth watching in the future.
Note that my calculation of FCF, operating cash flow less depreciation, is slightly different from the normal calculation, operating cash flow less capital expenditures. I subtract depreciation instead of capital expenditures because the majority of capital expenditures for both companies are expansionary as opposed to maintenance. By subtracting depreciation, I think it is more indicative of maintenance capex spending; thus, it provides a better estimate of the actual free cash flow.
From a price-to-earnings perspective, both companies are trading at a premium to the market. Given both Dawson’s and TGC’s growth, margins, returns, and future prospects, both companies seemingly deserve the market premium.
Conclusion
I have compiled a lot of information comparing Dawson and TGC. In summary, both companies provide customers with seismic data acquisition services as their primary source of revenue. Dawson is significantly larger than TGC in terms of crew count, employees and equipment per crew, assets, revenues, earning and market capitalization. Both companies have strong balance sheets, rapidly growing sales, and strong margins. While Dawson has a stronger balance sheet, TGC has posted higher growth rates, margins, and returns. Dawson and TGC are generating an abundance of cash from operations but TGC has done a better job in the last twelve months of managing its working capital.
In recent months, Dawson has been trading at a premium to TGC and both companies are trading at a premium to the market as a whole. I suspect Dawson and TGC will switch places many times in terms of one company trading at a premium to the other. At the same time, I expect both companies to continue to post strong growth, margins and returns, which should keep them both trading at a market premium over the next couple of years.
The benefits of seismic data acquisition services are clear. Assuming my thinking is correct in that commodities are in a long-term bull market and oil and gas prices will remain high for the next several years, onshore E&P activity will remain robust and Dawson and TGC will provide investors with above market returns.
Things to Watch
Remember I said weather can have a substantial impact on crew productivity from one quarter to the next. The weather across the nation in January and February was less than ideal for seismic data acquisition services. As such, I expect weather to have a negative impact for both companies in the quarter ending March. Furthermore both companies, and TGC in particular, are up against some tough year-ago comparisons. With the bad weather in the quarter and the tough year-ago comparisons, earnings could be a little disappointing for the March quarter. To the extent these factors have not been priced into the share of either company, a nice buying opportunity may present itself. TGC reports earnings tomorrow and shares are down about 4% on the day. I suspect the weather in the first quarter is getting priced in a bit now.
I expect both companies to report significantly higher depreciation expense in 2007. The higher depreciation expense is likely to mask the underlying growth of each company. As such, I suggest investors pay close attention to EBITDA, cash flow, and free cash flow.
TGC reports Q1 results on Thursday, April 20.
TGC will pay a 5% stock dividend on April 27. Stock dividends are different from cash dividends in that the person holding the shares at the time the dividend is paid will get the shares from the dividend. For all intensive purposes, the record date doesn't matter. When someone sells their shares after the record data and before the payment date, they are not only selling their shares but also the rights to the stock dividend.
Technical Take
Once again, downtowntrader has put together some technical analysis on both TGE and Dawson. For anyone interested in technical analysis, downtowntrader does a great job.
Disclosure
I own shares of TGC.
Sources
TGC 10K
Dawson 10K
Dawson 10Q - Q1 FY2007
Dawson Conference Call Transcript - Q1 FY2007
AP Article on Seismic
IBD Article on Dawson
Dawson Website
TGC Website
TGC New Equipment Announcement - Channels
TGC New Equipment Announcement - Vibration Equipment & Drill Rigs
TGC Acquisition of Highlands Industries
TGC Stock Offering 2005 - Pricing
TGC Stock Offering 2005 - Completion
Dawson Geophysical Company (Public, NASDAQ:DWSN)
TGC Industries, Inc. (Public, AMEX:TGE)
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