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Looking at profitability is a very important step in understanding a company. Profitability is essentially why the company exists and a key component in deciding whether to invest or to remain invested in a company. There are many metrics involved in calculating profitability, but for this article, I will look at Weatherford International's (NYSE:WFT) earnings and earnings growth, profit margins, profitability ratios and cash flow and future rig utilization.

Through the above-mentioned metrics, we will get an idea about the company's profitability over the past 5 years and a look at what to expect in the future.

By comparing this summary to other companies such as Schlumberger NV (NYSE:SLB), Baker Hughes (NYSE:BHI) and Halliburton Company (NYSE:HAL) which are in the same sector, you will be able see which has been the most profitable.

All material is sourced from Morningstar, MSN Money and Weatherford International's webpage.

Earnings and Earnings Growth

1. Earnings = Sales x Profit Margin

  • 2010 - $10.221 billion x -1.06% = $(108) million
  • 2011 - $12.990 billion x 2.02% = $262 million
  • 2012 TTM - $14.869 billion x -4.00% = $(596) million

Over the past three years Weatherford International's earnings have been negative two times. 2011 was the only year in the past three years where the company reported positive earnings. In 2011, the company reported earnings of $262 million.

2. Five-year historical look at earnings growth

  • 2008 - $1.354 billion,
  • 2009 - $254 million,
  • 2010 - $(108) million,
  • 2011 - $262 million,
  • 2012 TTM - $(596) million

In looking at Weatherford's earnings over the past five years, you can see a significant decline in earnings. They have fallen from $1.354 billion in 2008 to $(596) million in 2012 TTM.

Profit Margins

3. Gross Profit = Total Sales - Cost of Sales

In analyzing a company, gross profit is very important because it indicates how efficiently management uses labor and supplies in the production process. More specifically, it can be used to calculate gross profit margin. Here are Weatherford International's gross profits for the past two years:

  • 2011 - $12.990 billion - $9.665 billion = $3.325 billion
  • 2012 TTM - $14.869 billion - $11.421 billion= $3.448 billion

4. Gross Profit Margin = Gross Income / Sales

The gross profit margin is a measurement of a company's manufacturing and distribution efficiency during the production process. The gross profit tells an investor the percentage of revenue/sales left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors and industry is more efficient. Investors tend to pay more for businesses that have higher efficiency ratings than their competitors, as these businesses should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).

In reviewing Weatherford's gross margin over the past five years, we can see that the company's gross margin has been steadily decreasing. The 5-year low for the gross margin was reported in 2012 TTM with a margin of 23.19%. The 5-year high for the margin was in 2008 with a margin of 34.96%. The 2012 TTM gross profit margin of 23.19% is below the 5-year average of 27.27%.

  • 2008 - $3.358 billion / $9.601 billion = 34.96%
  • 2009 - $2.364 billion / $8.827 billion = 26.79%
  • 2010 - $2.638 billion / $10.221 billion = 25.81%
  • 2011 - $3.325 billion / $12.990 billion = 25.60%
  • 2012 TTM - $3.448 billion / $14.869 billion = 23.19%

As the gross margin is below the 5-year average this implies that management has been less efficient in the company's manufacturing and distribution during the production process over the past 5 years.

5. Operating income = Total Sales - Operating Expenses

The amount of profit realized from the operations of a business after taking out operating expenses - such as cost of goods sold (COGS) or wages - and depreciation. Operating income takes the gross income (revenue minus COGS) and subtracts other operating expenses, then removes depreciation. These operating expenses are costs that are incurred from operating activities and include things such as office supplies and heat and power.

  • 2011 - $1.324 billion
  • 2012 TTM - $466 million

6. Operating Margin = Operating Income / Total Sales

Operating margin is a measure of the proportion of a company's revenue that is left over after paying for variable costs of production, such as wages, raw materials, etc. A healthy operating margin is required for a company to be able to pay for its fixed costs such as interest on debt. If a company's margin is increasing, it is earning more per dollar of sales. The higher the margin, the better.

Compared to 2008, the operating margin has decreased. In 2008, the company reported an operating margin of 20.61%. In 2012 TTM, the company reported an operating margin of 3.13%. This signifies a significant drop in the ratio since 2008.

  • 2008 - $1.979 billion / $9.601 billion = 20.61%
  • 2009 - $704 million / $8.827 billion = 7.98%
  • 2010 - $781 million / $10.221 billion = 7.64%
  • 2011 - $1.324 billion / $12.990 billion = 10.19%
  • 2012 TTM - $466 million / $14.869 billion = 3.13%

The 2012 TTM operating margin of 3.13% is below the 5-year average of 9.89%. This implies that there has less of a percentage of the total sales left over after paying for variable costs of production such as wages and raw materials compared to the 5-year average.

7. Net Profit Margin = Net Income / Total Sales

The net profit margin is a ratio of profitability calculated as net income divided by revenue, or net profits divided by sales. It measures how much out of every dollar of sales a company actually keeps in earnings.

Profit margin is very useful when comparing companies in similar industries. A higher profit margin indicates a more profitable company that has better control over its costs compared to its competitors. Profit margin is displayed as a percentage - a 20% profit margin, for example, means the company has a net income of $0.20 for each dollar of sales.

Over the past 5 years Weatherford International's net profit margin has also fallen significantly. The latest net profit margin of (4.01)% is below the past 5 year average of 2.78%.

  • 2008 - $1.354 billion / $9.601 billion = 14.10%
  • 2009 - $254 million / $8.827 billion = 2.88%
  • 2010 - $(108) million / $10.221 billion = (1.06)%
  • 2011 - $262 billion / $12.990 billion = 2.02%
  • 2012 TTM - $(596) million / $14.869 billion = (4.01)%

As the 2012 TTM net profit margin of (4.01)% is below the 5-year average of 2.78%, this implies that there has been an decrease in the percentage of earnings that the company is able to keep compared to the company's 5-year average.

The above listed profitability margins are revealing that Weatherford International has been displaying declining results regarding its profitability. Every listed profit margin is loosing strength.

Profitability Ratios

8. ROA - Return on Assets = Net Income / Total Assets

ROA is an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment."

Like the above listed profitability margins the ROA is also showing weakness when compared to 2008. The current ROA of (2.62)% is below the 5-year ROA average of 1.53%.

  • 2008 - $1.354 billion / $16.477 billion = 8.22%
  • 2009 - $254 million / $18.866 billion = 1.35%
  • 2010 - $(108) million / $19.132 billion = (0.56)%
  • 2011 - $262 billion / $21.185 billion = 1.24%
  • 2012 TTM - $(596) million / $22.781 billion = (2.62)%

As the 2012 TTM ROA of (2.62)% is below the 5-year average of 1.53%, this implies that management has had less of the ability to use the company's assets to generate earnings when compared to the 5 year average.

9. ROE - Return on Equity = Net Income / Shareholders' Equity

As shareholders' equity is measured as a firm's total assets minus its total liabilities, ROE reveals the amount of net income returned as a percentage of shareholders' equity. The return on equity measures a company's profitability by revealing how much profit it generates with the amount shareholders have invested.

  • 2008 - $1.354 billion / $8.286 billion = 16.34%
  • 2009 - $254 million / $9.720 billion = 2.61%
  • 2010 - $(108) million / $9.401 billion = (1.15)%
  • 2011 - $262 billion / $9.532 billion = 2.75%
  • 2012 TTM - $(596) million / $8.882 billion = (6.71)%

Much like the ROA, the ROE has also revealed a decline. The current ROE of (6.71)% is significantly lower than the peak ROE in 2008. As the ROE has decreased over the past five years, this reveals that there has been a decrease in how much profit has been generated compared to the amount that shareholders have invested.

Cash Flows

10. Free Cash Flow = Operating Cash Flow - Capital Expenditure

A measure of financial performance calculated as operating cash flow minus capital expenditures. Free cash flow (NYSE:FCF) represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. Free cash flow is important because it allows a company to pursue opportunities that enhance shareholder value. Without cash, it's tough to develop new products, make acquisitions, pay dividends and reduce debt.

It is important to note that negative free cash flow is not bad in itself. If free cash flow is negative, it could be a sign that a company is making large investments. If these investments earn a high return, the strategy has the potential to pay off in the long run.

When reviewing the company's free cash flow, we can see that in all but one of the past five years, Weatherford International's free cash flow has been negative. This is not necessarily a bad thing as Weatherford International has used its free cash to purchase assets.

  • 2008 - $1.105 billion - $(2.508) billion = $(1.404) billion
  • 2009 - $614 million - $(1.604) billion = $(989) million
  • 2010 - $1.128 billion - $(1.001) billion = $127 million
  • 2011 - $833 million - $(1.532) billion = $(699) million
  • 2012 TTM - $1.120 billion - $(2.090) billion = $(970) million

11. Cash Flow Margin = Cash Flow from Operating Activities / Total Sales

The higher the percentage, the more cash available from sales.

If a company is generating a negative cash flow, it shows up as a negative number in the numerator in the cash flow margin equation. This means that even as the company is generating sales revenue, it is losing money. The company will have to borrow money or raise money through investors in order to keep on operating.

As Weatherford International's cash flow margin is positive, it does not have to take the above measures to continue operating.

  • 2008 - $1.105 billion / $9.601 billion = 11.51%
  • 2009 - $614 million / $8.827 billion = 6.96%
  • 2010 - $1.128 billion / $10.221 billion = 11.03%
  • 2011 - $833 million / $12.990 billion = 6.41%
  • 2012 TTM - $1.120 billion / $14.869 billion = 7.53%

Summary

In reviewing Weatherford International's earnings over the past five years, you can see a significant decline. Over the past 5 years the earnings have fallen from $1.354 billion in 2008 to $(596) million in 2012 TTM.

Being reflective of the company's earnings, Weatherford International's profitability margins are also displaying weakness. Every listed profit margin has been declining.

Like the earnings and profitability margins, the ROA and ROE have also revealed a decline. The current ROE of (6.71)% is significantly lower than the peak ROE in 2008. As the ROE and ROA have decreased over the past five years, this reveals that there has been a decrease in how much profit has been generated compared to the amount that shareholders have invested.

Over the past 5 years Weatherford International has posted negative cash four times. The company is generating positive cash but is using its cash to purchase assets. As the company is generating positive cash, this implies that the company does not have to borrow money or raise money through investors to keep operating.

Looking forward:

Over the next few years, analysis at Bloomberg Businessweek are predicting a turnaround for the company. Analysts are estimating revenues for FY 2012 at $15.1 billion and a revenue for 2013 at $16.1 billion. They are also predicting EPS for FY 2012 at $0.69 and EPS for FY at $1.02.

As indicated above, Weatherford's profitability has been declining over the past 5 years. In addition to this, the debt and liabilities have been increasing as stated in my article Analyzing Weatherford International's Debt And Risk. As analysts have a positive outlook for Weatherford, this could be an opportunity to pick up the stock at a cheap price, but I would wait for the fundamentals to improve significantly before I would step in.

Source: Weatherford International: Profitability Analysis