Seeking Alpha
Value, long only, debt, research analyst
Profile| Send Message| ()  

With the rapid evolution occurring in the oil and gas equipment service industry, National Oilwell Varco (NOV) looks to be a looks poised to capitalize on these changes. As the introduction of new fracking techniques, increased safety regulations and the International Energy Agency (IEA) forecasting the U.S. to become the world's largest oil producer by 2020, these factors should give the industry a boost. As National Oilwell Varco is situated very well to capitalize on these changes the recent pullback in price is offering an excellent opportunity to invest.

In the article below, I will look at National Oilwell Varco's past profitability, debt and capital, and operating efficiency. Based on this information, we will get to see the company's sales, returns, margins, liabilities, assets, returns and turnovers. We will get an understanding of how the company has grown over the past few years, thus keeping up with industry trends and what to expect in the future.

All numbers sourced from Company Webpage.

Profitability

Profitability is a class of financial metrics used to assess a business' ability to generate earnings compared with expenses and other relevant costs incurred during a specific period of time. In this section, we will look at four tests of profitability. They are: net Income, operating cash flow, return on assets, and quality of earnings. From these four metrics, we will establish if the company is making money, and gauge the quality of the reported profits.

  • Net income 2010 = $1.667 billion.
  • Net income 2011 = $1.994 billion.
  • Net income 2012 = $2.491 billion.

Over the past three years National Oilwell's net profits have increased from $1.667 billion in 2010 to $2.491 billion in 2012. This signifies a increase of 49.43% in earnings over the past 3 years.

  • Operating cash flow 2010 = $2.447 billion.
  • Operating cash flow 2011 = $2.937 billion.
  • Operating cash flow 2012 = $3.545 billion.

Operating cash flow is the cash generated from the operations of a company, generally defined as revenue less all operating expenses, but calculated through a series of adjustments to net income.

Over the past three years, the company's operating cash flow has also increased. National Oilwell Varco's operating cash has increased by 44.87%.

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."

  • Net income growth

    • Net income 2010 = $1.667 billion.
    • Net income 2011 = $1.994 billion.
    • Net income 2012 = $2.491 billion.
  • Total asset growth

    • Total assets 2010 = $23.050 billion.
    • Total assets 2011 = $25.515 billion.
    • Total assets 2012 = $31.484 billion.
  • ROA - Return on assets

    • Return on assets 2010 = 7.23%.
    • Return on assets 2011 = 7.82%.
    • Return on assets 2012 = 7.91%.

Over the past three years, National Oilwell's ROA has increased from 7.23% in 2010 to 7.91% in 2012. This indicates that the company is making more money on its assets than it did in 2010.

Quality Of Earnings

Quality of Earnings is the amount of earnings attributable to higher sales or lower costs rather than artificial profits created by accounting anomalies such as inflation of inventory. To ensure there are no artificial profits being processed, the operating cash flow must exceed the net income.

2010

  • Operating cash flow 2010 = $2.447 billion.
  • Net income 2010 = $1.667 billion.

2011

  • Operating cash flow 2011 = $2.937 billion.
  • Net income 2011 = $1.994 billion.

2012

  • Operating cash flow 2012 = $3.545 billion.
  • Net income 2012 = $2.491 billion.

Over the past three years, the operating cash flow has been higher than the net income. This indicates that the company is not artificially creating profits by accounting anomalies such as inflation of inventory.

Debt And Capital

The Debt and Capital section establishes if the company is sinking into debt or digging its way out. It will also determine if the company is growing organically or raising cash by selling off stock.

Total Liabilities To Total Assets, Or TL/A ratio

TL/A ratio is a metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt.

  • Total assets

    • Total assets 2010 = $23.050 billion.
    • Total assets 2011 = $25.515 billion.
    • Total assets 2012 = $31.484 billion
    • Equals and increase of $8.434 billion
  • Total liabilities

    • Total liabilities 2010 = $7.302 billion.
    • Total liabilities 2011 = $7.896 billion.
    • Total liabilities 2012 = $11.245 billion.
    • Equals and increase of $3.943 billion

Over the past three years, National Oilwell Varco has acquired more total assets than total liabilities. This indicates that the company has not been financing its assets through debt. Over the past three years, the company's total assets increased by $8.434 billion, while the total liabilities increased by $3.943 billion.

Working Capital

Working Capital is a general and quick measure of liquidity of a firm. It represents the margin of safety or cushion available to the creditors. It is an index of the firm's financial stability. It is also an index of technical solvency and an index of the strength of working capital.

Current Ratio = Current assets / Current liabilities

  • Current assets

    • Current assets 2010 = $10.535 billion.
    • Current assets 2011 = $12.110 billion.
    • Current assets 2012 = $15.678 billion.
  • Current liabilities

    • Current liabilities 2010 = $4.536 billion.
    • Current liabilities 2011 = $5.416 billion.
    • Current liabilities 2012 = $5.649 billion.
  • Current ratio 2010 = 2.32.
  • Current ratio 2011 = 2.24.
  • Current ratio 2012 = 2.77.

Over the past three years, National Oilwell's current ratio has increased from 2.32 in 2010 to 2.77 in 2012. This indicates that the company has more of the ability to pay off its short-term obligations than it did three years ago. As the most recent number is well above 1, this signifies strength and indicates that the company would be able to pay off its obligations if they came due at this point.

Common Shares Outstanding

  • 2010 shares outstanding = 421.14 million.
  • 2011 shares outstanding = 423.9 million.
  • 2012 current shares outstanding = 426.93 million.

Over the past three years, the number of company shares have increased slightly. The amount of common shares have increased from 421.14 million in 2010 to 426.93 million in 2012.

Operating Efficiency

Operating Efficiency is a market condition that exists when participants can execute transactions and receive services at a price that equates fairly to the actual costs required to provide them. An operationally efficient market allows investors to make transactions that move the market further toward the overall goal of prudent capital allocation without being chiseled down by excessive frictional costs, which would reduce the risk/reward profile of the transaction.

Gross 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.).

  • Gross margin 2010 = $4.369 billion / $12.156 billion = 35.94%.
  • Gross margin 2011 = $5.195 billion / $14.658 billion = 35.44%.
  • Gross margin 2012 = $6.373 billion / $20.041 billion = 31.80%.

Over the past three years, the gross margin has decreased. The ratio has decreased from 35.94% in 2010 to 31.80% in 2012. As the margin has decreased, this indicates the company has been slightly less efficient.

Asset Turnover

The formula for the asset turnover ratio evaluates how well a company is utilizing its assets to produce revenue. The numerator of the asset turnover ratio formula shows revenue found on a company's income statement and the denominator shows total assets, which are found on a company's balance sheet. Total assets should be averaged over the period of time that is being evaluated.

  • Revenue growth

    • Revenue 2010 = $12.156 billion.
    • Revenue 2011 = $14.658 billion.
    • Revenue 2012 = $20.041 billion.
    • Equals an increase of 64.87%.
  • Total Asset growth

    • Total assets 2010 = $23.050 billion.
    • Total assets 2011 = $25.515 billion.
    • Total assets 2012 = $31.484 billion
    • Equals an increase of 36.59%.

As the revenue growth has increased more than the assets on a percentage basis, this indicates that the company is making money on its assets.

Based on the nine different criteria above, National Oilwell Varco is showing excellent results. The company is showing strength in all aspects of the above analysis except for the gross margin. The gross margin for National Oilwell has decreased over the past 3 years but is still at a respectable 31.80%. Based on the above criteria, National Oilwell is showing that it is a solid company and has been able to take advantage of the growth in the industry over the past couple of years.

Analysts at MSN Money are estimating substantial growth for National Oilwell Varco over the next few years. They are estimating National Oilwell Varco to have an EPS at $6.41 for FY 2013 and $7.25 in FY 2014.

Valuation

B. Annual growth rate

  • EPS 2010 = $4.01
  • EPS 2011 = $4.79
  • EPS 2012 = $6.10
  • EPS 2013 = $6.41 (Estimate MSN Money)
  • EPS 2014 = $7.25 (Estimate MSN Money)

(A / P) ^ (1 / T) - 1 = R

(7.25 / 4.01) ^ (1 / 5) - 1 = R

R = 12.57%

Earnings per share average growth rate over the 3 past years and estimated 2 years forward = 12.57%

Current PE Ratio = 11.41 (Google Finance)

11.41 / 12.57 = 0.91

PEG Ratio = 0.91

A current PEG ratio of 0.91 based on an EPS average growth rate from 2010 to 2014 indicates that based on the next few years estimates the stock is currently at undervalued.

Based on the above analysis, National Oilwell Varco has shown strong financial strength over the past 3 years. National Oilwell Varco is situated in a sector poised for growth and looks to continue its strength and growth in profitability for the next couple of years. As a PEG ratio of 0.91 indicates, National Oilwell Varco is currently undervalued which provides an excellent opportunity to invest in a company with a strong balance sheet and excellent growth opportunities moving forward.

Chart sourced by (Finviz)

Source: National Oilwell Varco: An Excellent Opportunity To Invest In A Strong Undervalued Company