National Oilwell Varco: Undervalued Gem

 |  About: National Oilwell Varco, Inc. (NOV)
by: Sean Weston

Formed by a 2005 merger between National Oilwell and Varco International, National Oilwell Varco (NYSE:NOV) designs, manufactures and markets equipment and components for oil and gas drilling and production operations, oilfield services, and supply chain integration services for the upstream oil and gas industry. NOV has operations in over 1,160 locations in six continents.

NOV estimates that around 90% of the mobile offshore rig fleet and a large majority of larger land rigs, which were manufactured in the past 20 years, use components which were manufactured by NOV.

NOV operates in three main segments:

Rig Technology:

2012 Revenue: $10.1 billion

2012 Operating Income: $2.4 billion

Petroleum Services & Supplies:

2012 Revenue: $7.0 billion

2012 Operating Income: $1.5 billion

Distribution Services:

2012 Revenue: $2.9 billion

2012 Operating Income: $253 million

Note that the distribution business is being planned for spinoff in the 2nd quarter of 2014, in what should help to reduce some potential conflicts of interest. The new company will be called Distribution Now and will be able to sell other companies' products while NOV will be free to use other distributors if it wants.

Much of the reason behind their overwhelming rig market dominance lies in the fact that they've been actively pushing for standardization. In the past offshore rigs were custom made. Due to that fact costs were high, performance could be uncertain and it was more difficult to acquire necessary replacement parts in a timely fashion. All those problems have been solved thanks to NOV's standardization of the industry.

Floating production, storage & offloading units (FPSO) don't enjoy the standardization that the deep sea drilling rigs now enjoy, and as a result suffer the same problems previously seen with the rigs. Due to strategic acquisitions in recent years such as Advanced Production And Loading(FPSO turret designer) and NKT Flexibles (flexible pipelines) NOV is hoping to change that, and duplicate its success with the rigs.

A common prediction is for FPSOs to supplant some of the rig orders moving forward, as increased flexibility is going to be highly desired as oil and gas prove harder and harder to reach. Not being fixed, and able to move from one job to the next easily is a major advantage of the FPSO. Having a fleet of only 150 early in 2013 leaves a lot of room for growth for NOV.

Not all of their future growth prospects are tied into FPSOs either. Shallow water rigs, known as "jack-ups" are in very old condition. Over half date back to the early 80's or before. As they move into inevitable retirement, orders should be building with NOV.

Demand for land rigs has not been the strongest recently and as a result operating margins have taken a bit of a hit. This has led to EPS dropping from $5.91 to an estimated $5.35 for 2013, even as revenues increased 12%. As their FPSO business gets into full-swing margins should increase back up to their normal levels of around 24% from about 21% currently.

For the last 10 years NOV has seen its revenues and its EPS explode.

NOV EPS Diluted (<a href=

NOV EPS Diluted (TTM) data by YCharts

For much of that period it saw its share price rise alongside. Since 2011 it has been a different story, however. Currently with a P/E of 14.2, it's much too low for a company with this amount of growth potential. EPS is expecting to jump back up by 16% in 2014 to $6.23. Assuming a moderate 15 time earnings, that gives over $93 a share, or a 20% gain. Taking into account the spinoff, even more value could potentially be unlocked.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in NOV over 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.