Unbelievable Things you have to Believe to Bet Against Schlumberger

By Keith Speights - May 19, 2012 | Tickers: BHI, HAL, SLB, USO, WFT | 0 Comments

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This time it’s different. How many times have these words been spoken yet ultimately proven to be false? I propose we take advantage of this pattern. What if we found a stock for which things would have to be very different than in the past for it not to go up in the longer term? One stock that I think fits the bill is the giant oil services firm Schlumberger (NYSE: SLB).

Schlumberger is in a definite downtrend, slipping by over 30% from its 52-week high last summer. There are several major headwinds for the stock, including decreasing oil prices and global uncertainty with the Eurozone and Middle East. I suggest, though, that we would have to believe that “this time it’s different” for Schlumberger to not go up over the long run. Specifically, we would have to believe at least one of the following:

1. Schlumberger stock prices will not go up if oil prices go up
2. Oil and gas prices will not go up
3. Schlumberger’s growth will be much lower than projected

My opinion is that these statements are not believable. Therefore, I think that Schlumberger’s stock will go up over time. Here’s why.

1. Schlumberger stock prices WILL go up if oil prices go up

Let’s first establish that there is a linkage between Schlumberger’s share price and the price of oil. The chart below uses the United States Oil ETF (NYSEMKT: USO) as a proxy for oil prices.

The pattern is easily seen. As oil futures prices go, so go SLB prices. We would have to believe that this price correlation will no longer hold true to think that SLB will not go up if oil prices increase. Is there any reason to believe that some fundamental change will occur that decouples the price movement of Schlumberger and oil? Nope. Score one for unbelievable.

2. Oil and gas prices WILL go up

One of the laws of supply and demand states: “If supply decreases and demand remains unchanged, then it leads to higher equilibrium price.” To hold the opinion that oil and gas prices won’t go up, we would have to think that the supply of oil and gas will increase significantly greater than demand. There is a big problem with that opinion, though. It hasn’t occurred.

Total global energy consumption is growing by over 5% annually, according to Enerdata, a global energy research firm. Over 55% of that energy comes from oil and gas. Some experts estimate that the world will still get 50% of its energy from oil and gas in the year 2035.

So for oil and gas prices to not go up, something incredible will have to occur in either (a) generating major new sources for supply or (b) dramatically decreasing demand. Of course, there could be major new finds like have occurred in the Bakken region. New technology could reduce our dependence on fossil fuels. It is a stretch, though, to believe that either will make up for the increasing global demand for energy.

3. Schlumberger’s growth will NOT be much lower than projected

Analysts expect Schlumberger to grow earnings by 23% annually over the next five years. This gives SLB a PEG ratio of 0.64. Even if the estimates are off a good bit, the stock is still attractively valued. I don’t think the analyst estimates will prove to be overly optimistic, though.

First, the need for the types of services Schlumberger provides will likely increase at a solid pace. The success rate of exploration has been below 40% for the last 10 years. Exploration costs are rising. Schlumberger offers software covering seismic and petrophysical interpretation, and petroleum system modeling. Its services help customers greatly improve the likelihood of success in oil and gas exploration. Recently in Marcellus, a company was able to achieve 40% higher production using Schlumberger’s approach compared to standard completions.

Second, Schlumberger’s commitment to ongoing research and development position it well for the future. Exploring new oil and gas sites and making them profitable will become increasingly difficult. Schlumberger is investing in the R&D needed to continue its place of leadership. The chart below shows how it compares to its competitors in R&D investment.

Baker Hughes (NYSE: BHI) is a distant second to Schlumberger in R&D investments. Halliburton (NYSE: HAL) and Weatherford (NYSE: WFT) are increasing R&D spending at a faster rate than Baker Hughes. However, Schlumberger is increasing R&D spending even faster. With the demand for oil services and the company’s dominance in R&D, I find it unlikely that Schlumberger’s growth will lag projections by any significant levels.

History on its side

Schlumberger’s stock has seen declines in the past similar to what it is undergoing now. It bounced back each time. Why? Because SLB stock tends to go up with oil prices, and oil prices went up. Because there was a strong demand for the services that Schlumberger provides. Because Schlumberger was the largest company in the oil services sector with healthy fundamentals and a solid focus on R&D.

Schlumberger is trading at a trailing P/E of 16 and a forward P/E of 12. The low end of its range over the last 10 years has been 13 except for 2008 when the bottom dropped out of the market. Its P/E got as low as 8 then. The median P/E for the stock has been around 20 or so. Mark Twain once said, “History doesn’t repeat itself, but it does rhyme.” I think the odds of SLB getting back to a P/E of 20 are, well, plenty.

That’s not to say Schlumberger won’t go down more before it heads up. Investors should watch the price of oil. When oil makes its comeback, SLB should be a buy - unless this time things really are different.

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