National Oilwell Varco (NOV) reported strong numbers for 2012 along with encouraging 2013 earnings guidance, as its annual revenues in 2012 stood at $20.04 billion, up by 37% from $14.56 billion in 2011. Operating margins remained under pressure at 17.7% compared to 20% in 2011, but the decline was compensated by higher revenues and net income that came in strongly at $2.49 billion, up by 25% from $1.99 billion in 2011.
Despite the fact that NOV is currently valued at a trailing P/E multiple of only 11.26x and a PEG ratio of 0.81, the stock price has remained under pressure. In this article we outline a few items that could be holding back the price appreciation for NOV.
Low Dividend Yield
The cash flow per share in 2012 is $7.3, but the dividend per share is only $0.49 and the payout ratio is a miserly 8%. At such a payout ratio, the company loses favor from the income investors as the dividend yield is only 0.8%, much lower than even treasuries. While the dividend yield remains sub-par, the company issued a $3 billion debt last year, further dampening the hopes of a better payout due to potentially higher debt servicing preferences.
Oil Price Outlook
Fears are rising over a potential slowdown in commodities, as China recorded the longest streak of below 8% growth in at least two decades with an only 7.7% year-on-year increase in the first quarter of 2013. Although a broader global economic slowdown is yet to materialize, the expectations are already affecting the market sentiment in commodities. A sustained downward movement in oil prices reduces the capex appetite on the oil exploration and production side, subsequently affecting NOV's revenues and margins.
Declining Operating Margins
The operating margin is on a decline. It increased by 21% year on year, but the margin was 17.7% vs. 20% last year. Quarterly operating margins were even lower at 15.9% in Q4 2012 compared to 16.9% in the previous quarter. The erosion in operating margins is typical of a high-growth company, but also a cause of concern when coupled with a potential slowdown in revenue growth.
Expensive Purchase of Robbins & Myers
NOV acquired Robbins & Myers (RBN) in August 2012 for $2.5 billion in cash, This acquisition is set to expand NOV's offerings of tools, pumps, and valves used in oil production. The last reported 12-month EBITDA for RBN was $255.7 million, placing the deal at roughly 10x EBITDA, which appears to be a bit expensive. The major value addition is expected to come from NOV leveraging its current leadership position for better margins at RBN, while generating significant cost savings at operational levels. However, it would be interesting to see the incremental impact on NOV's bottom line once the acquisition process is complete and whether the price paid is justified by the results or not.
Lower Cash Flows From Operating Activities
The operating cash flows declined last year, but that was mainly to support the growing sales as inventories and accounts receivables increased along the way. If NOV maintains similar working capital ratios, the operating cash flows should improve this year as the inorganic growth in sales is expected to be slower in 2013. However, given the decline in 2012, unless the free cash flows return to $1 billion in 2013, the valuation would continue to seem considerably overstretched.
Slow Down in M&A-Related Growth
As the company continued on an acquisition spree, revenues grew by 37% and it is reasonable to expect the company to take a breather here. A slower year in M&A should help the company consolidate its leadership position, but the revenue growth is not expected to be as substantial as in 2012 when it grew by 37% year on year.
An Overoptimistic Buyer
Goodwill and intangible assets stand at approximately $12 billion, or 38% of the total assets, indicating the premium NOV pays on its acquisitions. The goodwill comprises 60% of the total $12 billion (or 23% of total assets, 35% of total book value), which could be a drag on earnings in case of any impairment due to a broader economic slowdown or less-successful realization of synergy-related benefits.
Political Tensions in the Korean Peninsula
Last but not least, NOV has $3.12 billion (15%) in annual sales to South Korea, and the political developments there could be a cause of concern for investors. The scenario is unlikely, but any flare up in this conflict would significantly hurt the NOV revenues at least in the short term.
Disclaimer: The opinion in this document is for informational purposes only and should not be considered as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. I do not recommend that anyone act upon any investment information without first consulting an investment professional as to the suitability of such investments for his or her specific situation.