Oil Exploration In The United States Is Slowing Down

Rupert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

When National Oilwell Varco (NYSE: NOV) announced its results in February the company's shares tanked, despite the fact that the company achieved record earnings. Despite this, shares dropped on the company's forecast that drilling rates in the US were slowing down and the oil boom US could be starting to cool off.

In my opinion this presents an excellent buying opportunity. I immediately purchased shares and will continue to add to my position when I can, while the shares trade under $70.

Why am I so bullish on the stock? Well for a start the company has a 60% market share of the oil services market. People will always need oil, and even if we run out one day, National Oilwell will be able to move into another industry, as the company's size and engineering experience are second to none.

Secondly, the sell-off in the stock is unfounded. Just because drilling rates in the US are falling does not mean the whole drilling industry has come to a halt. In addition, National Oilwell Varco has a significant after-market presence, so even if drilling rates are falling the company will still have plenty of orders and customers.

<img src="/media/images/user_14485/r1_large.png" />

The global rig count is reaching highs not seen for over twenty years, which is why National Oilwell Varco did so well in 2012.

I should say that although the US rig count and the rig count in the rest of the world appear to be highly correlated, they are not. The correlation between the rig count in the US and the rig count in the rest of the world (excluding the US) is actually 0.4, which signifies that a decline in rigs within the US does not necessarily constitute a decline in rigs within the rest of the world.

In addition, most rigs in the US are land based:

<img src="/media/images/user_14485/r1_1_large.png" />

Land based rigs demand a much lower rental cost than offshore rigs. So, a higher rig count in the rest of the world would indicate that the world is demanding more offshore, expensive oil rigs. If the rig count is falling in the US but rising in the rest of the world, then higher profits could follow as the world does more offshore drilling.

So, National Oilwell's sell-off was an unfounded knee jerk reaction, both rig counts and drilling rates continue to be high throughout the rest of the world, and National Oilwell Varco will continue to benefit.

Would it be better to buy an oil rig stock?

National Oilwell Varco is a great company, but would it be better to buy a stock that was directly involved in higher margin drilling, rather than the manufacturer of components?

<img src="/media/images/user_14485/r1_2_large.png" />

Transocean (NYSE: RIG) and Seadrill (NYSE: SDRL) are widely thought of as the best rig stocks on the market. The high rental costs they demand for offshore drilling really shows through in their bottom lines.

Seadrill has achieved the best net profit margin of all three companies over the past six years - achieving a net margin almost double that of National Oilwell Varco. Furthermore, apart from 2011, Transocean has also achieved a higher net margin than National Oilwell Varco, which indicated that rig stocks could be the better bets.


<table> <tbody> <tr> <td> <p>Sales Growth Past 5-years </p> </td> <td> <p> </p> </td> </tr> <tr> <td> <p>National Oilwell Varco</p> </td> <td> <p>15%</p> </td> </tr> <tr> <td> <p>Transocean</p> </td> <td> <p>20%</p> </td> </tr> <tr> <td> <p>Seadrill</p> </td> <td> <p>30%</p> </td> </tr> </tbody> </table>

Indeed, sales growth at the rig companies has been rapid, once again out-pacing that of National Oilwell.

I have used sales growth figures rather than EPS growth, as the figures for Transocean have been significantly distorted by fines stemming from the Deepwater Horizon disaster, which presents a biased picture.

Seadrill has produced the fastest sales growth over five years, closely followed by Transocean. National Oilwell has lagged the group, with sales growth coming in at 15%, half of Seadrills 30%.

Balance Sheets

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p>QUICK</p> </td> <td> <p>CURRENT</p> </td> <td> <p>NET DEBT</p> </td> <td> <p>DEBT EQUITY</p> </td> </tr> <tr> <td> <p>SDRL</p> </td> <td> <p>0.71</p> </td> <td> <p>0.71</p> </td> <td> <p>7,781</p> </td> <td> <p>0.59</p> </td> </tr> <tr> <td> <p>NOV</p> </td> <td> <p>3.31</p> </td> <td> <p>5.35</p> </td> <td> <p>-3,025</p> </td> <td> <p>-0.11</p> </td> </tr> <tr> <td> <p>RIG</p> </td> <td> <p>1.30</p> </td> <td> <p>1.42</p> </td> <td> <p>9,337</p> </td> <td> <p>0.46</p> </td> </tr> </tbody> </table>

Despite the rapid sales growth and strong margins, Transocean and Seadrill have very poor balance sheets relative to National Oilwell. National Oilwell has a net cash balance of $3 billion and working capital ratios of 3 and 5, which is much higher than the ratio of 1 required to show that the company is well-funded for the next 12 months.

On the other hand, Seadrill is not able to cover its current liabilities with current assets. In addition, net debt is $7.7 billion, a gearing level of 60%. Transocean has better working capital ratios of >1 and a lower gearing level of 46%.

Return on shareholder equity

So far, the rig stocks have the best net profit margins and the fastest growth rates. However, the rig stocks do have the worst balance sheets.

So, what about the most important factor, shareholder returns--and more importantly, returns on shareholder equity?

<img src="/media/images/user_14485/r1_4_large.png" />

I believe return on shareholder equity is one of the most important factors of any company.

Undoubtedly, over the last six years Seadrill has produced some of the highest returns on equity. Transocean produced some extremely high returns in 2007-2008, but has since produced negative returns, although it is forecast to start increasing ROE again this year.  Lastly, National Oilwell Varco has produced low, steady returns for the past six years and is expected to continue to do so. 

National Oilwell has produced an average ROE of 13% over the past six years. Seadrill has returned 18% on average, and Transocean 6%. Obviously, Seadrill has produced the best average returns, but this has come with some volatility:

Seadrill produced 18% ROE on average, but had a minimum return of -3% ( 2008) and a maximum return of 31% ( 2009). Transocean has produced a minimum return of -36% ( 2011) and a maximum of 25% ( 2007). National Oilwell has returned a maximum of 20%, but a minimum of 10%--this is the smallest range in the group.

The tight range of National Oilwell Varco's ROE makes the company predictable.  It may not have a high return like Transocean or Seadrill, but it is predictable and steady.

In Conclusion

Oil exploration may be forecast to slow in the US over the next year, but drilling throughout the rest of the world will continue growing. 

National Oilwell is perfectly positioned to take advantage of the rising rig count around the world. National Oilwell Varco does not command the same kind of profit margins or growth rates that the main drilling companies do, but the company has a solid balance sheet and continues to produce a steady return on shareholder equity.

In my opinion National Oilwell Varco is perfectly positioned to take advantage of the world’s increasing need for oil, and right now the shares are looking cheap.

Data Source: Saxo Capital Markets, Marketwatch

RupertHargreav owns shares of National Oilwell Varco. The Motley Fool recommends National Oilwell Varco and Seadrill. The Motley Fool owns shares of National Oilwell Varco, Seadrill, and Transocean. 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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