This is a re-post of the Mr. Harkant’s analysis originally posted on Stock2Own forum. I’m trying to keep original formatting, tables and other media prepared by the author. Mr. Harkant did a fantastic job analyzing and combining multiple sources into a comprehensive report. Enjoy the reading!
Schlumberger offers technical services and products to the oil production industry. The company focuses on technology, project management, and information.
The Company’s segments include Reservoir Characterization Group, which consists of the principal technologies involved in finding and defining hydrocarbon deposits; Drilling Group, which consists of the principal technologies involved in the drilling and positioning of oil and gas wells, and Production Group consists of the principal technologies involved in the lifetime production of oil and gas reservoirs and includes Well Services, Completions, Artificial Lift, Well Intervention, Subsea, Water Services, Carbon Services and the Schlumberger Production Management field production projects.
Oil production is becoming more difficult. New sources of petroleum are increasingly located in remote geographic locations, such as deep-water sites off shore.
Schlumberger is squarely positioned to benefit from the difficulties encountered when producers attempt to extract petroleum from hard-to-reach oilfield locations. While the energy sector has hit a rough patch, Schlumberger is a diamond in the rough.
Schlumberger is the biggest oilfield-services company in the world. The source of Schlumberger’s durable competitive advantage lies in (1) the breadth and depth of the company’s products and services, which create high switching costs, and (2) the company’s global footprint (i.e., economies of scope).
Schlumberger’s strength comes from its massive research and development expenditure and the geographic diversity of its portfolio that helps it to deliver superior customer solutions that are tailored to specific geographic needs. In 2012, the company spent $1.168 billion in R&D, increasing by 8.9% from $1.07 billion in 2011. Unlike its competitors such as Halliburton (HAL) that gets more than half of its revenue from North America, Schlumberger earns 68.1% of its revenue from outside of its home territory. Schlumberger is truly global with operations in 85 countries where it employs 115,000 people and operates either independently, through its associates or through joint ventures.
Backed by its extensive experience and millions spent on research and development, Schlumberger has developed a new fracking (or hydraulic fracturing) technique called channel hydraulic fracturing that can reduce the water consumption by up to 60% and increase production by 20%.
Today’s technique for finding oil, and bringing it to market, were all developed by Schlumberger. And throughout the recent fracking boom, the company was busy buying companies like GeoServices and ThruBit to expand its portfolio. Most of the deals it has done in the last five years are either purchases of private companies or divisions of other companies, and only get reported in the industry trade press.
All of the industry’s trends serve to benefit Schlumberger further. The pending merger of Halliburton (NYSE:HAL) and Baker Hughes (NYSE:BHI) will force the sale of assets that will strengthen Schlumberger, and will weaken the balance sheet of its primary competitor, Halliburton. The fall in oil prices demands that producers buy new technology to increase supply. Power in the industry is moving toward Schlumberger technology and away from oil producers.
Chief Executive Officer
Paal Kibsgaard is chief executive officer of Schlumberger Limited. Prior to this position, Kibsgaard held a variety of worldwide management positions including chief operating officer; vice president of Engineering, Manufacturing and Sustaining; vice president Human Resources for Schlumberger Limited; and president of Schlumberger Drilling & Measurements.
Earlier in his Schlumberger career, Kibsgaard was GeoMarket manager for the Caspian region after holding various field positions in technical sales and customer support.
A petroleum engineer with a master’s degree from the Norwegian Institute of Technology, Kibsgaard began his career in 1992 working for ExxonMobil. In 1997, he joined Schlumberger as a reservoir engineer in Saudi Arabia.
Schlumberger’s financials are a picture of prosperous stability. For the September quarter, it earned $1.949 billion and $1.49 per share on revenues of $12.659 billion. Compare this to the $1.715 billion in earnings, $1.29 per share and revenue of $11.651 billion a year earlier. The company beat its own earnings expectations for the third quarter despite falling prices.
At its current price, Schlumberger is trading at a P/E of about 16 and a yield of 1.86%. Expect that multiple to decline, and that yield to increase, as the month wears on. The company will doubtless experience some difficulties as those who pay its bills hit the wall, but it has cash reserves of $6.8 billion to cushion any blow.
FUTURE GROWTH PROSPECTS
Therefore, like in 2012, growth in the current year (2013) will be driven by activities outside of North America. The demand for oil is continuously rising but it looks like shale gas will also have an important role to play in the future.
There are new opportunities springing up in the Chinese shale gas sector. After its second round of shale gas auctions, China’s Ministry of Land Resources has announced that 16 firms, mostly state-owned enterprises, have pledged to invest $2.06 billion in the next three years on shale gas projects. Although the country is home to the world’s largest technically recoverable shale gas reserves of 1,275 trillion cubic feet or 36.10 trillion cubic meters (2009 estimates of U.S. Energy Information Administration) but the Chinese government officials have admitted that the country would rely on the technological support of Western firms to tap into its unconventional gas resources. This is where the three American oil field services firms in general — Schlumberger, Halliburton and Baker Hughes (NYSE:BHI) — and Schlumberger in particular come into play.
While the economy is picking up in the U.S., the rest of the world is experiencing prolonged economic troubles. Europe, Japan, and emerging markets are still down.
Russia is experiencing severe economic woes, including a currency crisis, due to western sanctions over the conflict with Ukraine and falling oil prices. The oil and gas sector comprise a disproportionate share of the Russian economy.
Schlumberger has a major presence in international markets, including Russia. Global economic woes could weigh on Schlumberger’s profit margins for some time to come.
While the commodity price cycle will start to reverse, it is uncertain exactly when this will happen. Oil and gas prices could remain low for a prolonged period before the cycle starts to reverse.
According to thehydrocarbon.com press release from October 20, drilling activity is actually going up in the U.S. despite the crush in oil price. U.S. rig count climb continues despite oil drop. In Q3 2014 the average U.S. onshore rig count added 46 rigs (3%) to make for a total of was 1,842 rigs. When matched up with last year’s Q3, the total is up 133 rigs or 8%. In fact, in the latest week before the announcement, as oil prices have slumped, the count has still increased by another 18 rigs. A $20 drop in the price of oil has not lowered activity at all.
According to Schlumberger, it continues to believe that the slow but steady recovery in the world economy is intact. While market sentiments are currently driven by fear of short-term over-supply, and although the oil demand outlook has been revised slightly downwards, the company sees a supply-demand situation that is relatively well-balanced. Furthermore, Schlumberger said on its Q3 conference call that it does not expect any decline in services despite this initial downturn in oil prices.
Halliburton (HAL) and Baker Hughes (NYSE:BHI) are in the middle of a buyout/merger. Their combined company would be larger than Schlumberger Limited (NYSE:SLB), but with the expected contraction of redundancies, the combined company may end up being same size/slightly smaller than SLB.
HAL’s Rule 1 numbers are worse than that of SLB. Debt is higher also:
Schlumberger has been paying uninterrupted dividends since 1982, the forward annual dividend yield is at 1.68% and the payout ratio is only 29.0%. The annual rate of dividend growth over the past three years was high at 14.2%, over the past five years was at 8.3%, and over the past ten years was also high at 12.8%. I consider that besides dividend yield, the consistency and the rate of raising dividend payments are the most crucial factors for dividend-seeking investors, and SLB’s performance has been very good in this respect.
- Annual dividend growth may remain at around 20% over the next few years with both free cash flow and earnings payout ratios being steady.
- Current stock valuation has only priced in ~10% dividend growth rate.
- Given the current low valuation and strong dividend growth potential, dividend yield on current cost should reach 2.0%-2.6% by February 2016.
As of the 2nd quarter 2014, Schlumberger has repurchased $2.6 billion under the $10 billion share buyback program.
On the second-quarter conference call in July, CEO Paal Kibsgaard announced that the company would accelerate its $10 billion share buyback program thanks to its strong free cash flow. It will now seek to complete the program in two and a half years instead of the original target of five years.
VALUATION (MARGIN OF SAFETY)
Schlumberger’s valuation metrics are good; the enterprise value-to-EBITDA ratio is low at 9.92, and the average annual earnings growth estimates for the next five years are very high at 16.22%. The forward P/E is at 15.03, and the PEG ratio is low at 1.05. The PEG Ratio – price/earnings to growth ratio is a widely used indicator of a stock’s potential value. It is favored by many investors over the P/E ratio because it also accounts for growth. A lower PEG means that the stock is more undervalued.
According to its historical valuation ratios, SLB’s stock is extremely undervalued.
Rule 1 valuation based on projected EPS growth:
As the world’s leading oilfield services company, Schlumberger Limited (NYSE:SLB) will continue to benefit from the climb in U.S. rig count. Schlumberger has good valuation metrics, strong earnings growth prospects. The company has shown earnings per share surprise in each one of the last four quarters, and according to its historical valuation multiples, the stock is extremely undervalued. This also does not factor in the remaining approximately 7 Billion dollar stock buyback (current market cap is 110 B).
Schlumberger is generating strong cash flows, and it returns value to its shareholders by stock buyback and increasing dividend payments. All these factors bring me to the conclusion that SLB stock is a smart long-term investment.