Jul. 31, 2007 (Investor's Business Daily)
He who controls the past controls the future. Schlumberger's (NYSE:SLB) efforts to build up its business over the last 30 years have set it up for future dominance.
The oil field services giant SLB has established itself in local markets around the world. It is truly a global company.
The Houston-based firm offers project management services and searching techniques to national oil companies as well as international and domestic energy firms.
It has set up local centers for its products and services around the world. It uses local employees from the country where it operates.
The three-decade effort allowed Schlumberger to penetrate new markets as well as win some of the oil industry's most lucrative contracts.
With 70% of its business staked overseas, Schlumberger is poised to take advantage of increased demand for oil services abroad.
Analyst David Rewcastle of Argus Research expects worldwide spending on oil services to grow more than 10% this year and in 2008.
He says spending should hit well over $600 million for the next two years.
"Though this is slower than the growth in 2005 and 2006," Rewcastle said, "it continues an expansion not seen in more than a quarter century, due to a shortage of services to satisfy demand."
Schlumberger (it's pronounced SHLUM-ber-ZHAY) is the company that can fulfill the starving needs of the oil industry.
It has two business segments, Oilfield Services and WesternGeco. Combined, the units helped Schlumberger increase its second-quarter sales 21% to $5.64 billion. It was the 10th straight quarter of 20% or better sales growth.
Earnings Growth
The company earned $1.02 a share in the quarter, up 40% from last year. Analysts were expecting 95 cents.
The Oilfield Services segment had sales of $4.97 billion, up 21%. The unit provides exploration and production, well completion and geological evaluation. It also offers consulting, software and technology services.
The WesternGeco unit does reservoir imaging, monitoring and seismic surveys. Sales rose 18% to $664.6 million in the quarter.
The company continues to see strong demand for its services. National oil companies from Russia to Malaysia have paid top prices for seismic exploration services in an effort to expand capacity.
Schlumberger's seismic imaging is some of the world's best, said analyst Stephen Gengaro of Jefferies (NYSE:JEF) & Co. Its Q-Technology searches and finds new reserves. It can also tell the quality of the oil or gas.
The world is in constant demand to find new reserves. Analysts agree that seismic spending will continue to grow over the next few years.
CEO Andrew Gould told analysts in a conference call that second-quarter results were driven by the increasing pace of international activity.
The company signed contracts worth $3.8 billion over the last six months, Gould said. The contracts and a backlog of $1.2 billion will cover its business in the Middle East, Latin America, Russia, North Africa, Europe and Malaysia, he said.
"Sequential revenue growth for Oilfield Services accelerated in all areas except North America, where higher activity on land and in the Gulf Coast was not sufficient to completely offset a significant downturn in Canada," Gould said in the call.
The Canadian rig count in the second quarter fell 74% to 139 from last year, according to Baker Hughes (NYSE:BHI) BHI. The oil field services firm tracks global rig counts.
The firm said the U.S. was up nearly 8% to 1,757 rigs last quarter. But most of the demand for the company lies overseas.
"What's impressive is management's ability to minimize margin erosion in North America in light of sluggish Canadian activity," Gengaro said. "But international demand is what's driving the bus as far as growth for Schlumberger."
The global rig count rose 10% to 1,002 rigs last quarter. Baker Hughes found that rig activity is the strongest in Africa and the Middle East. Europe and Asia-Pacific had solid rig growth as well.
All of this bodes well for Schlumberger. Its geographic footprint in these regions places it right in the middle of the action.
The company has outspent rivals on research and new products, Rewcastle says. This has paid off for Schlumberger, whose clients range from national oil companies to big guns like Exxon Mobil (NYSE:XOM) XOM.
"It's a powerhouse," said Rewcastle. "Its services are useful to any party in search of oil or gas. It can find the sweet spot almost anywhere and help the client extract it."
World Domination
Schlumberger is a dominant force all over the world. But it still faces several risks.
First, a recession could force the price of oil to plummet. Then drilling activity would drastically slow down.
"Oil prices in the 60s and 70s are not crucial to the profitability of oil service firms," Rewcastle said. "Sustained prices around $35 per barrel are necessary to stimulate projects with an adequate return. I expect the current environment of high prices to continue."
But with robust outlooks for the industry expected for next few years, there is a more imminent risk for the oil services giant.
Schlumberger operates in some politically unstable countries. These nations are heavily dependent on oil exports. It could be forced to close down business due to sanctions or volatility.
In the early 1940s, Texaco paid for its own dealings with hostile regimes such as Nazi Germany and Imperial Japan. And there are similarities with Schlumberger's business in Sudan, Iran and Venezuela, Rewcastle says.
Schlumberger is the only major E&P company left in Iran and Sudan, he says.
But its operations are well-diversified throughout the world. Its business sprawls over regions where drilling demand is surging, Gengaro says.
"Part of the cost of doing business is the political risk," he said, "But there are other state oil companies with sufficient capital to keep Schlumberger busy, such as Russia. Its positioning in the world and its technological innovation will keep it dominant."
20 July 2007
World #1 oil services company Schlumberger Limited (market cap $110 billion) reported net income and revenue above analyst estimates Friday, sending shares higher by 1.12% in pre-market action as of 7:24 a.m. EST.
Net profit jumped 47% on strong international performance despite weakness in the Canadian market, to $1.26 billion, good for EPS of $1.02. Revenue climbed 20% to $5.64 billion, on $4.97 billion in oilfield services revenue. Consensus analyst estimates were for EPS of $0.96 on revenue of $5.575 billion. N. American revenue was the weakest link, down 3% sequentially to $1.34 billion, and up just 6% y/y. The company didn't offer specific guidance but believes international oilfield revenue will continue to grow nicely as the production companies combat shortfalls. CEO Andrew Gould praised the "continued favorable revenue mix from exploration services - particularly in Asia."
Scott Rothbort submits: Schlumberger Limited (
SLB) is one of the premier oilfield service companies in the world.
While I have held SLB for several months personally and for clients, the stock is turning into a much longer term holding than I originally anticipated. I am expecting 20% or more EPS growth for SLB in the next several years and consider it an excellent long term investment. Considering my projected annual growth rate in earnings of at least 20% for several years, SLB sells at a reasonable 21 times current year’s consensus and 18 times next year’s estimates. Put this together and you get a sub 1 PEG ratio stock which is a bargain.
We believe that Schlumberger (SLB ; $62) will outperform its oilfield-services peers given its strong position in the faster-growing Eastern Hemisphere. This region, in our view, has the most attractive and lowest-cost drilling prospects for companies that explore for and produce oil and gas—the so-called "upstream" customers—and thus it's likely to see a growing share of upstream capital expenditures.
We also think that upstream customers place a very high importance on reputation and reliability, and thus are willing to pay a premium for improved performance and reduced downtime, particularly to the larger services players such as Schlumberger, which, in our view, possess strong, longstanding track records of performance. Combined with what we view as a compelling valuation, our recommendation is 5 STARS (strong buy).
INCENTIVE FOR NEW WELLS. As oil and gas wells increase in age, it becomes increasingly difficult (i.e., more expensive, and/or less technically viable) to maintain or expand production, typically requiring more advanced production techniques or equipment to do so. This 'decline rate' is, in our view, accelerating at mature oil and gas reservoirs worldwide, such as in the U.S. Gulf of Mexico and the North Sea. On the demand side, strong economic growth rates in several regions, including the U.S. and China, helped to create a surge in global oil demand in recent periods.
Combined, these supply-demand dynamics have, in our opinion, contributed to the ongoing persistence of elevated oil and gas prices, as supply struggles to keep pace with demand. Thus, we believe that upstream oil and gas companies have an incentive to continue their high levels of capital spending on both the drilling of new wells, and on techniques to enhance the productivity of existing wells.
Higher hydrocarbon prices, all else being equal, help to support capital spending plans by oil and gas exploration and production companies, by international oil companies, and by nationalized oil companies. In our view, it is this spending which fuels oilfield-services companies' revenue streams.
NUMEROUS OPERATIONS. Founded in 1927, Schlumberger is the world's largest oilfield-services company, employing over 60,000 people in more than 80 countries around the world. The company focuses on the provision of technology, project management, and information to the international oil and gas industry.
The company's two operating segments are Oilfield Services (88% of total 2005 revenues) and Western Geco (12%), a provider of seismic data services. Oilfield Services are divided into six technology groups: Wireline, Drilling & Measurements, Well Services, Well Completions and Productivity, Data & Consulting Services, and Schlumberger Information Solutions.
Wireline operations utilize downhole tools to provide information useful in evaluating formations, in planning well construction, and in monitoring existing production. Drilling & Measurements provides directional drilling, measurement-while-drilling, and logging-while-drilling services. The Well Services group assists in the construction of oil and gas wells, and helps to maintain optimal production levels over a well's lifespan using a variety of products and services, including stimulation, pressure pumping, coiled tubing, and cementing. The Well Completions group offers production optimization services, including perforating, intelligent completions, and artificial lift.
EASTERN PRESENCE. The final two technology groups offer a variety of information-management and consulting services. A seventh service, Integrated Project Management (IPM) leverages technologies from the other six groups and offers comprehensive project management and engineering services.
The Western Geco segment focuses on the provision of reservoir imaging, monitoring, and development services, complete with seismic crews, data-processing centers, and one of the leading multiclient seismic libraries. In April, 2006, the company acquired the remaining 30% stake in Western Geco that had formerly been held by its then-partner, Baker Hughes (BHI ).
In 2005, Schlumberger generated a higher percentage of its oilfield-services revenues from the Eastern Hemisphere (52%) than did either of its two largest competitors, Halliburton (HAL ) (39%), or Baker Hughes (48%). In absolute dollars, Schlumberger's oilfield-services revenues from this region (approximately $6.6 billion), are considerably higher than either Halliburton ($3.9 billion) or Baker Hughes ($1.0 billion). With a stronger presence in the Eastern Hemisphere—and our view that this region should grow relatively faster in the future—we think Schlumberger is well-positioned for growth.
COMPETITIVE ADVANTAGES. We believe Schlumberger's strong local foundation in frontier countries lends a competitive advantage in enabling it to grow market share in such markets. In Russia, for example, the company now has more than 8,000 employees, of whom 95% are Russian. Schlumberger's recent acquisition of PetroAlliance, one of the largest independent Russian oilfield-service companies, further deepens its presence in this important oilfield market. Global Insight projects that crude oil production from Russia will account for 11.4% of 2007 global supply.
We like Schlumberger's acquisition of the remaining interest in Western Geco, for two reasons. First, it should enable the company to leverage its existing portfolio of technologies from Oilfield Services to this segment without sharing such technologies with a primary competitor. Second, we believe, as the race to keep pace with hydrocarbon demand continues, and as maintaining existing supply remains a struggle, we see the likelihood of growing exploration spending, which typically requires advanced seismic services.
Based on continued high projections for oil and natural gas prices, and continued high levels of capital spending by E&P outfits, international oil companies, and nationalized oil companies, we project that Schlumberger will increase total revenues by approximately 32% in 2006, and an additional 19% in 2007. We expect EBITDA margins, which averaged approximately 29% in 2005, to reach 34% in 2006 and about 36% in 2007.
STRONG OPERATING MARGINS. We project Schlumberger to generate approximately 54% of total oilfield-services revenues, and 59% of total oilfield-services operating income, in the Eastern Hemisphere in 2007. We see operating margins of more than 30% in the Middle East/Asia region, and in the high 20% range in the Europe/CIS/West Africa region. Latin America is expected to trail at about 20% operating margins. In North America, we see operating margins in the mid-30% range.
Overall, we expect earnings per share of $2.97 in 2006 from continuing operations and excluding one-time items, and $3.83 in 2007.
Schlumberger has adopted accounting standard FAS 123R, thus expensing stock options on its income statement, and generating no impact on S&P Core Earnings. However, we deduct from operating EPS estimates 7 cents per share in each of 2006 and 2007 for projected pension adjustments. As a result, we see S&P Core EPS of $2.90 and $3.76, respectively, implying Core EPS divergence from operating EPS of about 2% in each year.
Our intrinsic value estimation is derived by calculating a sustainable growth rate for the company for the next 10 years, plus a terminal growth rate. We then discount the resulting free cash flows by the estimated weighted average cost of capital. Our calculations indicate an intrinsic value of about $81 per share.
TARGET PRICE. Given the company's leadership position in the industry, we believe that Schlumberger merits a premium valuation to peers, and historically the stock has been valued this way. Currently at a 9.6 times multiple to our estimated 2007 EBITDA (earnings before interest, taxes, depreciation and amortization), Schlumberger is trading at a 35% premium to our peer group average of 7.1 times. However, we believe that using a 14 times multiple (maintaining its premium above the 9.8 times projected peer average) is appropriate, and implies a value of $88 per share.
On a price to operating cash flow basis, Schlumberger trades at a 12.5 times multiple, about 17% above the 10.7 times peer group average. Using a 15 times multiple on projected 2007 operating cash flows—also a slight premium to the projected group average of 12.9 times—yields a value of $72 per share.
Blending these relative valuation metrics with our discounted cash-flow model yields a 12-month target price of $80 per share.
GOOD GOVERNANCE. We believe that Schlumberger's corporate-governance practices are generally sound. Independent outside directors represent 11 of the 12 seats on the company's board, and all board members are slated for reelection annually. The audit, compensation, finance, technology, and nominating & governance committees are all comprised solely of such outside directors. Stock option grants vest over four years and are granted at an exercise price equal to the fair market value on the date of the grant.
On the negative side, Andrew Gould serves as both chairman and CEO. In general, we prefer that a non-executive director serve as chairman.
Risks to our recommendation and target price, in our view, include events that would cause substantial declines in upstream oil and gas spending, such as lower-than-expected demand for crude oil and natural gas. Other risks include the potential for further political unrest in key frontier regions, including West Africa, the Middle East, Russia, and Southeast Asia.
