A Good Buy But Not Today

By Ankit Agrawal - September 13, 2012 | Tickers: BHI, HAL, SLB | 0 Comments

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Following Schlumberger Limited’s (NYSE: SLB) solid 2Q results and management’s bullish commentary on oil service capacity tightening in seismic, wireline, and drilling services, the stocks have rallied over 7%. Although spot market pricing for frac has been stabilized, I believe contract rollover will be a headwind in the near-term. Additionally, Canada has been slower to recover from spring break-up than initially expected. In August, Canadian rig count has averaged 311 rigs for 3Q12 (~25% below 2011). Therefore, there is a near-term risk associated with the stock.

The stock trend also suggests that August-September has historically been a tough period and I anticipate a downfall in the near term that may provide a good entry point. I expect the company to restart delivering good results from 4Q12 onwards, given the visibility over increasing demand for multi-client and marine contract, rising deep water activity worldwide, and higher international pricing. In my view, the following drivers supports that the long term growth story is intact.

• North American weakness seems concentrated in pressure pumping.

I expect margin declines for the pressure pumping business with pricing currently ~20% from the peak in the coming quarter. But I am optimistic about the recovery in the coming years given the company’s constant efforts to boost efficiencies and take advantage of its technological leadership in that market

• Guar cost issues are likely to abate beyond 4Q12.

I believe that expected lower guar costs, in 2H12, will filter into margins and thus will lead to modest improvement in overall margins.

• Several opportunities to push pricing on smaller contracts.

The company has begun to focus more on technology in existing contracts which tends to be higher margin products and services. Field reliability and technology have always been important drivers of new contract awards.

• Rising international markets and higher prices.

I believe that the international markets will continue to improve at a steady pace in late 2012 and 2013. However, I expect pricing gains only selectively and the majority of the gains to be driven by volumes across most regions.

I believe these events will take time to provide a meaningful impact on the earnings but definitely will provide huge upside.

Strong Growth Prospects to Support High Valuation

The following table summarizes the EPS growth and Forward PE of Schlumberger, Halliburton Company (NYSE: HAL) and Baker Hughes Incorporated (NYSE: BHI):

Clearly, the company has the highest annual growth rate among its peers and thus a premium valuation over its peers is justified. The company is optimally diversified both geographically and in service mix. Also, the company has been managed to escape from many of the execution miscues that have hit its peers. Although the company is trading at a premium on a relative basis, I believe the valuation is still not up to the mark on an absolute basis. Going forward, I believe the stock will enjoy multiple expansions as it becomes increasingly clear to investors that the company’s product-line exposure and geographical exposure will increase earnings power in the coming years.

I believe Schlumberger’s superior execution and technologies historically have allowed it to successfully defend its market share against competition and will continue to do so. In my view, the company is well positioned in international markets that have huge potential for growth. The stock has taken a fall recently and I believe it will fall further in the near term, but the long term growth story remains intact with more influential reasons. Thus, I suggest investors to closely watch this stock for a better entry point.

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