I wrote a bullish article on Dawson Geophysical (DWSN) (referred to as "Dawson" for the balance of this article) in late January and since then, the company is down roughly 10% after reporting less than stellar Q1 results. While it is never good to put too much emphasis on near term quarterly results, we should also not blind ourselves to them.
The main investment thesis for Dawson is that it is cash flow rich, possesses a conservative balance sheet and is in the latter stages of a major equipment overhaul. Once this equipment upgrade has been completed, shareholders should start to see more of the company's cash flow directed to them in the form of a regular dividend or share buyback plan. With that in mind, let us look to the Q1 results to see if this thesis still holds.
Brief Company Overview
Dawson is a seismic services provider to the O&G industry and operates primarily in the continental US ("the Lower 48"). They operate in every major basin in the Lower 48 and their primary customers are E&P's that operate in the region.
Seismic data acts like a modern day divining rod, allowing E&P's to understand the geology of what lies beneath the surface of their respective plays. This allows them to make better informed decisions about which plays should be drilled, where wells should be placed etc. Developing wells is an expensive proposition so E&P's generally like to have as much data as possible before moving forward with development.
Dawson generates seismic data by placing seismic receivers (that can have one or multiple "channels") across the surface area of the play in question which then record generate acoustical energy that Dawson's field teams generate through either truck mounted vibrator units or dynamite.
Dawson has one of the biggest and most advanced seismic recorder fleets in operation in the Lower 48 and due to this, they have a high level of operational flexibility that most competitors cannot match. For a more in depth review of the company's operations, please reference my previous article. Now on to Q1 results.
What Went Wrong
Utilization: Dawson has the capacity to operate 12 large channel count crews in the Lower 48 but only operated 6-7 in the first half of the quarter. This is obviously not ideal but had been forecast by the company all the way back in August 2013 and can be primarily attributed to a soft order market in the summer months of 2013. As it takes at least a few months to convert orders into revenue, it is not hard to see how a soft order market in the summer could lead to low revenue generation in the waning months of 2013.
In a business that is dependent on maintaining high levels of utilization, operating below 50% is not a recipe for success and the quarter's financial results bear this out. If the company were to maintain this level of utilization going forward there would need to be major structural changes to right size the company's operating crew count.
Luckily for investors, the soft summer market was somewhat of an aberration as the company has been reporting a stronger demand for seismic services ever since. This is evident by the fact that the company has now transitioned to full utilization of its 12 crews in the second half of fiscal Q1.
Weather: Weather issues are a fact of life in this business but this past winter has proven to be particularly difficult with the severe cold and heavy snowfall in the company's operating regions lowering utilization levels. In other words, even when the company was able to activate all of its operating crews, utilization continued to be a drag on the company's financial results due to adverse weather conditions. While this may continue to cause some drag on near term performance due to continued harsh weather in January and February 2014, I would not expect this to be a regular problem going forward. I live in the Northeast and I can say firsthand, this winter season has been uncommonly rough.
Canada Operations: While the company primarily operates in the Lower 48, it has made an attempt to break into the Canadian seismic market. While hindsight is always 20/20, this move has clearly been a mistake at least in the near term. The Canadian market is extremely competitive, constantly beset by poor weather conditions and is currently experiencing wide differentials in its energy pricing when compared to US counterparts. These differentials are causing E&P's to pull back on their Canadian development programs.
While the company only has one crew working in Canada, it continues to be a financial drag on the company. Once the current slate of Canada projects are completed, I would hope and expect company management to take a hard look at the viability of Dawson's presence in the region.
Cash Burn: At the end of 9/30/13, Dawson had $76M of cash and cash equivalents. Three months later, that balance had decreased to $38M which, at a headline level, is somewhat alarming. However, as we dig further into this we can see that this should be a temporary issue that will reverse as we progress through 2014.
One of the main drivers of this cash burn was the $18M increase in A/R which should reverse out as company collects payments from customers. The other main driver was the purchase of a new GSX recording system for $25M which was part of the company's multi-year equipment overhaul.
Given the company's reaffirmation of its $35M capital expenditure plan for FY 2014, we should expect the company to be in cash collection mode for the balance of the year.
What Went Right
Dividend Program: One of the main points of my original article on Dawson was the idea that the company should begin to start directing some of its free cash flow to shareholders. With this in mind, it was gratifying to see the company institute a regular dividend policy. While the amount distributed is smaller than I would like, this particular glass wall has now been broken and I would expect the company to steadily increase the disbursement or add on supplemental special dividends as management gets more comfortable with this policy. I am particularly optimistic about the verbiage from the quarterly earnings release:
"We will continue to evaluate from time to time supplemental dividend payments depending on market conditions, financial performance and capital needs in an effort to increase returns for shareholders."
Return to Full Utilization: As discussed, one of the major issues that the company experienced in Q1 of FY14 was the low level of utilization which was primarily driven by low demand for seismic services in the summer and by inclement weather. However, the company is now operating at full crew utilization and is expected to remain at this level at least for the next three quarters. This higher level of utilization should translate into much better financial results for the balance of FY14.
Forecasted Demand: Company management is forecasting steady demand for seismic acquisition services for the remainder of 2014. This should hopefully aid the company in maintaining utilization levels going forward.
Conclusion
In sum, I believe that Q1 '14 was an operationally difficult quarter for the company characterized by somewhat unusual weather circumstances and soft demand that should be well behind us at this point. As the company has returned to full crew utilization, I would expect much better results going forward.
The company's implementation of a dividend policy is encouraging and I continue to believe that the company is near the completion of its equipment overhaul which should allow the company to reward shareholders with higher dividends and share buybacks going forward.
I continue to believe that the company is capable of generating ~$35M of free cash flow on a regular basis assuming a $10M maintenance capex figure. Given the company should have a cash balance of ~$70M by the end of FY14 and virtually no debt, the company's $230M market cap seems like a bargain.
Disclosure: I am long DWSN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
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