Current Price: $100.22
P/E: 18.8
P/S: 2.8
P/Cash Flow: 11.7
Dividend Yield: 1.3
The Business:
While each investor should perform their own due diligence, I would highly endorse Schlumberger Ltd (SLB, Financial) as an equity worthy of placement in your portfolio. With great margins and an enduring moat not soon to be breached, this stock still has a long term run in a value investor’s portfolio.
Schlumberger is the global leader in supplying oilfield services to the oil and gas drilling, exploration and production industry. It is simply the largest in its field. If you need help locating the goods, Schlumberger is the leader in the industry. The company is split into fifteen (15) product lines with three (3) major segments which include Drilling Group, Production Group and Reservoir Characterization. The Schlumberger employee staff exceeds 123,000 that are distributed around the world in 85 different countries. Many of these countries have had the Schlumberger presence for over 70 years. This worldwide or global footprint cannot be matched by their competitors.
Each of the three major segments had advances during 2013 and each appears poised to continue with growth into 2014. Reservoir Characterization had a revenue increase of 10%, while Drilling Group grew revenue by 9% and Production Group by 8%.
The Drilling Group has launched several new innovative drill bits that have allowed them to improve penetration by 15% and improve the speed of the process, allowing them to gain market share and casting them as the market leader in this area.
The Production Group has conducted many tests of new technologies allowing for greater efficiencies. Notable improvements have been created with these tests, permitting higher production with the ability to reduce water consumption during the process.
The Reservoir Characterization Group finds and defines hydrocarbon deposits and contributed to 27% of the company’s revenue.
The incredible range of products and services for the industry include seismic acquisition and processing, drilling services, including horizontal drilling, drilling bits and fluids, wireline and testing services, well testing , water treatment, artificial lift, coiled tubing, formation evaluation, sand control consultation, software and a great many other such services and products.
Because the cost of oil exploration has become increasingly expensive, oil producers are looking for oil in more difficult locations including those at greater depths or at locations difficult to access such as the Arctic. They’ve consistently shown their ability to move quickly and discover the location and size or potential of assets for their customers. With their consistent advanced technology and growing patents, they continue to assist their clients in the most difficult or harsh environments. Schlumberger’s proven skills in these many areas have allowed them to bundle specific packages for their customer’s individual needs.
A Little History:
As described on the company’s website, Conrad and Marcel Schlumberger, were both energetic and goal seeking young men. Both with the desire to become scientist, they both ventured to Paris in the early 1900’s where Conrad graduated in physics and Marcel as an engineer.
Though some of their work was interrupted by World War I, both brothers realized the value of their research, patented their work in many countries and are known and still recognized as early pioneers of the industry .
Competitors:
While many include National Oilwell Varco Inc. (NOV, Financial) among the Schlumberger competitors, the industry is broken down in size by market capitalization….large, medium and small. While NOV is a great company also worthy of an investor’s investigation, it is not included here as a competitor because it falls under the medium sized competitors.
More accurately, Schlumberger’s competitors would best be described by the inclusion of Baker Hughes, Inc. (BHI, Financial) and Halliburton Co. (HAL, Financial). Noticeably, Schlumberger, like any company wishing to promote themselves in a presentation included Weatherford International (WFT, Financial) as a competitor. Weatherford’s market capitalization is approximately one half the size of National Oilwell Varco. While many choose to include NOV, the business model is certainly different and definitely smaller. Still, I will refer to most of the companies as they get compared. As an aside, I am long NOV anyway, though a little concerned about the size of their goodwill and intangible assets.
The Moat:
Stated simply, a company with a moat becomes an outstanding investment because of its potential to generate earnings for a long time. Those companies that demonstrate a high return on capital may generate great enduring cash flow.
While Schlumberger can claim 11,500 patents over the last five years, they acknowledge that their competitors may reproduce them without potential infringement, removing the intangibles out of the realm of creating a moat that is indestructible. Still, the competition must recreate these patents and they all cost the company precious capital.
What does appear to create a moat for the company are other particulars such as size of the company (economies of scale) and market share, switching costs advantages, number and types of products offered, reputation, research and development compared to its competitors. It holds a lead in market share for the vast majority of products in offered by the company.
This is all borne out by several metrics including ROIC, operating income, operating margins, free cash flow and a comparison between return on invested capital versus cost of capital. While both SLB and NOV each indicates high return on invested capital, one will note that the trend for NOV is beginning to trend downward, while SLB overall appears to be trending upward.
From their presentation, note the global footprint of the company and the following metrics:
While several websites calculated WACC for Schlumberger as low as 8.5%, I endeavor to look at the numbers closer and ended up with a weighted average cost of capital (WACC) of 11.5%. As an industry, the cost of capital appears to average in this range anyway. Still, with the preferred metric of Joel Greenblatt (Trades, Portfolio)’s ROIC number, Schlumberger has set itself apart for a company with a lot of profit potential. Ultimately, any company that can average a return on invested capital of approximately 41.0 is able to provide great returns for their shareholders when their cost of capital is significantly lower.
Valuation:
Schlumberger valuation is interesting in that it would be quite easy for a biased investor to choose the valuation process that gets them the best answer they are searching for due to the vast ranges. Investors of all stripes should be fair to themselves in determining a fair value for the stock. The different procedures available can lead to an extreme high and low, leaving the investor in a quandary of a fair value that will protect them. Fortunately, Schlumberger should be considered worth of a Buffett type stocks that is structurally sound with a great balance sheet, good growth and prospects and a moat that should perform long term to your advantage.
While several of my calculations using discounted cash flow, discounted earnings, discounted book value, using a reverse discounted cash flow gives me a range between $115 to a high of $170. On the low end of others calculations, such as the GuruFocus DCF calculator, you will find the stock currently at a fair price.
To take it a little further,
Morningside indicates the stock slightly undervalued and gives the stock a fair value of $116 with a sell at $156.60.
S & P indicates a more modest valuation:
Averaging several methodologies, I am comfortable with a valuation of approximately $133 or a 33% margin of safety.
Indication of Value / Strength:
Most of these numbers speak for themselves:
Schlumberger is currently indicating a P/E just below its 19 year average.
Once again, the price/sales ratio is just below the 10 year average.
Sporting a current EV/EBIT ratio of 14.25, the company is below its 10 year average, though it would be preferred if it were a little lower.
With a debt to equity of .312, indications are that the level of debt has remained generally at a stable and reasonable number, not placing the company in jeopardy.
Overall, this company has great margins and all indications are that it is running on all cylinders ready to continue to grow and create value for their shareholders.
The dividend is a modest 1.3% with a 34% payout. Overall, the dividend has not grown as hoped, however; with the increase in predicted cash flows, it is hoped that the company will begin to become a better steward.
Risk
Many contend that a major risk consists of the potential of lower oil prices, however; going deeper and into more remote locations, the fact is that it is more expensive to keep producing and probably keeping the prices quite high for some time in the future.
Another risk is the level to which Schlumberger has committed its resources to markets in both China and Russia. Would Russia create a confiscatory policy of this energy giant? It’s doubtful, they the present tension in Ukraine leaves many wondering the impact. Truth is, Russia is an energy giant with incredible potential still not fully recognized and Schlumberger is poised to take full advantage in both Russia and China.
Because of economic slowdown issues, several companies are endeavoring to cut costs, leaving some to believe that Schlumberger may be hurt by smaller margins.
On the positive side, they are clearly the market leader and outspending their competition in Research and Development considerably. With the new patents and new technology in place, they should separate themselves from the competition further.
Russia, China and Africa are incredible potential for this company and they are well positioned to take advantage.
Management
While management has performed well as evidenced by return on capital and other key metrics, they appear to be fairly compensated for their positions. Debt is being managed well and the company continues to generate lots of free cash flow. They’ve also done well with the smaller acquisitions they have with all indications that they’ve mostly increased value for the company. Paul Kibsgaard has been CEO since 2007.
While many tout that the company wants management to have a considerable part of ownership or “skin in the game”, I find those comments a little disingenuous when they attach a percentage of required shares to be held, but tie it to the base salary ,rather than the entire yearly salary. After all, with a compensation package for the CEO at nearly $23 million, the percentage at this number is quite different than that required from his base salary of only $1.7 million. Schlumberger policy is not alone in this. Competitors have similar requirements.
Outlook
With technological breakthroughs, it is believed that SLB will continue to grow by at least 10% this year and with a smaller exposure to the North American market, may actually have limited their exposure to the these markets for 2014 that appear to have head winds before them.
With many new patents and new markets, even with an economic slowdown, the company appears positioned to ride out any storms with a strong balance sheet and sizeable cash flow.
Guru’s Holding Schlumberger:
The list is long, indicating that it is quite popular with many of the gurus and the many investment style nuances. The common thread is that they all appear to find plenty of value in SLB during these tough investment times. Among those holding SLB is:
Joel Greenblatt (Trades, Portfolio)
David Tepper (Trades, Portfolio)
David Rolfe (Trades, Portfolio)
Manning & Napier Advisors
John Rogers (Trades, Portfolio)
Paul Tudor Jones (Trades, Portfolio)
George Soros (Trades, Portfolio)
Steve Cohen
Robert Olstein (Trades, Portfolio)
And many others!!
Conclusion:
While Schlumberger could be cheaper, it is cheap enough to take a position and add to it based upon how economic times play out. Either way, with a strong balance sheet, great metrics such as return on equity, return on assets and equity, the company has a bright future. I am definitely long on this stock.
Disclosure: Long SLB, NOV, HAL
