Buying This Solid Drilling-Equipment Provider on Weakness

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National Oilwell Varco (NYSE: NOV)), with a market cap of $28.1 billion, is one of the largest providers of equipment and components to the energy industry. It supports oil and gas drilling and production operations, oilfield services, and supply chain integration services to the upstream oil and gas industry. Despite weak quarterly numbers, it may be a good time to consider buying National Oilwell Varco.

Lower operating margin

On April 26, National Oilwell Varco reported weaker-than-expected Q1 results due to a lower operating margin in all of its segments. Excluding transaction costs, EPS of $1.29 missed the Zacks' consensus estimates by $0.08. Revenue increased to $5.3 billion, up 23% from Q1 2012, but still missed the projection of $5.4 billion.

Segment breakdown

<table> <tbody> <tr> <td> </td> <td> <p><strong>Revenue</strong></p> </td> <td> <p><strong>Profit</strong></p> </td> <td> <p><strong>Operating</strong> <strong>Margin</strong></p> </td> <td> <p><strong>Impacted</strong> <strong>by</strong></p> </td> </tr> <tr> <td> <p><strong>Rig Technology</strong></p> </td> <td> <p>$2.6 billion (up 16.3% yoy)</p> </td> <td> <p>$557 million (up 1.1% yoy)</p> </td> <td> <p>21.2% (down from 24.4% for Q1, 2012)</p> </td> <td> <p>Higher <a href="">demand</a> for capital equipment used for newbuild offshore rigs</p> </td> </tr> <tr> <td> <p><strong>Petroleum Services & Supplies</strong></p> </td> <td> <p>$1.7 billion (flat yoy)</p> </td> <td> <p>$311 million (down 19.8% yoy)</p> </td> <td> <p>18.3% (down from 22.8% for Q1, 2012)</p> </td> <td> <p>Lower demand for products and services on the back of a weaker North American market</p> </td> </tr> <tr> <td> <p><strong>Distribution & Transmission</strong></p> </td> <td> <p>$1.2 billion (increase 117.5% yoy)</p> </td> <td> <p>$65 million (up 51.2% yoy)</p> </td> <td> <p>5.3% (down from 7.6% for Q1, 2012</p> </td> <td> <p>N/A</p> </td> </tr> </tbody> </table>

Challenging quarter

At the end of Q1, backlog for capital equipment orders for National Oilwell Varco's rig technology segment was a record at $12.9 billion, up 8% sequentially and rising 24% from Q1 2012. New orders during the quarter were $3 billion, reflecting continued strong demand for oilfield equipment. Nonetheless, it was a challenging quarter.

National Oilwell Varco faced a challenging Q1 due to a choppy market in North America, and more headwinds are expected. However, management remains bullish on offshore-rig demand, floating production systems, and for products and services in the international land markets. Management also expects a strong Q2 for the rig-technology segment.

Robbins & Myers, the largest acquisition since 2009, was finally closed in Q1, strengthening National Oilwell Varco's position in a number of key technologies. One of the company's strengths is to make acquisitions and then plug those businesses into its larger footprint to drive higher growth. With the completion of the Robbins & Myers deal, more long-term growth is expected.


The long-term outlook for National Oilwell Varco remains promising, as quoted from Pete Miller, Chairman and CEO of National Oilwell Varco: 

While we are cautious regarding the timing of a North America recovery, we remain confident that land drillers and well service firms will soon consume their current inventories, ultimately requiring more of our products and services. Until that time, we take comfort in knowing that we are well positioned for this market, given our strong financial resources, unparalleled market presence, exceptional backlog, and extraordinary workforce.

Fundamentally, National Oilwell Varco has higher revenue growth (three-year average) at16.4% as compared to the industry average of 6.5%. National Oilwell also has higher margins and stronger ROE/ROA than the averages. 

It has a healthy balance sheet with a debt/equity ratio of 0.2. From the valuation perspective, the company's P/E of 11.4 is lower than the industry average of 26.5, and its forward P/E of 9.4 is lower than the S&P 500's average of 14.3.

National Oilwell is also undervalued compared to its peers, such as Schlumberger (NYSE: SLB) and Baker Hughes (NYSE: BHI)with P/E ratios of 18.1 and 14.9, respectively.

Schlumberger is a supplier of technology, integrated project management and information solutions to the oil-and-gas exploration-and-production industry globally. With a market cap of approximately $101.2 billion, Schlumberger continues to the be the leading play in the oil-services industry with its wide diversification, strong research, and solid financial strengths. Schlumberger has higher margins and returns than the industry averages.

Baker Hughes, with a market cap of $20.7 billion, operates in the oilfield-services industry. By acquiring pressure-pumping provider BJ Services and reorganizing the company, Baker Hughes is now providing more integrated services for its customers.Despite lower margins and returns, Baker Hughes has higher revenue growth (three year average) of 30.3% as compared to National Oilwell and Schlumberger.

How to invest

Despite the short-term headwinds due to softness in North American market, National Oilwell remains well positioned for the long term. With the recent completion of the Robbins & Myers deal, more long-term growth is expected. It is a good time to accumulate National Oilwell slowly and buy on weakness for long-term positions.

Disclaimer: Investors and traders are recommended to do their own due diligence and research before making any trading/investing decisions.

National Oilwell Varco is perhaps the safest investment in the energy sector due to its industry-dominating market share. This company is poised to profit in a big way; its customers are both increasing the number of new drilling rigs and updating aging fleets of offshore rigs. To help determine if it could be a good fit for your portfolio, you're invited to check out The Motley Fool's premium research report featuring in-depth analysis on whether NOV is a buy today. For instant access to this valuable investor's resource, simply click here now to claim your copy.

Nick Chiu has no position in any stocks mentioned. The Motley Fool recommends 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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