Hold Schlumberger in a Long-Term Energy Portfolio but for the Short-Term Recovery You Can Find More Risky/More Profitable Picks

01/21/2015 8:20 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Looking past the plunge in oil prices to focus on a longer horizon is fine for the long-term, but MoneyShow's Jim Jubak doesn’t think it is for the short-term, so he’s selling this leading supplier of oil and natural gas technology out of his short-term portfolio, as of today, January 21.

On January 20, Schlumberger (SLB) announced that it will pay $1.7 billion for a 46% stake in Eurasia Drilling (EDCL in London), Russia’s largest drilling company. Schlumberger can buy the rest of Eurasia Drilling three years after the deal closes.

This is exactly the kind of long-term thinking that a patient investor with a long-term time horizon wants to see from a company. Schlumberger is able to look past the current plunge in oil prices and the current sanctions on Russia’s oil industry, imposed as a result of the war in Ukraine, to see the time when today’s oil surplus has again turned into a deficit and when the world is again willing to invest in tapping (and modernizing) Russia’s huge oil reserves.

But Schlumberger’s move throws the dilemma facing investors now into stark relief. Do you want to be; can you be as patient as Schlumberger? Current forecasts of oil prices suggest that markets won’t see a recovery in oil prices until the second half of 2015 and that even then the increase in oil prices might only be to $65 or $60 a barrel from the current $45 a barrel. And a number of forecasts predict that oil prices will stagnate or even retreat again in the first half of 2016 as oil that has been pumped into storage tanks and oil tankers comes back on the market in response to higher prices.

Wouldn’t it be better to wait until a mid-2015 recovery in oil prices is visible before buying Schlumberger? Or maybe even wait until that second dip, if it happens, in 2016?

What you think of Schlumberger (SLB) now depends on two things.

First, it depends on how far away you think any recovery is for oil prices and the oil industry.

Second, it depends on your strategy for building an energy sector position for the eventual recovery in the sector. (Schlumberger is a member of both my Jubak’s Picks 12-18 Month portfolio and my long-term Jubak Picks 50 portfolio.)

Let me start with the first “it depends” and then move onto “it depends” number 2.

On January 15, the company reported earnings of $1.50 a share for the fourth quarter of 2014, excluding special items. That $1.50 a share was 4 cents a share above Wall Street estimates. Revenue rose 6.2% year over year to $12.64 billion, matching the consensus from analysts.

Two caveats on that earnings beat, for course.

First, those special items for the quarter included a $1.77 billion pre-tax charge for cutting 9,000 jobs ($296 million) and an $806 million charge for writing down the value of offshore seismic survey ships. I’m not sure that I’d call these special items since that implies that they won’t be repeated next quarter and the quarter after that.

Second, those earnings and the earnings surprise are backward looking, that is, they reflect what Schlumberger’s business was like in the last three months of 2014. Here I’d pay special attention to the difference between Schlumberger’s confidence in its October guidance after third quarter earnings and the company’s clear expression of uncertainty in the January conference call.

In October, Schlumberger said falling oil prices—what it characterized as fears of “short-term over-supply”—won’t have a significant impact on its business. “Our view of the overall market continues to include a mix of economic and geopolitical headwinds and tailwinds,” said CEO Paal Kibsgaard. (October’s guidance was itself quite different from the company’s June outlook, which was based on oil at $100 a barrel.)

The tone was markedly different in the company’s January 16 conference call. In that call, Schlumberger said it anticipates lower spending by customers this year, which is why is cutting its workforce by 7%. “In this uncertain environment, we continue to focus on what we can control,” said CEO Kibsgaard. “We have already taken a number of actions to restructure and resize our organization.”

The problem facing Schlumberger, Wall Street analysts, and investors is that estimates of spending plans for 2015 are still a guess. Less than half of the 150 oil and gas companies it follows, Invesco portfolio manager Norman MacDonald told Bloomberg, have reported spending plans for the year. Competitor Halliburton (HAL), which reported on January 20, confirmed those negative trends in the market. The company, which has much more exposure to the North American market than Schlumberger does, reported that the drilling rig count has fallen by 15% recently in the United States and that it expects the rate of decline to accelerate.

Right now, Wall Street analysts are projecting first quarter revenue of $113 billion for Schlumberger—which would be significantly lower than the $12.6 billion in the fourth quarter—and earnings per share of $1.16 versus the $1.50 a share, before special items, in the just completed quarter.

So, what do you do with Schlumberger?

I think the stock remains a core energy sector holding in a long-term portfolio. The company’s technology edge and its dominant market position in many of its markets haven’t been impaired during the current oil price plunge. Company management is correct in targeting this downturn in the sector as a time to pick up market share and I like the company’s attitude that the merger of Halliburton and Baker Hughes (BHI) is an opportunity to pick up market share. Schlumberger stays in my long-tern Jubak 50 portfolio.

On the other hand, I think its worth re-evaluating Schlumberger’s role in a more aggressive, short- to medium-term portfolio. The very solidness that makes the stock such an attractive long-term holding means that it hasn’t declined as much (a good thing) as some of more leveraged and risky holdings in the sector—deep sea drillers such as Ensco (ESV) and SeaDrill (SDRL), for example—but that it won’t show as big a gain (a bad thing) when, sometime after the middle of the year, investors get evidence that the energy sector is rebounding and that some of the stocks that have been hammered hardest are about to show the biggest gains. At that moment, I’d like to own shares that have been beaten down more and that have biggest upside (because of their higher current risk) than Schlumberger. To give me the cash to buy those short- and medium-term plays in June or so, I’m selling Schlumberger out of my short- to medium-term portfolio now. (So, yes, I will be selling Schlumberger out of Jubak’s Picks on Wednesday, January 21. The shares closed at $82.21 today.)

Let me make clear the strategic assumptions behind this particular call on Schlumberger. I’m suggesting dividing your energy position into two pieces, one devoted to companies that are focused on using this downturn in the sector to increase dominant long-term positions and the other devoted to riskier shares that have been pounded more in this oil-price plunge and that, therefore, have even bigger upside potential when this downturn ends. How you divide your own energy position between those two poles depends on your own risk/reward profile. I can see some investors going all for the Schlumberger’s of the energy sector. I can see others with portfolios more heavily weighted toward the recently pounded.

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