Problem solvers are valued by customers
I remember how many students, presenting their business proposals for an entrepreneurship module in my university days, were unable to answer a simple question from the professor: “What problems does this company solve for its customers?” It is a simple question that separates successful companies which retain and grow their customer base from failures which saw their customer walk out of the door.
It will be easy to illustrate the value of Ion Geophysical Corp (NYSE:IO)’s services and its importance to customers, through a few examples of the kind of problems that its customers face. For example, the Arctic, where a quarter of global undiscovered reserves is thought to be, is tempting for many exploration and production companies, but they have difficulty in acquiring sufficient data to mitigate exploration risk. Ion Geophysical Corp (NYSE:IO) has proprietary under-ice technology that allows it to provide critical seismic data for customers in certain areas in the Arctic, which was previously not possible. Back to the example of shale gas, with low natural gas prices, shale operators have to be more efficient with their exploration efforts to protect their margins. That is where Ion Geophysical Corp (NYSE:IO)’s 3D ResSCAN program comes into play, helping customers reduce development costs with better measurement techniques.
Asset light model avoids the twin evils of leverage
I am skeptical when I read research reports where analysts are positive on certain high-ROE companies because of high operating leverage and financial leverage. Leverage is a double-edged sword that cuts both ways. During good times, higher leveraged companies outperform their peers in terms of profit margins and ROEs. However, when the tide turns, excessive debt levels and a high proportion of fixed costs to variable costs could result in operating losses and bankruptcy.
Ion Geophysical Corp (NYSE:IO) maintains an asset-light model by focusing on its strengths in technology and owning only the seismic equipment, data processing infrastructure and software. It neither owns any seismic data acquisition assets such marine vessels nor operates any land crews of its own. Instead, third party contractors are hired to do most of the seismic data acquisition work for Ion Geophysical Corp (NYSE:IO). As a result, ION Geophysical keeps its fixed costs and capital expenditures low with this strategy. Also, it has a strong balance sheet with a low gearing of about 20%, as it does not incur huge amounts of debt since it does not have to finance vessel ownership. In the event that oil & gas prices drop and business activity decreases, the negative impact on margins and ROA will be less severe, given ION Geophysical’s smaller asset base.
Peer comparison
ION Geophysical’s peers include Dawson Geophysical Company (NASDAQ:DWSN) and CGG Veritas.
CGG Veritas, based in Paris, France, provides a range of geological, geophysical and reservoir related services to its customers in the oil & gas industry. It owns Sercel, a direct competitor of Ion Geophysical Corp (NYSE:IO), which has a 60% market share of the seismic equipment market, according to its most recent investor presentation. ION Geophysical’s edge over CGG Veritas is its asset-light model, reflected in a higher ROA of 6.1%, double than of CGG Veritas’s ROA of 3.0%. In line with the reasoning above that an asset light model requires lower leverage; CGG Veritas is more highly geared than ION Geophysical, with a gross debt-to-equity ratio of 55%.
Operating leverage cuts both ways and the tables might be turned in boom times. Investors in CGG Veritas will contend that it has a competitive advantage in that case by owning marine vessels and operating land crews of its own, making it less susceptible to vessel and manpower shortage. Moreover, given its dominant market share, CGG Veritas is able to extract cost savings from its asset heavy model by spreading its fixed costs over a larger base.
However, being a conservative investor, I prefer a seismic data related products and services provider like Ion Geophysical Corp (NYSE:IO) which has the ability to weather bad times by simply engaging less contract ships. In contrast, it is more difficult for CGG Veritas to dispose of ships or lay off workers when things are not going well. I will gladly exchange the upside of operating leverage, in exchange for downside protection in the form of an asset light operating model.
Unlike its peers, Dawson Geophysical Company (NASDAQ:DWSN) does not provide offshore seismic data acquisition services; instead it focuses on onshore imaging services. It also actively avoids conflicts of interest issues, as it neither sells data acquired as part of client assignments, nor stores such data in its own data libraries. Dawson Geophysical Company (NASDAQ:DWSN) has the strongest balance sheet of the three with a net cash financial position.
Conclusion
I like companies like Ion Geophysical Corp (NYSE:IO), which provide critical “must-have” services to customers and have the ability to weather difficult conditions. ION Geophysical ticks the boxes on both counts and is attractively priced at a PEG below 1.
Mark Lin has no position in any stocks mentioned. The Motley Fool recommends Dawson Geophysical Company (NASDAQ:DWSN). The Motley Fool owns shares of Dawson Geophysical Company (NASDAQ:DWSN).
The article This Company Solves the Most Critical Problem That Its Customers Face originally appeared on Fool.com.
Mark is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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