Solid Investing Opportunity With National Oilwell Varco

| About: National Oilwell (NOV)

National Oilwell Varco (NOV), a company into the development and manufacturing of products required for rigs, reported 7% year over year rise in its third quarter revenue this year. With the increase in demand for high-tech rigs for oil and gas exploration in the deeper regions of the sea, the demand for the company's products and services are expected to rise. In this article, we discuss how the deepwater offshore rig market and the jackup rig market can provide a major growth opportunity in the coming quarters. As of the end of the third quarter, the company has a backlog of around $15.15 billion for its rig technology division. To focus more on the development of its rig technology, the company decided to spin off its distribution division into a separate public entity.

Offshore rigs going hi-tech

National Oilwell Varco realized an increase in its revenue from the rig technology segment. The rig technology segment grew by 12% over the third quarter of last year to around $2.84 billion. This segment provides the company's technology products to the rigs. These technologies are both employed in offshore as well as onshore rigs.

We believe the company will benefit more from the offshore drilling segment compared to the onshore segment. According to Wood McKenzie, the deepwater drilling market is expected to grow from $43 billion last year to around $114 billion by 2022. During the third quarter ending in September this year, the company sold six deepwater packages to newbuild projects, which brings the total count of deepwater drilling packages sold during this year to 22. Packages are products and services combined, which are essential for the functioning of the rigs. The areas where deepwater drilling is expected to rise are in deepwater Brazil, offshore Angola, offshore Australia, the Krishna Godavari basin in eastern India, and the Gulf of Mexico. The chart below shows the utilization of offshore rigs by rig types:

Rig Type

Current Utilization Rate (as of October 2013)

Utilization Rate (Six months ago)

Drill Barge












Source: Rigzone

Utilization rate denotes the percentage of rigs in operation out of the total number of available rigs. As can be seen from the table, there is a utilization increase in the drillships and the semi-submersibles. The utilization of jackup is remaining almost constant.

The demand for drillships and semi-submersibles are on the rise because of the increasing depth of oil exploration, which could range from a water depth of around 5000 ft to around 12,000 ft. Water depth is the distance from the surface of the water to the surface of the sea floor, from where the drilling begins. The number of offshore rigs operating across the world last year was around 694, which increased to around 739 up to October of this year. So, there is considerable room for growth for National Oilwell Varco's products, which are required for deepwater drilling. While there is growth in deepwater offshore rigs, there is similar growth of components required in these rigs. A blowout preventer, or BOP, is one such important component of offshore rigs. BOPs are specialized valves that control and monitor underwater oil wells. The cost of each BOP is around $45 million. The increase in offshore rigs will require more BOPs and is expected to drive the company's revenue in the coming quarters.

During the third quarter of this year, National Oilwell Varco sold around 13 packages for jack-up rigs, bringing the total count for this year to around 42. We expect there is a demand for more jackup rigs in the Middle East in the coming quarters due to aging rigs. According to Clarksons, there are around 337 jackup drilling rigs in this region. An estimation by National Oilwell Varco shows that around 54% of these rigs are above the age of 30. The average working age of a jackup rig is around 12 to 15 years, but with rigorous maintenance, the service life can be extended up to 30 years. So, we believe the demand for jackup rigs will continue to be stable over the coming quarters. Another factor that is adding to the demand for jackup rigs is the increasing depth of exploration by jackup rigs at around 625 ft, as oil reserves are located farther away from the coastlines.

A major player in the manufacture and design of BOP is Cameron International (CAM). The company earned revenue of $2.5 billion during the third quarter ending in September this year, which is a 12% increase over its third quarter last year. The company's backlog is around $11.2 billion as of the end of the third quarter. With the increase in the growth of the offshore drilling market, Cameron International is focusing heavily on this market. Last year it formed a joint venture, OneSubsea with Schlumberger, to focus on the increasing opportunity from the offshore rig market. We expect that the OneSubsea service is going to gain momentum as oil and gas companies are expected to spend around $13.8 billion by the end of this year, which is a 63% jump over last year's spending in subsea oil field development.

Distribution Spin-off

In September this year, National Oilwell Varco announced the spin-off of its Distribution Business into a separate publicly traded company and is expected to be complete by the first half of next year. The distribution division of National Oilwell Varco deals in the distribution of pipe, valves, and fitting products, or PVF, to oil and natural gas companies and contributes around 6% of the company's operating profit. The distribution business has a presence in more than 415 locations with operations across 26 nations. We believe the spin-off of the distribution business will benefit the company because it will be able to streamline its business divisions and better manage its rig technology business.

Last year, the distribution business contributed around 20% of the company's $20.04 billion revenue, which is around $4 billion. According to analysts, the growth of National Oilwell Varco is estimated around 12.10% for this year and around 9.60% next year. If we assume a similar growth rate for the company's distribution business, the revenue will grow to around $4.5 billion by the end of this year and around $5 billion by the end next year. At the company's current enterprise value/revenue, or EV/revenue, of 1.63, this would likely bring the enterprise value of the distribution business to around $8.15 billion next year.

A major player in the oil and gas PVF distribution business is MRC Global (MRC). This company has presence of in around 400 locations across 44 nations. We believe the company is vulnerable because of its customer base. According to the company, the top 25 customer's give around 49% of its revenue and another 18,000 customers provide around 27% of the revenue. On completion of the spin-off process, National Oilwell Varco's Distribution business will be a direct competitor of MRC Global. This might put pressure on MRC Global's customer base.


National Oilwell Varco is strongly focused on the development of rig technology, which is its core offering. With the growing market for offshore rigs, this company is well positioned to take the opportunity. Its current P/E is around 15.18 while the forward P/E is around 13.13. The lowering of its current P/E is because the company is able to generate more revenue from its rig technology division. We believe the spin-off of the distribution business will help the company focus on its rig technology division. So, the demand for offshore rigs and the company's continued development of product and services for offshore rig technology will generate revenue for the coming quarters in a sustainable manner.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Fusion Research is a team of equity analysts. This article was written by Madhu Dube, one of our research analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.