Schlumberger: Big is Beautiful

09/05/2013 8:00 am EST


Richard Moroney

Editor, Dow Theory Forecasts

For this company, big is beautiful. Scale has become a burden for oil majors struggling to grow their production, but this oil services firm can still count it a blessing, observes Richard Moroney, editor of Dow Theory Forecasts.

Founded in 1926, Schlumberger (SLB), operates in all major facets of oilfield services, essentially covering the lifespan of reservoirs that house natural gas and oil.

About 75% of the 27 energy equipment and services companies in the S&P 1500 Index have market values below $5 billion. By comparison, Schlumberger's market cap tops $106 billion.

Schlumberger's scale—greater operating cash flow than its three largest US rivals combined—allows the company to pursue opportunities worldwide.

North America generated 31% of sales for the 12 months ended June, followed by Europe and Africa (28%), Middle East and Asia (23%), and Latin America (18%).

The US land-drilling industry suffers from declining rig counts and relatively weak pricing. But international markets have rebounded, especially Saudi Arabia, China, and Australia.

Schlumberger has shifted its near-term focus overseas, resulting in fatter profit margins from growth in exploration, seismic, and deepwater services.

All three of the company's business segments grew sales at least 7% in the past year, with the strongest growth (13%), coming from Schlumberger's most-profitable business, reservoir characterization.

Reservoir characterization (27% of 12-month sales, 39% of earnings before taxes) helps uncover oil and natural gas through strategies such as evaluating underwater rock formations.

The drilling unit (38%, 34%) sells drill bits and other tools, and provides engineering expertise for drilling and positioning wells. The production business (35%, 27%) offers well-completion, pumping, and subsea services.

Long-term growth could benefit from a proposal by Mexico's new president, Enrique Peña Nieto, to open up the state-controlled energy sector.

The measure, if passed, could boost production, especially if drillers begin tapping the country's deepwater and shale reserves. Schlumberger already offers some consulting services in Mexico and stands to benefit from increased activity in the country.

Schlumberger generated $2.35 billion in free cash flow over the last 12 months, versus a negative $590 million one year earlier. Management has raised the quarterly dividend at least 10% in each of the past three years, after holding it steady during the financial crisis.

The payout ratio remains below 30%, allowing Schlumberger flexibility to keep growing the dividend. Earlier this year, the company announced plans to repurchase up to $10 billion of shares by June 2018.

Analyst estimates are rising, with the consensus now projecting Schlumberger's per-share profits will grow 20% in the second half of 2013 and 21% in 2014.

At 19 times trailing earnings and 2.5 times sales, the shares trade 16% and 18% below their three-year averages. Schlumberger is a Buy and a Long-Term Buy.

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