Seismic Survey Says...

Shares of Veritas DGC (VTS) climbed 9% to $37.28 Thursday after the Houston company beat Wall Street's fiscal first-quarter earnings estimate by 77% thanks to soaring sales and an insurance settlement.

"Veritas posted excellent fiscal first-quarter earnings, easily surpassing expectations," says Stephen Gengaro, an analyst at New York investment bank Jefferies & Co. "Record backlog, strong demand for both multiclient surveys and contract work and an excellent energy environment support our bullish outlook for the stock." Gengaro reiterated his Buy rating and $38 price target. (Gengaro doesn't own shares of Veritas DGC; Jefferies & Co. doesn't have an investment-banking relationship with the company.)

For the three months ended Oct. 31, Veritas reported net income of $11.8 million, or 32 cents a share, a 12-fold surge over the $978,000, or three cents, earned in the same period last year. Excluding a pretax gain of $2 million related to insurance settlements for lost equipment, income was 30 cents a share. Thomson First Call had a consensus estimate of 18 cents. Revenues jumped 30% to $168.7 million. Operating margins climbed to 10.8%, vs. 2.4% a year ago.

Veritas uses seismic data, acquired by sending out sound waves and recording the vibrations, to create images of what lies below the ground. The company makes money two ways: selling access to its library of seismic data, and performing custom location surveys for oil and gas companies. The surveys help petroleum companies manage reserves and find new drilling locations.

"The exploration cycle is starting to kick in, and as more oil companies spend on drilling they need more data, creating more demand for Veritas's service and data," says Joe Agular, an analyst at Johnson Rice & Co., a New Orleans brokerage. "With a higher return on investment and higher commodity prices, the quantity of drilling is increasing and oil companies are spending more." (Agular doesn't own shares of Veritas DGC; Johnson Rice & Co. doesn't have an investment-banking relationship with the company.)

Oil prices hit a record high of $70.85 on Aug. 30 on strong demand from China and India and supply fears spurred by hurricanes and America's war in Iraq. Prices had eased slightly in recent months, but a cold snap across the country this week increased demand for heating fuel, reigniting the rally in oil and natural gas. On the New York Mercantile Exchange Thursday, natural gas jumped 9% to a record high of $15.08 per million British thermal units and January crude oil futures climbed $1.45 to $60.66 a barrel.

"Commodity pricing is definitely a factor, but it's more than that," says Mark Baldwin, Veritas's chief financial officer. "The biggest driver is the supply/demand balance. That affects the commodity price, but it also puts pressure on customers to replace their reserves. Up until about 18 months ago, exploration spending had been flat. But it has started to pick up quite nicely. There is now an increased focus on exploration to find new reserves, coupled with more money from higher commodity prices, that's driving seismic spending higher."

The company doesn't give earnings or revenue guidance, but Baldwin says Veritas plans to spend between $140 million and $160 million this fiscal year on new surveys for its library. Capital expenditures for equipment to acquire data will be in the range of $60 million to $65 million.

Both of Veritas's business lines prospered in its fiscal first quarter. Library revenues soared 65% to $74.5 million. Increases came primarily from surveys in process in the Gulf of Mexico, Canada and the North Sea. Contract revenue rose 11% to $94.2 million.

As of Oct. 31, the company posted a record backlog of $459 million, compared with $302 million on July 31, and $252 million in the year-earlier quarter. Veritas ended the fiscal first quarter with approximately $228 million in cash and $155 million in convertible debt.

"Veritas's revenue increase moves in conjunction with the overall spending on exploration," says Johnson's Agular. "This will last as long as we have this type of commodity price environment. And I expect this to last a while, maybe five years, as a lot of companies spend a lot on drilling. With fundamentals like this in place, Veritas should do very well."

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"You are seeing a little bit of a shift from exploitation mode to exploration mode," says Jefferies' Gengaro. "The oil companies are working hard to find oil and gas and that's what's driving the oil-services industry. The shift to searching for new reserves should result in a larger amount of dollars spent on seismic data. We assume crude oil demand will grow at a steady 1.5%, but slower than the past year. Right now, our view is that oil-service companies offer a better return for investment than the oil companies. We think this cycle will persist for the next 12 months and into 2007, and probably longer."