The shale boom has opened up investment opportunities in North America we haven't seen in years. The advent of horizontal drilling and hydraulic fracturing unleashed previously untouchable reserves and boosted U.S. oil and gas production to a record high. Worldwide oil and gas reserves previously inaccessible or too costly to tap are now within reach.
Although there is the fear that US circumstances can be hardly replicated elsewhere, the shale gas revolution is also expanding internationally. On that front, things evolve rapidly in Europe, South America and China where the governments try to catch up and make one more step towards their energy independence. To capture the latest developments on the international shale oil and gas front, I wrote two articles recently. These articles are here and here.
Separating The Winners From The Losers
The ongoing shale gas revolution creates both winners and losers. The shale revolution is not a panacea and does not shower all the companies with a ton of profits. Many oilfield service companies and shale producers that have been beating the drums of shale revolution have not managed yet to turn their ship around and generate consistent profitability.
This problem stems primarily from the fact that several oilfield companies focus on the US and Canadian markets. These firms have to restructure their operations and make the strategic decision to discontinue their loss making segments. These firms have to assign resources and redeploy existing capital to emerging key international markets instead, in order to achieve reasonable revenue growth, optimize cost structure, maintain robust margins and enhance their liquidity position.
Separating the wheat from the chaff is not an easy task because the reality is often disguised by the hype. This reminds me of Buffett's quote: "Bad things are not obvious when times are good. After all, you only find out who is swimming naked when the tide goes out".
Meanwhile, I believe that the oilfield service sector will continue to show growth and prosperity, because certain macro oil-industry changes, increase the demand for these types of companies. For instance, oil exploration and drilling continues to grow, and the oilfield company will be paid for its services either the well is a gusher or a dry hole. These dynamics motivated me to write some articles about the small and intermediate companies of the sector two months ago.
Those folks who followed my latest bearish and bullish calls have already recorded some sizeable gains. For instance, I was quite bearish on Basin Energy Services (BAS) at about $14.5 as disclosed. Basic's stock lies at about $11.5 today which is a drop of 20% in two months. My bearish article about Basic Energy Services is here.
During the last couple of months, I was also bearish on Halcon Resources (HK) as disclosed. Things with Halcon worked according to my analysis, and the stock has dropped almost 20% since the syndication of my article. My latest bearish article about Halcon is here.
In this article, I ll discuss the big oilfield services companies. By saying big oilfield companies, I determine those with a market cap of $10 billion or higher. Furthermore, the revenue stream of the following big players is coming primarily from the onshore drilling activity. During the next weeks, I plan to discuss all the other publicly-traded companies (small, intermediate, big) from the US and Canada whose revenue are coming primarily from the offshore drilling activity.
Let The Balance Sheets Speak For Themselves
FFO: Annual Estimated funds from operations.
EV: Enterprise Value.
EBITDA: Annual Estimated EBITDA.
- Cameron International Corporation provides flow equipment products, systems and services to oil, gas and process industries. It operates in three business segments: Drilling, surface and subsea systems businesses.
Cameron's backlog was at its highest historical level in Q2 2013 and the overall record backlog was up 41% from last year. Nevertheless, the growing backlog has not been coupled with cash flow or bottom line growth. The top line has remained flat for several quarters now and the operating margin has dropped considerably since 2012. Although the company's CEO said that he expects Cameron to generate meaningful cash flow from operations for the full year, the company recorded marginal funds from operations for the first six months of 2013. So it does not surprise me that Cameron does not pay a dividend currently. Cameron is definitely overvalued with more downside than upside, and the gravity can take hold at any time.
- Halliburton has a significant exposure to North America as more than 50% revenues come from this market. In Q2 2013, the company's strength overseas was enough to offset the weakness in North America resulting from a relatively flat U.S. land rig count and seasonally lower Canadian activity levels. Halliburton has delivered year-over-year international revenue growth for five consecutive quarters. Middle East and Asia (China, Malaysia) are the company's fastest growing markets, where revenue improved 12% and operating income 17% sequentially.
In July, the company purchased 23 million shares of common stock at a total cost of $1.0 billion in Q2 2013. This significant repurchase activity left $0.7 billion of repurchase capacity remaining under a program initially authorized by Halliburton's board of directors in 2006. Furthermore, Halliburton increased the authorization to purchase its common stock by $4.3 billion, to a new total repurchase capacity of $5.0 billion.
- Schlumberger has managed to offset the low gas prices and flat rig count in North America, because it is well diversified internationally. Most of revenue (70%) are coming from overseas markets where drilling activity touched a 30-year high. Although the company faced the competitive land pricing in North America and the effects of the Western Canada spring break-up, the international drilling boom coming primarily from Australia, China and Middle East drove the company's bottom line in Q2 2013 and boosted the net income on a year over year basis.
During Q2 2013, Schlumberger repurchased 6.8 million shares of its common stock at an average price of $73.07 for a total purchase price of $500 million. As of June 30, Schlumberger had repurchased over 105 million shares of common stock under the program for a total purchase price of $7.8 billion and the remaining balance of $187 million will be exhausted in Q3. This repurchase substantially completed the share repurchase program of $8 billion of April 2008. Last July, Schlumberger approved a new share repurchase program of $10 billion to be completed by June 30, 2018.
- Baker Hughes has been heavily affected by the fierce competition and the seasonality in North America. The international exposure is the company's Achilles' heel. Due to the fact that Baker Hughes lacks significant international exposure to beat the lack of growth in North America, Q2 2013 results were a mixed bag. The company's activity levels continued to rise in Europe, Africa and Russia but these gains were more than offset by a flat performance in the US, the typical Canadian seasonality and a sharp decline in Latin America. I believe that Baker Hughes can return back to a growth trajectory only if it spreads its wings to some key international markets like Africa and South America.
Based on the key metrics above and the markets where Halliburton, Schlumberger and Baker Hughes operate, they are all fairly priced at the current levels.
- During the first six months of 2013, National Oilwell Varco was another company that faced a challenging US market and enjoyed significant international growth primarily from its Asian operations. National Oilwell Varco has been on an acquisition spree during the last couple of years. The latest deal took place a few months ago when it acquired Robbins and Myers.
Before that transaction, National had acquired the Canadian CE Franklin. The progress on the integration of the acquisitions made recently has been coupled with solid progress on several organic expansion initiatives, resulting in consistently growing top and bottom lines since 2010.
Furthermore, the company doubled its regular dividend in Q2 2013, demonstrating the belief that its future prospects are bright. The operating margin is healthy and higher than average while the debt ratios remain low. Since the company does not trade in line with its peers (PBV, EV/EBITDA), its valuation has room to grow further.
The table above also illustrates why Buffet picked National Oilwell Varco among the companies of the sector and increased his holdings by 18.65% a few months ago. The guru purchased a total of $1,395,700 shares in the price range of $64.14 to $71.57, with an estimated average price of $68.35. Buffett now owns 8.88 million shares of National Oilwell, representing 2.08% of the company's shares outstanding and 0.69% of his total portfolio.
In several international markets, there's no "spring breakup", no natural gas glut and oil fetches prices closer to Brent rather than WTI. This is why, the expansion to some key international markets is a do-or-die strategy for the oilfield service companies. Those companies that are not willing to adjust their business plans to the new international business environment, will face severe growth problems and gradual implosion of their top and bottom lines. They can expand internationally either organically or through acquisitions like National Oilwell Varco has been doing it so successfully for the last 3 years. To me, this international expansion is of paramount importance to the direction of the share price. This is why, several small oilfield service companies with international exposure will be acquisition targets in the next couple of years. A very smart strategy that can truly boost the returns of a portfolio is to buy these small players. However, more discussion about these acquisition targets is out of the scope of this article and I plan to discuss it with more details in the future.