Is Schlumberger a Buy?
Shares of Schlumberger (SLB) have dropped since the announcement of its first quarter results on April 21, 2016. However, its stocks are still up nearly 11% since the beginning of this year due to recovery in the oil and natural gas prices. This decent run of its stock on the stock market suggests that the company has started benefiting from the recent rebound in oil and gas prices. So, the investors should maximize on the recent dip in its stock price to increase their holdings. Let us see why.
Good results under a bad situation
Despite persistent pricing pressure and a significant drop in the activity level, Schlumberger’s first quarter results topped the analysts’ estimates on both the top as well as the bottom lines.
However, both the top, as well as the bottom lines got declined by 32% and 62% respectively on a year-over-year basis. This dramatic drop in the revenue and earnings is due to a significant decrease in the investments of the E&P companies and reduction in the rig counts. According to the management, the global spending reduction during the first-quarter came close to 25%, principally due to a related fall of around 40% to 50% in North America and around 20% in the global market.
On the other side, the land rig count in the United States declined by 31% on a sequential basis. In fact, the United States land rig counts dropped to near 400 rigs, representing a slump of around 80% from the second-half of 2014. As per the company, it is the most severe downturn the industry has seen in the last 30 years. However, this significant drop in the rig counts is a compelling opportunity to invest in the oilfield services and equipment companies like Schlumberger, because the recovery in the rig count will drive its performance at a much higher rate than expected, creating value for its investors and shareholders.
Rig count are nearing the bottom
At the current rig counts, the production will find it difficult to match with the growing oil and gas demand across the world. According to a report by EIA released on May 10, the global consumption of petroleum and other liquids fuels will grow by 1.4 million barrels of oil equivalent per day in 2016 and by 1.5 million barrels of oil equivalent per day in 2017. On the other side, the agency expects the non-OPEC supply will fall by 0.7 million barrels of oil equivalent per day in 2016 and by 0.2 million barrels of oil equivalent in 2017.
In my opinion, this inverse relationship between demand and supply will push the oil and natural gas prices higher while accelerating the rig counts due to the fact that the current rig counts will not be able to produce the required output. In fact, the reversal in rig count is expected in the second-half of this year. For instance, OAODC expects the active rig counts in Western Canada in the third quarter to grow to 157 rigs from the current rig counts of 88 rigs and to 204 rigs in the fourth-quarter, representing an increase of 78% and 132% respectively from the current rig counts.
Likewise, the plunge in the U.S rig counts is projected to get over in about 12 weeks. As per Morgan Stanley, the recovery in the U.S rig counts is around the corner and expects to take place in about three months. Thus, with this rebound in the rig counts, Schlumberger should see higher orders for its equipment due to increasing fleet and utilization rate as seen above in the chart. In my view, this is the high time to put your money in the oilfield services companies, primarily in Schlumberger, which is doing a fair job at the operational level. Let us have a look at these operational initiatives that should improve its margin upon the recovery in the rig counts.
Leveling of the costs structure to activity levels is strengthening its decremental margins
In this tough environment, Schlumberger continues to tailor service capacity and G&A costs to activity levels while focusing on preserving long-term operational and technical capabilities. For instance, the company on a temporary basis closed few of its operations that were difficult to maintain due to higher maintenance costs. As a result of the closure of these operations, its decremental margin for the quarter improved to 30% from 20% in the fourth-quarter of 2015.
In addition, its G&A expenses for the quarter dropped by 8% to $110 million as compared to $119 million in the same quarter last year. In fact, the company lowered the research and engineering costs by 10% on a year-over-year basis.
Looking ahead, Schlumberger is expected to benefit from the Cameron transaction. It expects a pre-tax synergy of around $300 million for the next twelve months and approximately $600 million in the following year. Apart from the cost synergies, the company expects significant revenue synergies from this transaction. Let us have a look at those revenue synergies.
Revenue synergies from Cameron
Schlumberger expects the acquisition of Cameron to strengthen its technology going forward. At present, the company is integrating Cameron’s technology to develop a new generation of incubated surface and subsurface systems. The company is of the opinion that the development of this system has the potential to make a step change in both drilling and production performance.
For instance, Schlumberger’s future land drilling system, basically the purpose-built surface and downhole hardware is almost ready to be integrated into a complete drilling system. The company plans to manage this technology with common optimization software that should increase operational efficiency for E&P significantly in the future.
Along with this, Schlumberger is additionally working on developing a new rig design acquisition and rig manufacturing system. It expects a couple of engineering prototypes of this new system to be available for field testing in 2016 in Ecuador and remains high on the full commercial introduction in 2017 in the U.S. In fact, the company beyond 2017 plans to develop a new hydraulic fracturing system to regroup the new hardware technologies and process reengineering on a common operating and optimization software.
Schlumberger expects this system to offer a complete range of surface components like that of Cameron’s CAMSHALE pressure control and wellhead system, along with its own perforating, fracturing, cleanup, and flowback services, as well as its latest downhole completion technology and fracturing fluids.
Thus, Schlumberger remains a safe bet on the recent dip due to above-stated reasons. Moreover, the company continues to invest in the technologies and merger & acquisition while lowering its costs. This move should enable the company to improve its financial performance in the future.