Whenever you see a company that is undervalued with plenty of competitive advantages and financial strength, you are looking at a winner. The company that meets these specifications in the energy business is National Oilwell Varco (NOV). The company supplies drillers and producers with anything they need ranging from rigs to drilling parts and also provides a range of services, whether it is piping inspection or the training of drilling crew in the use of sophisticated systems. It exerts such a profound influence that, according to a Morningstar estimate, it has a 60% share in the market for rig equipment and 90% of all rigs carry some of its equipment. It also operates in over 700 locations across the world. We should remember that the folks who made the real money in the Gold Rush were the suppliers of picks and shovels.
2013 first-quarter financials
For the first quarter of 2013, the company reported net income of $502 million ($1.17 per fully diluted share) compared with net income of $668 million ($1.56 per fully diluted share) in the preceding quarter. The results include transaction costs related to the acquisition of Robbins and Myers as well as devaluation charges on the Venezuelan currency which totaled $73 million. Excluding these costs, net income was $553 million ($1.29 per fully diluted share). Revenues for the quarter at $5.31 billion were up 23% year over year but down 7% over the preceding quarter. The backlog for orders for the Rig Technology segment stood at a record figure of $12.9 billion, up 24% year over year and up 8% from the preceding quarter. The continued strength in demand for drilling equipment was substantiated by the $3.04 billion in new orders booked during the quarter. The company attributed the slightly weaker performance to softer than anticipated markets in North America. The company is confident that the markets will recover sooner rather than later and that it is well placed to take full advantage of the revival in demand.
Revenues for the Rig Technology business were $2.63 billion up 16% year over year but down 9% from the preceding quarter while operating profit was $557 million amounting to over 21% of sales. Revenues for the Petroleum Services and Supplies business were $1.7 billion consistent with the prior year period, but down 4% from the preceding quarter. Operating profit was $311 million amounting to over 18% of sales. Revenues for the Distribution and Transmission business were $1.2 billion up 118% year over year but down 3% from the preceding quarter. Operating profit was $65 million amounting to over 5% of sales.
North America was a problem for the company in the first quarter and is likely remain weak in the near future. Volume and pricing remain critical issues and the rig count in the United States has declined by another 3% adding to a decline in spending from Canada. Even the high-growth regions in the United States such as the Permian Basin and Eagle Ford have seen cutthroat competition. International markets are far more encouraging and National Oilwell Varco is moving aggressively into areas like Brazil, Angola and Russia. The use of technology such as horizontal drilling will be a further boost for the company's prospects. There has been a spike in demand for offshore drilling rigs and the year over year increase in shipments is expected to be over 80%. It should be noted that over 90% of the order backlog is for rigs to be used in international operations.
The investment thesis
The stock has strong fundamentals and appears to be undervalued. The TTM P/E at just over 12 times is well below the industry average of 22 times and the forward P/E is just over 10 times. The Price/Book ratio is 1.44 against the industry average of 3.8. The company has also doubled its quarterly dividend. Jefferies has placed the company on its favorites list based on the argument that "bigger is better" when it comes to oil services firms. The 26 analysts who cover the stock have a median price target of $84 a share and S&P has given the stock its highest rating "Strong Buy" a target price of $89. In addition to the enhanced dividend yields, the balance sheet is A rated.
The bottom line
The weakness in the company's North American market is offset by its international markets and any resurgence in demand in North America will put the company on a favorable footing. The share is currently trading at around $70.30 and, because I see a considerable upside of at least 20%, I have no hesitation in recommending this stock as a "Buy."