Schulmberger: Best-in-Class

08/06/2013 7:40 am EST


Stephen Leeb

Founder and Research Chairman, Leeb Group

This company is a best-in-class giant; it's been the leading oil services provider for more than two generations, and there are no challenges to this status on the horizon, says Stephen Leeb of The Complete Investor.

This year, Schlumberger (SLB) should complete the turnaround from its 2008-2009 slide, with profits likely to top their previous record.

It's notable that the fall in revenues and earnings during the Great Recession was far less deep than in earlier periods of falling oil prices, such as the late 1990s. That's because hydrocarbon scarcity has become so evident, that even when prices drop, the search for new supplies goes on.

Yet Schlumberger, whose P/E historically has been higher than the market's, currently trades at a marginal discount. Our 12-month target of 100 assumes an expanding P/E along with rising earnings.

The company has three business segments. Its most profitable and longest-standing franchise is reservoir characterization. This division consists of several leading-state types of services that define the potential of an energy deposit and the best ways to exploit it.

The division operates on both land and sea and delivers operating margins of nearly 30% in bad times and 35% or more in good times.

It's the part of Schlumberger's business that holds up best during recession, as hydrocarbon producers seek to ensure, against a backdrop of fewer viable projects, stakes in future production that will pay off when oil prices rise.

The drilling segment brings in the most revenue, as a result of several acquisitions in recent years, including Schlumberger's 2010 purchase of leading drill parts producer Smith International.

Worth emphasizing is that Schlumberger's financial strength enabled it to buy a first-class asset like Smith, along with other smaller companies, when competitors were being buffeted by recession. In the past, the company has made acquisitions outside its area of expertise, rather than strengthening its franchise.

The third division, hydrocarbon production, is the one most sensitive to oil prices. It also offers the greatest potential for an upside surprise because of its role in deepwater production. The coasts of Africa and South America should both witness strong growth in production.

Schlumberger is diversified geographically, as well as by its products. Indeed, it's the most geographically diversified of any oil services company, by a wide margin. This will serve the company well in the years ahead.

Today, for example, the Middle East and Asia account for about 20% of revenues. Led by China's rapacious energy appetite, that will rise to well over 25% by mid-decade. Latin America is also expected to be a very rapid grower.

The balance sheet is excellent, and there's ample free cash flow. Despite the recent buying spree, the debt-to-equity ratio has remained steady. Over the next several years, investors in Schlumberger will likely be treated to both growing dividends and share repurchases.

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