Schlumberger: A Big Slob You Can Love

Schlumberger: (NYSE:SLB) Dec. 18, 2008 price $39.44

52-week range: $37.24 (Dec. 5, 2008) - $111.95 (July 2, 2008)

Yield = $0.21 quarterly = 2.13% current yield

Schlumberger is the world's largest oilfield service firm with operations in 80 countries. 74% of revenues are generated outside of North America. This year's sales should come in above $27 billion and earnings per share are now expected to finish at about $4.64/share for calendar 2008.

With oil prices hitting 4 ½ year lows today at under $37 barrel, SLB shares are near their lowest trading level since mid-2005. Declining commodity prices mean next year's EPS will likely drop to $3.50 - $4.50 although much will depend on how oil prices behave going forward. The current consensus view for 2009 EPS is now centered on $4.28.

Why would I want to get into this industry now with commodity prices falling? That's when you can buy at good prices. SLB shares are now available at just 9.2x the $4.28 forward estimate and the yield is more than double what it's averaged over the past four years.

The question becomes, "Do you think oil prices are in a permanent state of decline or is this a temporary dip in a longer term uptrend?" If you believe we'll see higher prices over the next year or two this might be a very opportune time to buy.

Schlumberger shares fell from a split-adjusted high of $47.20 in 1997 to a 1998 low of $20 as oil sold off about 10 years ago. Buyers at the low back then saw SLB shares more than double to $44.40 by August of 2000.

The same "investors" who were keen to own these shares last July at $112 are nowhere to be found now that the shares are cheap. Here are the per share figures for the past few years as reported by Value Line:

Year ….… Sales ….. C/F ….… EPS …… B/V …...Avg. P/BV ….. Div

2002 …… 11.57 ….. 1.92 …… 0.60 …… 4.81 …….. 4.98x …….. 0.38

2003 …… 11.85 ….. 2.12 …… 0.78 …… 5.02 …….. 4.58x …….. 0.38

2004 ……. 9.75 ……2.16 …… 1.03 …… 5.20 …….. 5.81x …….. 0.38

2005 …...12.15 ….. 2.86 ……. 1.67 …… 6.45 …….. 6.36x ……. 0.41

2006 …...16.33 ….. 4.51 ……. 3.04 …… 8.85 …….. 6.95x ……. 0.48

2007 …...19.47 ….. 5.94 ……. 4.18 ……12.44 ……. 6.83x ……. 0.70

2008* ….23.00 ….. 6.70 ……. 4.64 ……15.80 ……. 4.87x ……. 0.81

2008 data includes estimates for Q4 ending Dec. 31, 2008

I think using a price/book value is more relevant than looking at historical average P/Es on this company to determine a 'normalized' price target. At the dead low in 1998 when oil prices hit their all-time, inflation adjusted nadir SLB shares briefly touched 2.7 times book value. Today's price is an even lower P/BV of 2.5x.

A return in the next cycle to even four times book value would bring SLB shares back to $65 - $80 depending on when it takes place. A double is entirely predictable with the only real question being the timing. If it takes 3 – 4 years that's still a very decent return and I don't believe it will take that long for oil prices to firm up again.

My one year target range would be $60 – $70 and my 3 – 5 year view is for at least an $80 goal price. SLB has a 10-year median P/E of 31. Value Line is using a 20 multiple in making their 3 – 5 year target price range. Even 14 times next year's estimate would put these shares back at $60 for better than a 50% return (not including dividends).

If you like the idea but feel we might need a couple of years to see higher oil prices due to the weak worldwide outlook try this:

………………………………………….. Cash Outlay ……… Cash Inflow

Buy 1000 SLB @ $39.44 ……………….. $39,440

Sell 10 Jan. 2011 $50 calls @ $9.10 ……………………………. $9,100

Sell 10 Jan. 2011 $50 puts @ $19.50 ………………………….. $19,500

Net Cash Out-of-Pocket ………………… $10,840

If SLB shares rise to > $50 (up 27% from today's price) by expiration date in Jan. 2011:

• You will have no further option obligations.

• Your shares will be called (sold) for $50,000.
• Your $50 puts will expire worthless (a good thing for you as a seller).
• You will have $50,000 for your original net cash outlay of $10,840.
• A 27% gain in the stock over a 25 month period would give you a $39,160 profit on your $10,840 cash investment.

What's the risk?

If SLB shares are < $50 at expiration you will be forced to buy an additional 1000 shares at a net price of the $50 strike price less the $19.40 /share put premium = $30.60 /share.

Your first batch of 1000 shares were bought at $39.44 but you received $9.10 /share for the $50 covered calls you sold making your break even on those shares $30.34.

Your break even point on the whole transaction would be $30.47 per share or 22.7% below your starting price (today's close).

If the shares go up 27% or more you will earn a tremendous return. If the shares decline by up to 22% you will not lose money.

Disclosure: Author bought SLB shares and sold SLB puts on 12/18/08.

Comments

[maelstrom:]

SLB will probably drop a bit more and get close to $20 a share again..this time things are worse than the last 20years. Wait till 20 -25 to get in

2008 Dec 19 09:07 AM

[SJD:]

It may be worse this time, but there are more consumers of oil by the hundreds of millions when compared with the last 20 years. Good entry points are hard to determine, but the option premiums provide "shock absorbers" and reduce cost basis.

2008 Dec 19 10:10 AM

[stay strong:]

People can so negative sometimes. I have heard buy AAPL only at $50, RIMM at $19 and now SLB at $20????? Stocks are already so discounted, you might miss opportunities if you wait too long. Buy now

2008 Dec 19 11:28 AM

[herbert hoover:]

Stay strong:

The reason everyone is so "negative" is because some of us owned AAPL at 200; RIMM at 105 and SLB at 110. Perhaps you might want to listen to what the folks are telling you. Those stocks probably will hit those price levels in 2009

2008 Dec 19 11:58 AM

[AlexS:]

The other good thing about SLB is that their headquarters is outside the U.S., making them potentially less exposed to the wealth-robbing ideas of Pelosi, Reed, Obama, and the other demagogues.

2008 Dec 19 09:11 PM

[Jeez:]

Great options arithmetic. But did anyone think that to sell 10 puts at $50 for 2011, means you have to keep aside $50,000 on your margin account (at least on a complicated sliding scale). If you sold calls on your original purchase of 1000 shares, you cannot use that equity to calculate your margin purchasing power.

Or am I wrong?

2008 Dec 20 11:41 PM

[Paul Price:]

Jeez,

You don't lose the 'equity value' of paid-up shares in your account when you write covered calls. In fact, once you've sold calls you get credit for the cash premiums received as if you had depsoitied that amount of money into your account. Selling calls increases - not decreases -your buying power.

Selling puts does tie up buying power equal to approximately 30% of the net exercise value on the trade date [e.g. sell $50 puts for $19.50/share = initial requirement of 30% of $30.50 = $9.15/share free equity].

This can be met with cash, t-bills held in the account or any other marginable securities that are already paid for. If you have a margin type account with decent size equity, the strategy described in my write - up works great with the need for any 'cash' tie-up.

2008 Dec 21 09:32 AM

[Paul Price:]

The last sentence above shoud read "without" the need for any cash tie-up.

2008 Dec 21 02:41 PM

[aquaman:]

I'll buy @ 15/share

2008 Dec 22 02:23 PM

[Paul Price:]

Today's Barrons had an interview with Jerry Jordan, Portfolio Manager of the Jordan Opportunity Fund [ranked 5-stars by Morningstar].

SLB was listed as his #1 holding by portfolio weighting at 4.73% .

He also held significant positions in Diamond Offshore and Smith International at 3.91% and 2.78% respectively.

Jan 03 07:20 PM