After the market for West Texas Light crude peaked in July 2014 above $105 per barrel, prices plunged to a low around $24 per barrel by the beginning of 2016. That decline set off an even more extended bear market for related stocks like Halliburton Company (HAL) and Schlumberger N.V. (SLB), the world’s two largest oil services companies. According to SLB’s CEO, the industry’s inability to recover even as oil prices stabilized and rebounded to their current levels (as of this writing, WTI crude is around $70 per barrel) is because of the reluctance of global oil producers to invest in new exploration and production (termed E&P) projects. After briefly rebounding to about $80 at the beginning of this year, SLB is about 21% lower and is close to its lowest point in the last two years. Does that mean the stock is a good value right now?
In their latest quarterly earnings report, SLB’s CEO gave his view of the long-term state of the oil market. In it, he pointed out that while producers have been seeing better results lately, service companies like SLB have been forced to bid for limited project work; the excess equipment available relative to demand has limited the industry’s ability to follow producer’s trends higher, at least until the last quarter. It appears that global markets are finally starting to increase their production activity, which means that the demand for oil services like those provided by SLB is finally starting to improve. In fact, SLB projects that they will have no spare equipment capacity by the end of 2018, which will give them the ability to negotiate more favorable pricing arrangement with their customers.
Even more favorable in the long term is that while U.S. producers have been able to ramp up production quickly is the relatively short amount of time it takes to drill a shale well. On the other hand, producers in other parts of the world don’t have the ability to bring inactive rigs back online so quickly, but the fact is that OPEC’s spare capacity, which has historically always held some capacity in reserve is at levels not seen since Operation Desert Storm in the early 1990’s. OPEC has finally decided to start increasing production, but that will also require those countries to invest in new products and projects. That means more E&P, which is exactly the kind of tune that oil service companies like to hear. That could offer a great opportunity in the long-term for investors who are interested in investing in this segment of the global economy.
I think it is important to pay attention to what executives say about their respective markets, certainly even more than it is to track analyst forecasts. However, as a value-oriented investor, I also have to balance that information against what a company has been doing. That means using historical information to determine if the stock’s current price justifies making any kind of a bet on the long-term prospects of any stock I’m thinking about. In the case of SLB, I think the future looks encouraging, and the stock’s current price is intriguing; but based on their performance over the recent past, it doesn’t quite represent the kind of value that would make anxious to find a new opportunity right now. Here are the numbers.
Fundamental and Value Profile
Schlumberger N.V. provides technology for reservoir characterization, drilling, production and processing to the oil and gas industry. The Company’s segments include Reservoir Characterization Group, Drilling Group, Production Group and Cameron Group. The Reservoir Characterization Group consists of the principal technologies involved in finding and defining hydrocarbon resources. The Drilling Group consists of the principal technologies involved in the drilling and positioning of oil and gas wells. The Production Group consists of the principal technologies involved in the lifetime production of oil and gas reservoirs and includes Well Services, Completions, Artificial Lift, Integrated Production Services (IPS) and Schlumberger Production Management (SPM). 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. SLB has a current market cap of about $87.4 billion.
- Earnings and Sales Growth: Over the last twelve months, earnings grew by impressively, at more than 23%, while sales grew a little over 11%. That growth is in contrast to the company’s profile, since over the last twelve months, Net Income as a percentage of Revenues was negative, at -2.34%. The picture has gotten better over the last quarter, which I believe is a reflection of improving market conditions as described by SLB’s CEO, to a little over 5%.
- Free Cash Flow: SLB’s free cash flow is healthy, at more than $3.5 billion. This number declined from mid-2015, when it was more than $7.5 billion, to a low in mid-2017 at about $3 billion. That’s growth in Free Cash Flow of about 16.6% in the last year.
- Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for SLB is $26.66 and translates to a Price/Book ratio of 2.36 at the stock’s current price. The stock’s historical average Price/Book ratio is 2.66, suggesting the stock is only about 12.7% undervalued, with a long-term target price around $71 per share. Using the stock’s Price/Cash Flow ratio shows the stock remains overvalued, since its price is current about 10.5% above that ratio’s historical average. Interestingly, at $56 per share the stock would be roughly in-line with its historical Price/Cash Flow ratio, but 20% below its historical Price/Book ratio. That gives me a good reference point for a minimum price at which I would want to see the stock priced at before I would be willing to say it is discounted enough to justify a new position.
Here’s a look at the stock’s latest technical chart.
- Current Price Action/Trends and Pivots: The red diagonal line measures the length of the stock’s downward trend from December 2016 until the end of 2017; it also provides the basis for the Fibonacci retracement lines shown on the right side of the chart. if you discount the temporary, rapid rise from the stock’s trend low point in December 2017 to its peak at about $80 in late January this year, the stock has mostly been holding a sideways trend throughout the year. Last month, the stock dropped below its sideways range up to that point and appears to be establishing a new trading range, with support around $62 and resistance right around $65.
- Near-term Keys: I would look for a push above July’s peak around $69 to mark any kind of new, potential upward trend; that would be the minimum price that I would begin thinking about any kind of short-term bullish trading opportunities. As a value investor, I would watch the stock with a weather eye on the stock’s trend low from December 2017 around $61 as a critical test of any continued stabilization or price consolidation. A drop below that point would likely give the stock room to drop down into the $56 range – a level the stock hasn’t actually seen since August of 2010. That is where I would start giving a long-term position in the stock some serious thought.