Sunday, September 1, 2013

This Oilfield-Services Titan Stands Out From the Crowd

Oilfield-services titan Schlumberger (NYSE: SLB) recently released its quarterly results, in which it beat both revenue and income estimates while significantly increasing its buyback program. Analysts at Global Hunter have identified that the company could deliver solid earnings of more than $6 per share by 2014, up from the current $4.59 per share. Its competitive advantage lies in its global footprint and technological prowess.The industry outlook is also looking bright as Schlumberger is expecting a “double-digit” uptake in customer spending on oil exploration. 
Sector review
The strong performance was attributed to more deep-water drilling. Schlumberger reported an 8.1% increase in quarterly revenue to $11.2 billion, $30 million above consensus, which translated into EPS of $1.15 per share, $0.04 above estimates. The international segment outperformed the North American units; the former registered sales growth of 8%, while the latter saw a 2% increase. Unlike its rivals Halliburton (NYSE: HAL) and Baker Hughes (NYSE:BHI), Schlumberger earns about two-thirds of its revenue from outside of the U.S and Canada.
Schlumberger’s closest rival, Halliburton, also
reported a decent quarter. With revenue of $7.3 billion and EPS of $0.73, Halliburton also managed to beat both top- and bottom-line estimates. The company is also looking to settle its 2010 Gulf of Mexico oil disaster liabilities, which explains its recent rally. Halliburton yields considerable influence in the North American market and will reap the biggest rewards from the U.S. oil boom.
On the other hand, Baker Hughes, the smallest of the big three oilfield-services firms, has disappointed investors. Its earnings came in below estimates as the company’s net profit dropped by 45% to $240 million, which was blamed on margin pressure in North America and weakness in Brazil and Mexico.
However, Baker Hughes delivered better-than-expected performance in the international market with growth of 7% coming from strength in Middle East/Asia, Russia and Africa. Nonetheless, Baker Hughes’ bottom line is its biggest weakness, and its revenue growth isn’t impressive either. The company needs to deliver solid earnings growth consistently, but I don’t see that happening until North America recovers.
Buyback update
During the quarter, Schlumberger repurchased 6.8 million shares, nearly completing its $8 billion share-buyback program announced in April 2008. However, a new and even bigger $10 billion buyback program has been approved, which will be completed by the middle of 2018.
Industry outlook
The great thing about oilfield-service firms is that they (or at least most of them) continue to generate reasonable returns even when oil prices are depressed. But the healthy pricing environment creates even more opportunities as oil companies have an incentive to increase their exploration and production budgets.
The Brent oil prices have averaged at about $100 per barrel since 2011, which is luring the clients of oilfield-services companies to continue their hunt for oil and gas reserves in the farthest corners of the world. This has created a healthy business environment. This trend will likely continue in the near term, which will translate into more business for the oilfield-service firms in general and international services-focused Schlumberger in particular.
Therefore, at the current price levels, I am long-term bullish on this sector, particularly Halliburton and Schlumberger, which have been more profitable and far more efficient in terms on returns on assets and equities than Baker Hughes.
Baker Hughes
Performance summary
The three are currently trading close to their 52-week highs. In fact, in the early hours trading of August 13, Halliburton was just $0.10 below its year's high level. But I expect the stocks to move higher in the long run. This year, Schlumberger is up 18%, Halliburton up 35.3% and Baker Hughes up 19%.
Baker Hughes
Stock YTD
P/E 2013 Est
P/E 2014 Est
Although Schlumberger has been behind its rivals and is trading at slightly higher multiples of current year and next year’s earnings estimates (shown in the table above), I believe the stock is still attractive at these price levels.
Conclusion:  Beyond P/E
What makes Schlumberger more attractive than its rivals?
Firstly, Schlumberger has a solid track record of revenue and income growth. Secondly, Schlumberger has been more profitable than its rivals. On a trailing-12 month basis, Schlumberger has operated on a profit margin of 14.0%, as opposed to Halliburton’s 6.6% and Baker Hughes’s 4.7%.Thirdly, Schlumberger has generated a much higher return on equity of 18.1%, which is above the industry’s average of 15%.
Fourth, its ability to generate free cash flows stands out from the crowd. In the trailing-12 months, Schlumberger has generated leveraged free cash flow of $4.1 billion, which is significantly more than the combined leveraged free cash flows of Halliburton and Baker Hughes.
This is one of the reasons why the credit-rating agencies are not worried about Schlumberger's rating, despite the enormous buyback program and they are not pleased with Halliburton's repurchase program (here's a link to ratings agency Moody's press release in which they have changed Halliburton's outlook to negative).
And finally, as indicated earlier, Schlumberger could be the biggest beneficiary from an uptake in international drilling activity due to its large global footprint. Schlumberger is the leader in its industry and this alone warrants a higher P/E, but it is not too far ahead of its rivals and therefore, due to the reasons explained above, even at these price levels, Schlumberger is a buy. 
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Disclosure: I, Sarfaraz A. Khan, have no position in any stocks mentioned and no plans to initiate any within the next 72 hours of this publication. I have no business relationship with any company mentioned in this article. 
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