Seeking Value in the US: Schlumberger

Oil and industry company still delivered slumping sales in recent quarter

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Jun 13, 2017
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Schlumberger (SLB, Financial), the $97 billion oil and gas service provider, logged 5.7% revenue growth to $6.9 billion in the first quarter but reported a 44% profit drop to $279 million (4% margin vs. 7.7% in the year earlier period).

Along with an added $82 million cost associated to merger and integration of the company’s acquisition of Cameron, costs of sales markedly shot up by 174% to $1.8 billion therefore leading to lower profits.

Chairman and CEO Paal Kibsgaard provided a lengthy update of the overall oil and gas industry condition in relation to Schlumberger.

"In the first quarter, the North America land market continued to strengthen in terms of both activity and pricing, leading us to begin accelerating deployment of idle capacity for multiple product lines. Revenue growth was led by hydraulic fracturing and drilling services but was also increasingly supported by Artificial Lift, Surface Systems and Valves & Measurement. In spite of our capacity reactivation being heavily back-end loaded toward the end of the quarter as we continued to adhere to our profitable growth approach, we still generated 16% sequential revenue growth and 66% incremental margins in our hydraulic fracturing and directional drilling services in U.S. land. These results were driven by productive customer engagement around pricing recovery and operational efficiency, together with timely resource additions and proactive supply chain engagement.

“In the international markets, revenue declined 7% sequentially, driven by a greater than expected seasonal decline in activity and sales, particularly in China, Russia land and the North Sea. In addition, we saw lower sequential activity in key parts of the Middle East while production constraints imposed on our Schlumberger Production Management (SPM) Shushufindi project in Ecuador also had a negative impact on our first-quarter results. Still, the underlying activity and sentiment from our global customer base were in line with expectations as seen, for instance, by the flat sequential revenue trends in the rest of Latin America as well as in Africa, confirming that these regions have indeed reached the bottom of the cycle.

"Among the business segments, the first-quarter revenue declines were led by the Cameron Group, which fell 9% sequentially driven by lower project volumes in OneSubsea and reduced product sales in Surface Systems. Reservoir Characterization Group revenue decreased 3% sequentially due to the seasonal reduction in revenue for our Software Integrated Solutions (SIS) and WesternGeco product lines. Drilling Group and Production Group revenues were each 1% lower sequentially as continued strong growth in hydraulic fracturing and directional drilling activity in North America land was offset by seasonal revenue reductions in the international markets.

"As we begin the recovery from one of the deepest downturns on record, we see four areas as critical for the industry to restore its strength and advance its capabilities. They are – the need for higher E&P spending to meet growing hydrocarbon demand over the coming years; the need to protect and encourage investments in R&E throughout the entire oil and gas value chain; the need for new business models that foster closer technical collaboration and commercial alignment between operators and suppliers; and the need for broader and more integrated technology platforms that combine hardware, software, data and expertise.

"While our view of the fundamentals of supply and demand in the oil markets remains constructive, the continuing underinvestment in new supply is increasing the likelihood of a medium-term supply deficit as reservoirs are produced but reserves are not replaced in sufficient volume. In particular, the market continues to focus on headline decline numbers, suggesting that production is holding up well. However, a closer examination of the underlying data clearly shows that the rate of depletion of proven developed reserves is rapidly accelerating in several key non-OPEC countries.

"As the recovery builds momentum, industry cash flow and productivity remain under pressure and limit the industry's ability to increase present levels of E&P investment. At the same time, the value chain remains focused on trying to capture the limited value that is created, rather than seeking new ways to collectively create more value. This approach is not sustainable, either from addressing the underlying industry challenges or from ensuring that the future supply of hydrocarbons can meet the projected growth in demand.

"At Schlumberger, we are therefore actively seeking to position the company at the forefront of an industry that needs to evolve. We are doing this by proactively managing our base business and responding to the ongoing pressures of commoditization, tailoring our offering and performance to the prevailing market conditions. In parallel, we are constantly looking to expand our opportunity set by pursuing a broad and active M&A program; engaging with existing and new customers to establish closer collaboration and more aligned business models; and expanding our offering from technical support to investing alongside our customers in their projects –Â all with the aim of driving more activity for our 19 product and service lines. As we continue to carefully navigate the current industry landscape, we remain confident and optimistic about the future of Schlumberger, knowing very well that beyond the current market challenges lies a wealth of opportunity for the industry players who are ready and able to think new and to act new."

Total return

Schlumberger has generated total losses of 15.9% so far this year to its shareholders compared to the Standard & Poor's 500’s 8.8% gains (Morningstar).

Valuations

Despite not having any trailing earnings in the past 12 months, Schlumberger remains overvalued compared to its peers in other metrics. According to GuruFocus, the company had a price-book (P/B) ratio of 2.4 times vs. the industry median’s 1.1 times and a price-sales (P/S) ratio of 3.5 times vs. the industry’s 1.1 times.

The company also had a trailing dividend yield of 2.9% with 0% payout ratio.

Average 2017 sales and earnings per share indicated forward multiples of 3.2 times and 47 times.

Schlumberger

According to filings, Schlumberger was founded in 1926. The company is the world’s leading provider of technology for reservoir characterization, drilling, production and processing to the oil and gas industry. Schlumberger has principal executive offices in Paris, Houston, London and The Hague.

Schlumberger supplies the industry’s most comprehensive range of products and services, from exploration through production, and integrated pore-to-pipeline solutions that optimize hydrocarbon recovery to deliver reservoir performance.

In 2016, Schlumberger generated 33% of its revenue in Middle East & Asia, 26% in Europe/CIS (Commonweath of Independent States)/Africa, 24% in North America and 15% in Latin America.

Schlumberger operates in each of the major oil field service markets, managing its business through four groups: Reservoir Characterization, Drilling, Production and Cameron.

Reservoir Characterization

The Reservoir Characterization Group consists of the principal technologies involved in finding and defining hydrocarbon resources. These include WesternGeco, Wireline, Testing & Process, Software Integrated Solutions and Integrated Services Management.

In the recent quarter, sales in Reservoir Characterization fell by 5.9% to $1.6 billion or 23% of total unadjusted sales and delivered an income before tax (IBT) margin* of 17.4% vs. 19.4% in the same period one year earlier.

*Base/revenue excluded any adjustments.

As observed, revenue decline was not quite as severe as the 34% drop the segment had in its first-quarter 2016 to first-quarter 2015 comparison.

Drilling

The Drilling Group consists of the principal technologies involved in the drilling and positioning of oil and gas wells. These include Bits & Drilling Tools, M-I SWACO, Drilling & Measurements, Land Rigs and Integrated Drilling Services.

In the first quarter sales in Drilling fell by 20.4% to $1.99 billion (28% of total unadjusted sales) and recorded an 11.5% IBT margin compared to 14.9% in the first quarter of fiscal 2016. Although already a big drop at 20% on a year-over-year comparison, this decline is somewhat "softer" from what the Drilling segment suffered during the same period last year when revenue fell 36.4%.

Production

The Production Group consists of the principal technologies involved in the lifetime production of oil and gas reservoirs. These include Well Services, Completions, Artificial Lift, Integrated Production Services and Schlumberger Production Management.

In the first quarter sales in Production fell 8% to $2.19 billion or 31% of total unadjusted company sales, and IBT margin of 5% vs. 8.7% the same period last year. In review, production sales fell a lot more, 36.6%, in the first quarter of 2016 on a year-on-year basis.

Cameron

The Cameron Group consists of the principal technologies involved in pressure and flow control for drilling and intervention rigs, oil and gas wells and production facilities. These include OneSubsea, Surface Systems, Drilling Systems and Valves & Measurements.

In April 2016, Schlumberger acquired all of the outstanding shares of Cameron International Corporation for $9.9 billion. According to the acquirer, the move was expected to create technology-driven growth by integrating Schlumberger reservoir and well technologies with Cameron wellhead and surface equipment, flow control and processing technology.

Revenue in Cameron for the first quarter was at $1.23 billion or 17.5% of unadjusted sales, and reported an IBT margin of 13%.

Sales and profits

In the past three years, revenue fell an average of 15.5%. In addition, Schlumberger only had recorded losses in both the second and fourth quarters in 2016.

Cash, debt and book value

As of March, Schlumberger had $1.9 billion in cash and $19 billion in debt with a debt-equity ratio of 0.47 times compared to December’s 0.48 times. As observed, the company was able to trim $629 million of its debt in the recent three months.

Of Schlumberger’s $76.2 billion assets 46%Â were identified as goodwill and intangibles while having a book value of $40.6 billion compared to $41 billion in December.

Cash flow

In the first quarter Schlumberger experienced a 46% drop in cash flow from operations to $656 million. In addition to lower year-on-year profits, the oil and gas company had higher cash outflow in relation to its inventories and other current assets.

Capital expenditures were $497 million leaving the company with $159 million in free cash flow compared to $661 million in the same quarter last year. In addition, Schlumberger allocated almost seven times its free cash flow in both shareholder dividends and share repurchases in the period while averaging 87% free cash flow payouts in the recent three fiscal years.

The company also was mostly a debt payer in the recent quarter having allocated $569 million in net of issued debt and other financing activities.

Conclusion

Schlumberger recorded less sharp decline in its revenues when compared to what it experienced the same period last year after the initial affectation of the oil price collapse was revealed. The company, nonetheless, did not stop facilitating business enhancement through its Cameron acquisition in 2016. The acquisition, in hindsight, was a smart one resulting from buying a competitor at a much cheaper level.

In review, Cameron's share price had already dropped 42% during the tumult in the oil industry, and the offer was about 41% premium after the fall. This would indicate Schlumberger buying Cameron at near 20% discount from its previous share price prior to the oil price decline.

Still, Schlumberger was able to trim down its debt despite the ongoing slowdown in its business while having goodwill and intangibles more than half of its assets. The once dire situation in the industry did not also deter the company’s continuous generous payouts to its shareholders.

Thirty-three analysts have an average target price of $91.03 per share, or near 30% upside from the share price of $70.09. Assuming a 5% revenue growth rate from Schlumberger’s 2016 multiplied by three-year P/S multiple average followed by 20% margin would indicate a value of $47 per share.

Nonetheless, Schlumberger is a speculative buy with $90 per share target price.

Disclosure: I do not have shares in any of the companies mentioned.