The Pick (and Shovel) of Energy Stocks
11/04/2011 7:30 am EST
This is a good way to play growth through the down-and-dirty side of the energy industry, writes Stephen Ellis of Morningstar StockInvestor.
Schlumberger (SLB) is one of the top firms in the oil-services industry. In our view, the company is well positioned to benefit from the industry’s current weakness and future rebound, given its financial strength, geographical and product diversification, well-regarded research labs, and unique technology-acquisition strategy.
We believe the company’s focus on building out a product set by making small software-oriented acquisitions to provide deeper insights into solving oilfield issues will result in an edge over smaller peers when conditions improve. This strategy is geared toward winning large integrated project-management contracts with national oil companies (where Schlumberger excels), which offer ample opportunities to sell additional services from its wide-ranging portfolio.
Schlumberger’s comprehensive services portfolio offers pressure pumping services, seismic services, and integrated project-management efforts. The company’s services are typically used to extract oil and gas from wells, an effort that has grown more complicated with the increased complexity and depth of the oil and gas reservoirs under development.
We think Schlumberger’s one-stop approach earns it customer loyalty, which results in premium prices for its services. Further, we think the company’s large product portfolio lets it package many of its products into a single attractive offering, making it very difficult for more narrowly focused competitors to win work.
Accordingly, the firm generally has the leading market share in all its product lines. This factor, combined with its research and development strength and technology approach, leads us to assign a wide economic moat to the company.
We believe Schlumberger’s market share gains are driven by its substantial R&D investments, which are supported by a clever acquisition strategy. Oil and gas companies will rapidly adopt new products if they can see the value proposition.
Schlumberger has had numerous R&D successes during the past few years, including its seismic Q-technology, which has grown into a billion-dollar business. The R&D successes mean Schlumberger can consistently commercialize its research efforts for rich payoffs, which we think peers find harder to accomplish.
Further, the company’s acquisition strategy feeds its R&D advantages. We believe the firm thinks more like a technology firm and acquires soft assets (such as software), whereas its peers think like consumer goods companies and acquire hard assets (like a Latin American oil services firm).
We think these types of technology deals, such as petro-physical software firm Techsia in 2009, keep the firm ahead of competitors and positioned for long-term growth around the world.
Our fair-value estimate of $94 per share implies a forward 2012 P/E multiple of 18 and a forward 2012 EV/EBITDA multiple of ten. International markets such as Brazil, Mexico, Iraq, and Russia all offer growth opportunities for the next few years. Overall, we see Schlumberger’s revenue growth at 42% in 2011, mostly thanks to the additional revenue from Smith.
Over the long term, we believe many of Schlumberger’s markets can grow 10% annually (on average) as the increasing complexity of the oil and gas reservoirs requires more services to fully develop.
We expect the firm’s long-term operating margin in North America to be around 26%, because the company will be able to charge more due to the intensive need for services in many oil and oily shale wells. In the international markets, we believe margins will be 24%, as the markets gradually recover from the last downturn.
We expect Schlumberger’s capital expenditures in 2011 and 2012 to be $4.4 billion and $4.6 billion (which includes M&A activity and Smith’s capital expenditures) as the company continues to build out its international presence.