As earnings for Q113 start up, one of the most intriguing stocks remains Weatherford International (WFT). The company has infamously failed to accurately remediate federal income taxes for several years now. Even as Weatherford reported record revenues for Q412, earnings failed to match the previous years. The company also incredibly recorded an effective tax rate for the quarter of an amazing 92% to cap off a string of disappointing results.
The company is a multi-national oilfield services firm with a large international presence operating in over 100 countries. For 2012, international revenue accounted for 58% of total revenue. Notably it also focuses more on liquids production in North America.
With domestic natural gas prices surging, all oil services firms will benefit though Halliburton (HAL) and Baker Hughes (BHI) are the most focused on domestic gas. Weatherford is a play on that rebound as domestic pricing will improve, but in addition the stock will benefit from a resolution of the accounting issue on top of the improved pricing. All of the ducks could be lining up for a big rally in 2013 for the oil service sector with Weatherford leading the rebound.
Resolution Of The Lingering Tax Issues
It remains perplexing that the tax issue is still a lingering problem after all these quarters. Even now, the company forecasts a 34% effective tax rate years after it moved headquarters to Switzerland in order to lower the effective tax rate to a more reasonable 30% level or lower. The company has now spent millions upon millions on professional fees for the remediation efforts. The last quarter alone cost an incredible $43M in fees.
While Weatherford has finalized the material weaknesses on internal controls for percentage of completion projects, it hasn't signaled a complete remediation of the accounting for federal income tax issues. It appears close to resolving this issue and has made a substantial hiring push to ensure this issue never occurs again. Around 18 high-level accounting professionals have been hired from multinational companies and big 4 accounting firms to beef up the skill set.
The internal controls and tax issues can be linked to an underperformance of the stock during a period that its international focus should've provided better returns. International focuses Schlumberger (SLB) had the best returns in the sector. As the below chart shows, Weatherford was the worse performer even as it recently reported record revenues:
Investors should be cautioned that the upcoming earnings report for Q113 in early May will likely confound the market. Due to various charges and the on going tax issue, the company has missed earnings estimates in the last 3 quarters. While analysts forecast strong earnings growth, the levels won't be meaningful until the company can establish a baseline level based on updated accounting systems.
The analysts expect earnings to hit $1.33 in 2014 and jump to nearly $2.40 by 2016. The stock remains cheap based on those levels with the key being whether the company can hit those estimates.
Lufkin Buyout Valuation
Last week General Electric (GE) announced the deal to buy Lufkin Industries (LUFK) at a significant premium to the previous price of its stock. Not only does the deal value Lufkin at a nice premium, but also the value is significantly above the current valuation of Weatherford that also participates in the artificial lift segment.
GE is paying $88.50 per share in cash or $3.3B for Lufkin. The deal values the stock at about 13.5x average 2013 EBITDA estimates. With revenue forecast to exceed $1.4B in 2013, this deal values Lufkin at nearly 2.4x revenue.
On a comparable basis, Weatherford trades at a market value significantly below the revenue run rate of $16.4B. While not the best indication of value, it does highlight the potential if the company can improve margins and streamline operations.
The stock actually has potential for a technical breakout on a reverse head and shoulders. The stock originally struggled to move back above $13 during last summer before plunging to $9. Now it appears set up to reclaim the $13 level and move higher. The stock traded in the $20s before all of the accounting issues started. See the chart below:
Clearly Weatherford remains a conflicted stock as the company struggles to wrap up the accounting issues so that management can return to focusing on the profitability of the business. The Lufkin buyout provides a sample of where the stock could go in the short-term though analysts have been clear that the deal likely removes GE from a list of potential suitors.
The plunging natural gas inventories should lift all boats in this sector and improve the pricing environment even for those companies more focused on the liquids sector. Halliburton or Baker Hughes are better direct investments for people wanting to focus solely on the rebound in drilling activities for domestic natural gas. Overall though, Weatherford provides the largest snapback potential based on resolving lingering tax issues and overall global demand.
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