5 Reasons to Hold On to This Energy Company

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11% of the S&P 500’s value is derived from energy stocks. I have the same amount of my retirement portfolio allocated toward the energy sector as well. But unlike the S&P 500, my energy portfolio consists of just one company - National Oilwell Varco (NYSE: NOV).

Since buying the company, and making a CAPS pick, last fall, the stock has underperformed the market by about 20%. Meanwhile, plenty of names in the energy sector have handily outperformed the market. But I’m not jumping ship (or rig, as the case may be). There are five main reasons I’m holding onto National Oilwell.

Growing demand for oil

Even as Americans are trying to shrug off their oil dependence with Teslas and Prii, the demand for oil continues to grow. China has become a big oil consumer, and will continue to grow as its economy develops further. The recovering U.S. economy is also a big contributor, as oil is still one of the most efficient forms of energy.

As demand increases, the finite supply of oil means the price of a barrel will likely increase in time. While this doesn’t directly affect National Oilwell Varco, it provides incentive to the companies National Oilwell supplies to continue drilling. In that way, the company’s revenue is still influenced by the price of oil.

Natural gas - not a problem

Some investors may be worried that alternative energy sources such as natural gas may keep oil prices low. But if they’re investors in National Oilwell Varco, they shouldn’t be. Its rigs are equally capable of extracting natural gas as they are oil.

While natural gas prices in America have been low, that could change if the energy source rises in popularity. That would actually benefit National Oilwell Varco in the same way rising oil prices do.

Meanwhile, natural gas prices remain high internationally, where the company has done very well recently. Those energy high prices have allowed the company to expand in Russia, Brazil, and Angola.

Big backlog

National Oilwell Varco added more than $1 billion sequentially to its order backlog in the first quarter. The backlog now stands at a record $12.9 billion. To put that in perspective, that’s more than half of analysts’ average revenue estimate for 2014. A backlog that continues to grow is a good sign of good things ahead for the company.

For the first quarter, National Oilwell booked $3 billion new orders, and delivered about $2 billion out of the backlog. There is a limit to how large the company will allow the backlog to grow, but CEO Pete Miller said he expects the book-to-bill ratio to exceed 1-to-1 for 2013. As demand grows, the company will have to increase production capacity to prevent the backlog from getting out of hand. A company could have worse problems.

Balance sheet and cash flow

National Oilwell’s debt levels have increased over the last six months from $1.5 billion to $4.35 billion. Most of that debt was added to finance the company’s $2.5 billion acquisition of Robbins & Myer’s, its largest acquisition in four years. But considering the company’s cash position of $2.45 billion and its excellent cash flows, this debt level is very attractive.

The company has averaged $1.35 billion in free cash flow over the last five years. That includes a 2012 restructuring of working capital that caused the number to skew negative for a couple quarters. With a net debt position of about $1.5 billion - after including $400,000 in investments on the balance sheet - the company should be able to pay down its debt very quickly.

Dividend growth

But management won’t use all of its free cash to pay down debt. It also returns some of that cash to shareholders through its dividend. Since it started paying a dividend in 2009, management has raised the dividend every year. Most recently it doubled the quarterly dividend to a 1.5% yield.

The companies payout ratio is a miniscule 9%, meaning there’s plenty of room for the company to grow its dividend in the future. It also means management believes there are opportunities for it to invest in during the meantime - perhaps increased production capacity. Investors should feel secure with the dividend yield, and know it will likely continue to grow.

Energy in the sector

During the latest earnings call, Pete Miller indicated National Oilwell Varco typically typically lags behind service providers and drilling contractors. Looking at the rest of the sector gives us a rosy picture for National Oilwell’s future.

Schlumberger (NYSE: SLB), the biggest name in oilfield services, saw excellent international growth last quarter. Its revenue grew year-over-year on that strength, but fell sequentially. The company maintained its strong margins (21% gross profit) by allocating assets to the most profitable locations. National Oilwell is following a similar story of expanding internationally as North American energy prices stay low.

Haliburton (NYSE: HAL) continues the pattern of growing international operations, and saw a record first-quarter revenue of $7 billion this year. Despite relative weakness in North America, the company intends to increase its rig count in the region by 100 to 150 by the end of 2013. Halibruton’s expansion plan indicates continued growth for National Oilwell Varco abroad as well as domestically.

Similar stories can be seen across the industry. These companies are spending money to grow. Specifically, they’re spending money at National Oilwell Varco, which supplies the majority of oil rig equipment in the world. That’s why the company will remain in my portfolio for the foreseeable future.

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Adam Levy owns shares of National Oilwell Varco. The Motley Fool recommends Halliburton and National Oilwell Varco. The Motley Fool owns shares of National Oilwell Varco. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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