Schlumberger NV: Where Do We Go From Here?

Apr.23.14 | About: Schlumberger Limited (SLB)

Summary

Growing well count within the United States and globally.

What will keep the stock moving higher?

Where does Schlumberger currently stand regarding valuation?

Even with the significant run over the past couple of months, does Schlumberger Limited (NYSE:SLB) have more legs to run?

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In December 2013, I wrote an article titled: Schlumberger: A Great Time To Buy, within the article I examined how the oil services sector (NYSEARCA:OIH) had sold off, but was preparing for a strong run this spring. Based on built-up demand and what I thought was irrational selling because of temporary setbacks this past fall, I calculated a price target ~$105. So, as we are approaching the $105 price target, the next question is, what's next?

North American Demand and Well Count

The next couple of years look to be a very prosperous time for oil and gas service stocks. In 2014 and 2015, the amount of oil and gas wells are expected to increase significantly. Recently, RBC Capital stated that it predicts the 2014 horizontal well count within the United States to increase to 20,061.

This is a significant increase over 2013's well count. Total well count during 2013 in the United States was estimated at ~18,580. Looking forward, 2015 looks to be a stronger year for well counts. Within the United States, well counts are expected to reach 21,551.

If these estimates come to fruition, well counts within the United States will increase by ~15.99% over 2013 numbers. Well counts within the Permian, Eagle Ford, Bakken and Marcellus are expected be the dominant plays, as analysts expect an increase of ~25.57% over 2013's numbers.

As expectations are that well counts within in the United States are on a significant upward trend, this bodes well for oil and gas service companies that create a bulk of their revenue within the U.S.

Global Growth

The expected increase in global onshore spending is not limited to the U.S. or North America. In 2014, E&P spending is expected to increase by 14% in the Middle East, 13% in Latin and South America and 11% in Russia. So, looking forward, Schlumberger has a strong reason to be very optimistic.

Source: (Barclay's)

So Why Does Schlumberger Have More Upside?

In an article published on the Wall Street Journal, author Barbara Kollmeyer cited four reasons why to remain bullish on oil service companies:

1) The world is increasingly short of energy
2) Hydrocarbon prices are at attractive levels for investment and set to rise further
3) Capital expenditure on energy investments is growing, and
4) As the bottleneck, the oil services group is expected to "capture the lion's share of the economic benefit of this unfolding trend."

So, as the macro picture for horizontal drilling looks positive globally, which companies will be able to capitalize from this increased demand?

It is expected that some of the best companies positioned to capitalize on this trend are major integrated service companies, such as Halliburton (NYSE:HAL), Baker Hughes (NYSE:BHI) and Schlumberger, as well as smaller companies that have a specific niche.

Valuations

After a very strong run since the beginning of the year, where, on a valuation basis, does Schlumberger stand right now? In the section below, I will use the EV/EBITDA to estimate where Schlumberger Limited is regarding its valuation.

EV/EBITDA = Enterprise Value / Earnings before interest, Taxes, Depreciation and Amortization

In the next section, I will use the EBITDA to calculate the EV/EBITDA. The adjusted EBITDA takes into account foreign exchange and share-based payment expenses. The EV/EBITDA ratio is one of the most commonly used valuation metrics, as EBITDA is commonly used as a proxy for cash flow available to the firm.

Enterprise Value or EV = Market Capitalization + Total Debt - Cash and Cash Equivalents

  • EV - 133.39 billion + $12.489 billion - $7.078 billion = $138.801 billion
  • EV = $138.801 billion
  • EBITDA = 12.36 billion
  • EV/EBITDA = 11.23

As the oil and gas service stocks trade in the 8.63x trading range, an EV/EBITDA ratio of 11.23 states at current levels, the stock is trading over fair value.

Seasonality

According to a 20-year seasonal average supplied by Equity Clock, the spring is usually a positive time for Schlumberger NV. So, after an excellent run, I believe we will be entering a period of consolidation for the stock. As the EV/EBITDA ratio has revealed, the valuation may have "outpaced itself," or is at least fully valued, so a period of consolidation is not out of the question.

Strategy

At this point in the market, I would not be surprised if there was a 5-10% correction over the next few months. If such a correction were to occur, this could present an excellent opportunity to add positions in a company with excellent growth prospects. Currently, I believe there is further upside to equity markets, as major world economies are either recovering or on the verge of recovering. As interest rates continue to remain near zero, this should favor equities.

Conclusion

As Schlumberger NV's stock price has had a solid increase thus far in 2014, I believe we will be entering a period of consolidation. Having stated that, I also believe any pullback in the market would provide an excellent opportunity to add a position or add to your position.

Driven by the increase in global onshore spending, Schlumberger has had an extensive price run thus far in 2014. As global onshore capex spending is expected to continue for the foreseeable future, I believe Schlumberger is a strong long-term candidate for your portfolio. Currently, I own the stock and have no intentions of selling it.

Disclosure: I am long SLB, HAL. 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.