Like many stocks in recent weeks, Lufkin (LUFK) has sure been a roller coaster. After recommending the stock back in July at about $78, the stock soared after an exceptional earnings report, only to completely collapse over the last week or so in the broader oil/commodity sell-off. Given sharp share price drop, I thought it might pay to take a step back and run an earnings stress test on LUFK assuming oil prices continue to decline dramatically. Interesting, this type of stress test can be done for many other oilfield service shares, in order to determine potential downside in the event that oil prices do not stabilize (an unlikely scenario in my opinion).

In looking at past 10-K’s, I noticed that back in 2006 when oil prices were in the 50′s and natural gas prices were at about current levels ($7.50 MCF), LUFK was still able to earn nearly $5 per share. Going back to 2005, with oil prices below $50 and natural gas at under $6, LUFK earned $3 per share. Even going back to 2000, to before oil even entered most speculator’s minds, LUFK was profitable and was earning over a $1 per share.

As one can see, sharply lower oil prices will have no effect on LUFK’s profitability, though of course the level of profits would fall off. But, since the recent years numbers are prior to the huge jump in oil prices and record profits at oil producers, it seems clear that even if oil prices would fall by another 50%, LUFK would still earn about $4+ per share (Note: oil producers are so flush with cash, they can and will spend on infrastructure for years even at much lower oil prices). This earnings level, combined with $100 million in cash, no debt, and low cap-ex needs, leads me to believe that the downside in LUFK is quite low at current prices.

Assuming 10X low-end estimates of $4 per share (in a $50 crude environment) + cash, LUFK would probably still be worth about $50, or about 30% below current prices.

On the upside, if oil prices remain at higher levels (even assume $80 oil), it seems clear that LUFK will earn well above $5 per share and the stock would be valued at much higher levels. Currently, I actually estimate that LUFK will earn over $6 per share over the next year, giving me an upside value of $100+.

Fair value, given the above numbers, if you assume a 50% chance of oil going back to $50, would then be about $75.

In conclusion, though it’s disheartening to see such huge drops in formerly profitable holdings, I think it’s important to remember that stocks like LUFK are by no means comparable to the .com’s of old, which imploded and never recovered. Those .com’s had no earnings, cash-flow or any type of business model. It was truly a bubble. In the case of LUFK, there has been solid demand for LUFK’s products for over 100 years already, and there will probably be solid and increasing demand for the next 100 years. As such, I see no reason to panic, and believe the stock still represents an excellent investment in the energy space in the year ahead, for the reasons detailed in my first report.