3 Reasons National Oilwell Varco is A Buy

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

Calling National Oilwell Varco (NYSE: NOV) the "picks and shovels" of the oil industry is certainly appropriate. While not in the business of producing oil themselves, the products and services they provide are critically important to those who are. Virtually every oil rig in the world utilizes the products of National Oilwell Varco. They operate in 3 business segments. The Rig Technology segment generates the most revenues and profits for NOV. This segment is involved with the design, manufacturing, and selling of equipment related to the construction of oil and gas wells. Whenever a new oil well is being built you can bet National Oilwell Varco's products are being used. Once the wells are built producers need equipment to extract the oil, using things like drills, pumps, and specially tailored chemical solutions. National Oilwell Varco services these needs through their Petroleum Services and Supplies segment. During the process of producing oil the equipment being used takes some serious punishment.  Fortunately the Distribution and Transmission segment of NOV is there to provide the maintenance, repairs, and spare parts for the world's oil rigs. A wide variety of factors exist that support the conclusion that National Oilwell Varco is an attractive investment--here are 3 that I find especially convincing.

An Aggressive Growth Strategy

Management at NOV has repeatedly stated in their filings with the SEC that they are pursuing an aggressive growth strategy and plan to continue to do so in the future. Just last week they completed a merger with Robbins and Myers (NYSE: RBN), for a price that represents about 8.8% of the market cap of NOV ($2.5 billion). Robbins and Myers has no debt, and over $200 million in cash. Better yet, cash from continuing operations over the past 5 years has been $491.3 million, growing at a 15.8% rate per year over the past 5 years.  The people running NOV did good by their investors when they bought a company whose business nicely compliments their own and is rapidly increasing the rate at which they generate profits.

Strong Working Capital Position

One piece of NOV's balance sheet that struck me as being particularly attractive was working capital. In "The Intelligent Investor" Ben Graham proposed that a company is worth at least as much as their working capital value. In the case of NOV that number is $10.029 billion. Over the past 5 years working capital is up an astonishing 248%! A working capital position that represents a third of market cap, and has grown at a 49.7% annual rate over the past 5 years, is a very positive sign.

Can You Say Moat?

National Oilwell Varco has an estimated 60% market share in oil rig equipment. The nickname "no other vendor," a play on the ticker symbol, is an accurate description indeed. A history of acquisitions stretching back to the 1980's has resulted in the oil rig equipment industry being consolidated to a large degree. Luckily for investors of National Oilwell Varco that consolidation has transformed NOV into the hulking giant of the industry. At this point the threat of new entrants into the market is virtually non-existent. Decades of being in the industry has allowed NOV to build up an extensive customer base and become an efficient low cost producer. Attempting to compete with what the folks at NOV have created without economies of scale or a reputation for excellence is financial suicide.

The Competition

National Oilwell Varco has acquired dozens of companies over the past few decades. Last year they purchased 17 businesses for almost $2.9 billion, not including the recent $2.5 billion purchase of Robbins and Myers. Still, there are companies that do successfully compete with National Oilwell Varco. One notable competitor is FMC Technologies (NYSE: FTI). Although a big player in the oilfield services industry, over the past 5 years FMC Techonologies has had net profit margins that were 5.1% points lower than NOV. Additionally, NOV has on average generated from operating activities 5.84 times greater than FTI has over the past 4 years, while having a market cap only 2.34 times as large. With stronger margins and a cheaper valuation relative to operating cash flow I'd say NOV is the better investment out of these two.

And then there is Schlumberger (NYSE: SLB), the world's largest oilfield services company. Schlumberger's working capital amount is $11.788 billion, or roughly 17% more than NOV. That being said, if you bought Schlumberger you would pay $8.64 for each dollar of working capital. On the other hand, purchasing NOV would result in you only paying $2.65 per dollar of working capital. The conglomerate status of Schlumberger has given it a valuation that is much more expensive than National Oilwell Varco.

So, there we have it, two prominent competitors. One has margins preventing it from significantly disturbing National Oilwell Varco's dominance. The other has margins that are neck and neck with those of NOV. However, in terms of valuation based on EPS or working capital amount, NOV is clearly the cheaper investment.

Final Foolish Thought

National Oilwell Varco's business goes as the oil industry goes. High oil prices lead to more profits for oil producers. More profits for oil producers leads them to drill for more oil.  Drilling for more oil results in demand for the products that only National Oilwell Varco, and a handful of its much smaller competitors, can provide. While the short term future of the oil industry is incredibly hard to foresee, oil will be drilled in the coming decades. The drilling of oil will necessitate the construction of rigs. Excellent managerial decisions over the past few decades have allowed National Oilwell Varco to establish themselves as the undisputed market leader. They have created a set of advantages for themselves that other companies will find impossible to duplicate. Margins created by decades of massive consolidation can barely be achieved by anyone else. Those companies who can compete with the margins of NOV have much more expensive valuations.  A strong financial position and absolute dominance in supplying vitally important products to the oil production industry, one that will almost definitely exist in the foreseeable future, make National Oilwell Varco a company that is certainly worth owning a piece of.

Studyearnenjoy has no position in any stocks mentioned. The Motley Fool recommends FMC Technologies 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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