Oil is officially in a bear market - and that could be a good thing for SLB

November 15, 2018

Oil is officially in a bear market – and that could be a good thing for SLB

The stock market has seen a lot of turmoil and turbulence since the beginning of October, with all three major indices touching, or coming very near to the 10% level that most technicians consider correction territory. What you may or may not be aware of, however is that at nearly the same time the stock market was hitting a peak, so was oil – but the decline in the oil market is significantly more severe. As of Wednesday’s close, West Texas Intermediate crude was sitting around $56 per barrel, which marks a decline of more than 26% from its peak on October 2, which topped $76 per barrel.

The decline isn’t just limited to U.S. oil – the price of Brent crude, which also hit a multi-year high at the same time as WTI, has declined from a little above $86 per barrel to its current price around $66. What is the big driver? Increasing supply, for one; oil inventories across the globe are high and increasing. Late in the summer, Brent prices were driven higher on speculation that economic sanctions on Iran would pressure OPEC oil production capabilities, but even as the U.S. put those sanctions in place, it also granted waivers to eight countries, including China, India, South Korea and Japan who are heavily dependent on Iranian imports. Additional reports suggest that while Iranian production is declining, it is also being more than offset by production increases in Saudi Arabia and the United Arab Emirates.

In the U.S., shale producers have been boosting production in a major way as well; another complicating factor is the reality that while production in shale-rich areas like the Permian basin are high, pipeline capacity is maxed out, with little hope for short-term relief. That reality has pushed prices for shale coming from that region to as much as $20 per barrel below the going rate for WTI crude in general. New reports now also indicate that pipeline under-capacity is spreading to the Bakken region of the Dakotas as well. Shale producers are producing about 1.3 million barrels per day right now, while the region’s pipeline capacity can only handle about 1.25 million barrels per day. Just as with the Permian, there are projects underway and being proposed to increase the areas capacity, including a proposed “Liberty pipeline” that Phllips 66 and Bridger Pipeline have announced an open season to gauge interest that would move Bakken crude to Wyoming.



The problem is that pipelines take time to bring online – most of the current projects are forecast to be completed in mid to late 2019, with a number of others expected for 2020. That’s a positive in the long run for U.S. producer’s ability to meet demand, but in the short run it is also contributing pretty heavily to the current pressure, and it doesn’t look like that is going away quickly.

In his book, The Intelligent Investor, Benjamin Graham (the man who mentored Warren Buffet, and referred to by many as the father of value investing) wrote that when a sector of the economy is in a bear market, a reasonable long-term strategy is to identify the leader in the sector. As long as their balance sheet is healthy, all you have to do is buy in and be willing to wait out the decline for the inevitable decline. Oil producers can be a bit of a mixed bag, since many of even the largest of these companies operate with high debt levels, but a smart way to invest in oil and energy is with the companies that provide the equipment and services explorers, drillers and producers rely on.

Schlumberger N.V. (SLB) remains the largest oilfield services company in the world, and while some of their fundamental measurements have suffered from some of the same dynamics that have pressured the oil sector throughout the year, the truth is that their balance sheet remains very healthy. They also fit the description of the kind of company that will not only still be around when the sector finally finds bottom, but will also be in a prime position to take advantage of that bottom by acquiring the assets of weaker competitors. The stock’s price performance in the last month is nearly -20%, which is a little less than the sector’s decline. More interestingly, the stock is down more than 40% since reaching its 52-week high at around $80 at the beginning of the year. It may not be done dropping, but if you’re willing to follow Mr. Graham’s advice, this looks like it could be a very good time to think about buying this stock.



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 $66.2 billion.

  • Earnings and Sales Growth: Compared to other stocks I’ve highlighted in this space, SLB’s earnings and sales growth has been modest: over the last twelve months, earnings increased 9.5%, while sales increased 7.5%. Growing earnings faster than sales is difficult to do, and generally isn’t sustainable in the long-term; however it is also a good indication of a management’s ability to maximize their business operations. By contrast, the company’s Net Income versus Revenue over the last year was -1.9, but improved in the last quarter to 7.5%, which can be taken as an indication their bottom line has improved in the last quarter.
  • Free Cash Flow: SLB’s Free Cash Flow is healthy, at nearly $3.5 billion.
  • Debt to Equity: SLB has a debt/equity ratio of .38, which is conservative and indicates the company has a disciplined approach to debt management. While the company’s cash and liquid assets have declined significantly since the beginning of 2016, they also totaled more than $2.6 billion in the most recent quarter. Their balance sheet indicates that operating margins are more than adequate to service the company’s debt, which was a little over $14 billion in long-term debt in the last quarter.
  • Dividend: SLB pays an annual dividend of $2.00 per share, which at its current price translates to a dividend yield of about 4.18%. The stock’s dividend offers a compelling reason for patient investors to hold this stock, with a current yield well above even long-term Treasury yields, which remain around 3% right now.
  • 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 $26.68 per share. At the stock’s current price, that translates to a Price/Book Ratio of 1.79. The stock’s historical Price/Book ratio by comparison is 2.66 and puts the top end of the stock’s long-term price target at around $71 per share. The stock’s Price/Cash Flow ratio provides a more conservative target at around $56, since SLB is currently trading a little more than 17% below that historical average. Either way, the long-term upside from the stock’s current price level looks very attractive right now.



Technical Profile

Here’s a look at the stock’s latest technical chart.

 

  • Current Price Action/Trends and Pivots: SLB’s downward trend is pretty easy to recognize on this chart – particularly the way that trend has accelerated since the first week in October. The stock is currently in free-fall, dropping below levels not seen since the first half of 2009. Investors naturally correlate SLB’s stock price, and its peaks and valleys, with movement in oil and energy prices. That actually provides another interesting take on the stock’s value proposition, since when WTI crude bottomed at $27 per barrel in 2016, SLB’s price found a bottom at around $65. Crude might not be at a bottom right now, but it remains more than twice as high as that 2016 bottom, while SLB is plumbing levels that are more than 25% below its low point in 2016. Most U.S. producers for the last couple of years have publicly referred to being able to maintain healthy profitability with WTI in the mid-$40 range, which is something that lends credence to the idea that production isn’t going to taper in the U.S. quickly.
  • Near-term Keys: Given the strength of the stock’s current bearish momentum, I don’t think a short-term bullish trade is anything but a speculative, low-probability play right now. Its pivot levels in early 2009 indicate it could find good support in the $45 range, so a pivot and bounce higher from that level could offer some kind of short-term bullish opportunity; but I would wait to see the stock break above $52, where it saw some very short-term stabilization last week before thinking about any kind of near-term bullish trade using call options. Given how close the stock is to support from those 2009 levels, i’m also not sure a bearish trade, either by shorting the stock or buying put options is a very good trade, either. The stock would need to break below $35 to offer a decent bearish signal at this stage. The best bet with SLB right now? Play the long game; but the stock and enjoy the passive income from its high dividend payout while you wait for it to reverse its downward trend and reclaim its highs.