Combining municipal construction operations with mineral exploration sounds like it should be something out of a Dickens novel ("It was the best of times ..."), but that's the basic story at Layne Christensen (Nasdaq:LAYN). While mineral exploration activity continues at a strong pace, municipalities are spending less on water projects. While Layne Christensen has an interesting mix of businesses and seems undervalued today, management must prove that it can consistently deliver free cash flow, if this stock is going to work.

Investopedia Markets: Explore the best one-stop source for financial news, quotes and insights.

A Disappointing Result
Layne Christensen did not post an especially strong third quarter. Though this relatively under-followed company beat the revenue expectation and posted 9.3% top line growth, margins and earnings were disappointing.

Revenue growth was driven almost exclusively by the mineral exploration business, where revenue rose almost 40%. Water was quite a laggard, with reported revenue growth of under 3% and acquisition-adjusted "growth" of negative 6%. The company's unconventional energy business chipped in about 3% growth, as well.

Margins were a disappointment; gross margin slid nearly a point and operating income declined almost 5% from the year-ago level. Although the energy business reversed a year-ago loss and posted a small profit, the water business was a big disappointment. With margins pressured by tough budgetary environments and cost overruns, segment income fell 67%, offsetting the 79% income growth in mineral exploration. (To know more about income statements, read Understanding The Income Statement.)

Mining Good, Municipalities Bad
Mining activity is still moving along at a very healthy pace. So long as copper stays above $3 a pound, miners are interested in advancing projects. Keep in mind, though, that Layne does not deal so much with the Freeport-McMoRan's (NYSE:FCX) or Rio Tinto's (NYSE:RIO) of the world; their focus is more on the junior miners in copper and gold. However, so long as copper and gold prices can clear the production costs of junior miners, Layne Christensen's exploration rigs are likely to be busy. Although there is some risk of saturation, competitors like Boart Longyear (OTCBB:BLGPY) and Major Drilling Group (OTCBB:MJDLF) have survived past market gluts and won't be looking to kill the golden goose.

The water side of the ledger is a much different story. Special projects like Afghanistan are winding down for Layne Christensen and the general state of municipal water markets is poor, as state and local budgets remain under pressure.

Are investors still even interested in the water story? It seems like this has been the next great market for years now, and sources like Forbes, Wall Street Journal and Barron's have flogged the story relentlessly. Now, that story may eventually play out, but it won't likely happen any time soon and investors in names like Mueller (NYSE:MLI), Badger Meter (NYSE:BMI) and Aegion (Nasdaq:AEGN) have to be getting a little tired of the wait.

The Bottom Line
There is a lot to like about the Layne Christensen story. Municipal water infrastructure should be a solid (if slow-growing) long-term business, while mineral exploration offers some boom/bust excitement. Moreover, the company's returns on capital are not terrible.

What's problematic, though, is the record of free cash flow performance, or rather the lack of it. Layne Christensen has posted negative free cash flow in four of the last 10 years, and basically insignificant amounts in three other years. This has to change, for the stock to work as a long-term holding. The stock could certainly rebound from here, if and when municipalities start spending again, and metrics like P/E and enterprise multiple look reasonable, but long-term success has to be predicated on good economic returns and cash flow. For investors willing to believe that new management can guide the company in that direction, these shares are worth a serious look today. (For additional reading, check out 5 Must-Have Metrics For Value Investors.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  2. Fundamental Analysis

    4 Predictions for Oil in 2016

    Learn four predictions for oil markets in 2016 including where prices are heading and the key fundamental factors driving the market.
  3. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  4. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  5. Investing News

    Is Buffett's Bet on Oil Right for You? (XOM, PSX)

    Oil stocks are getting trounced, but Warren Buffett still likes one of them. Should you follow the leader?
  6. Economics

    Will Silver Recover in 2016? (SLV, GLD, JJC)

    The end of the silver downtrend is likely to coincide with similar recoveries in gold, iron and copper.
  7. Stock Analysis

    The Top 5 Silver Penny Stocks for 2016 (LODE,AG)

    Learn about five of the top silver penny stocks and why investors may want to consider adding them to their investment portfolios in 2016.
  8. Investing News

    Chipotle Served with Criminal Probe

    Chipotle's beat muted expectations and got a clear bill from the CDC, but it now appears that an investigation into its E.coli breakout has expanded.
  9. Stock Analysis

    Analyzing Sprint Corp's Return on Equity (ROE) (S)

    Learn about Sprint's return on equity. Find out why its ROE is negative and how asset turnover and financial leverage impact ROE relative to Sprint's peers.
  10. Stock Analysis

    Why Alphabet is the Best of the 'FANGs' for 2016

    Alphabet just impressed the street, but is it the best FANG stock?
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
Trading Center