Over a year after announcing accounting problems in the tax department, Weatherford International (WFT) continues to struggle to complete the restatement. For investors, the most boggling aspect of the tax restatement is that the company moved headquarters to Switzerland in order to reduce tax liabilities, yet the company continues to incur the highest in the industry.
The international oil services provider guided to an effective tax rate of 45% for all of 2012. More importantly the guidance for 2013 is for the effective tax rate to drop to a more historical 34% rate. The real improvement will come in later years as the company finally benefits from expected reduced rates.
So how should investors value the earnings of a company with temporarily high tax rates? The market spoke with dramatically lower stock prices to the tune of a 52-week low.
Q3 2012 Highlights
The company reported the following highlights for Q3 2012:
- Third quarter revenues of $3,818 million were a quarterly record, up two percent sequentially from the revised second quarter revenues of $3,747.
- Third quarter earnings before income taxes of $191 million, or $264 million after excluding pre-tax losses of $73 million.
- North America revenue was up four percent sequentially limited by the lower than anticipated rig count in Canada and pressure pumping pricing declines in the U.S. and up seven percent versus the same quarter of 2011.
- International revenues were flat sequentially but up 20 percent versus the same quarter of 2011.
The incredible part about the story with this stock is that the company continues to report strong operational results even in the face of the distracting and lingering accounting issues. The company managed to report sequential revenue growth in a tough market.
The company guided to income of $0.20 for Q4 assuming a 45% tax rate. Weatherford forecast a positive outlook in most major markets for 2013. Most importantly the tax rate should drop to 34%.
Normalized Tax Earnings
The best example of the normalized tax rate targeted by Weatherford is the 23.6% paid by Schlumberger Ltd. (SLB) in Q3. Applying this tax rate to Weatherford drastically changes the earnings profile of the company. The below table adjusts the earnings to the normalized effective tax rate:
|Quarter||EBIT||45% ETR||25% ETR|
The company expects the tax issue to be resolved by the end of November. Finalizing the restatements will allow for a much higher stock price. As shown above, the company can achieve 10% earnings growth over the next couple of years from reducing the effective tax rates to normal levels.
As mentioned prior, the stock plunged 15% on the day to new 52-week lows. While Weatherford hit new lows, Schlumberger's stock continues to meander between the highs and lows for the year.
1 Year Chart - Weatherford International
The stock provides an incredible bargain, as investors are distracted with the lingering tax issues. As shown above, the normalized earnings are significantly above the reported numbers. The stock should be valued based on the future earnings ability of the company.
The increasing prices of natural gas in North America should benefit the sector as a whole and the profits of Weatherford going forward. Combined that with a stronger focus on free cash generation, the company will also be able to reduce leverage and hence interest costs.
Either management will eventually get the taxes down to attractive levels or a competitor will come along and snap the stock up. The company provides valuable exposure to international markets coveted my most oil service providers. Once the accounting issues are resolved, it won't stay at these levels for long.
Investors need to snap up this stock assuming the restatement is completed by the end of November. The improving market, lower taxes, and the re-focus of management on capital returns should send profits much higher.
Additional disclosure: Please consult your financial advisor before making any investment ideas.