Oil Services Giant on Sale
09/24/2008 12:00 am EST
Elliott Gue, editor of The Energy Strategist, says oil services stocks are at their lowest prices in years and giant Schlumberger is a bargain.
The oil and gas services group is one of my favorite subsectors in the energy patch. The average estimated price-to-earnings multiple for the Philadelphia Oil Services Index (OSX) is 12.5x based on this data, while the low was 8.95x, touched briefly in October 2006. The current value based on this chart is 10.85x, and the P/E did drop below 10x intraday on one of the big recent selloffs.
But on October 6, 2006, crude oil traded at less than $60 per barrel compared to more than $90 per barrel at the current time. More importantly, the international rig count—a measure of global drilling activity—stood at 3,134 compared to more than 3,500 today. Bottom line: I doubt the Oil Services Index will trade under nine times earnings as they did in late 2006, but if that were to happen, downside is still highly limited.
In July 2002, the OSX hit a valuation low of 7.95x cash flow; today that ratio is at less than 8.3x. And from an overall market standpoint, the comparison with 2002 is even more ridiculous than the comparison with late 2006. Back then, oil traded at $27.02 per barrel, and the global rig count stood at 1,822, barely half the current level.
And some of my absolute favorite companies are trading at levels unseen since 2002.
Schlumberger (NYSE: SLB) is the world’s largest oil services company. The term “services” is loosely defined and can refer to a large number of very different functions related to exploring, drilling, and producing oil and gas fields.
The key point to remember is that Schlumberger has a solid market position in a wide array of high-tech service offerings. This makes it an outstanding play on my "end of easy oil thesis."
Specifically, the large onshore oil reserves that the world has relied on for decades to meet demand are mature and seeing declining production. To generate growth in output, producers are increasingly turning to more complex and tough-to-produce fields such as those located in deep water or in the Arctic. Producing these fields requires more complex services such as those provided by Schlumberger.
One headwind that’s been holding back Schlumberger's growth over the past year is the bottleneck in new deepwater drilling-rig supply. Deepwater projects are extremely profitable for Schlumberger; a shortage of rigs has crimped growth somewhat. Schlumberger has managed to generate plenty of growth even with that rig shortage, but management has indicated that more deepwater drilling activity would accelerate its growth rate.
That bottleneck is set to ease significantly. Between now and 2010, a large number of new deepwater rigs currently under construction are scheduled to leave shipyards and be put to work on deepwater projects. More deepwater projects spell acceleration in Schlumberger's growth over the next four quarters. Trading at less than 18x this year's projected earnings, Schlumberger is as cheap as it's been at any time since early 2007, right before the stock took off on a 70% run-up. (It closed above $86 Tuesday—Editor.) Buy Schlumberger.