- Analyst presentation sparks enthusiasm among investors, sending shares to fresh all-time highs.
- Ambitious EPS, ROCE and FCF targets allow for greater payouts to investors in this world class player.
- After the huge momentum, I'm only a buyer on significant dips or modest corrections.
Shares of Schlumberger (NYSE:SLB) have seen huge momentum in recent weeks. The reason is a very detailed and ambitious multi-year growth plan which were cheered by investors.
While the improved future visibility is welcomed, the accompanied momentum has diminished the short to medium term appeal in my eyes. The assumptions underlying the plans still assume healthy oil markets and prices, as well as solid global GDP growth. As such the run-up in price is based upon "talk" and not tangible improvements at this moment.
On significant dips, I like the appeal of shares, but I won't jump the current momentum bandwagon.
The Big Presentation
In the final week of June Schlumberger gave a big management presentation, outlining and announcing an aggressive set of goals and targets for 2017.
CEO Paal Kibsgaard outlined the company's future growth plans driven by the usage of technology, efficiency, reliability and integration. Kibsgaard noted that oil majors have seen pressure on their free cash flows in recent years amidst cost inflation, stable oil prices and challenged production levels.
With production becoming ever complex, the ¨efficiency¨ of oil-service providers like Schlumberger is becoming increasingly more important. Suppliers like Schlumberger have the capability and will have to overcome most of the operational challenges for their clients to succeed in the future.
For the upcoming three years, Schlumberger sees global GDP growth moving along at current levels of 3-4%. The company anticipates some geopolitical impacts, yet oil and gas markets and prices are anticipated to remain balanced at current relatively high levels.
Exploration and production spending by oil majors is seen up between 6% and 7% per annum. All of this combined with the operational excellence should be hugely accretive to earnings. Schlumberger anticipates earnings between $9 and $10 per share by 2017, which would result in a CAGR of 17-20% going forward.
Topline sales growth, margin expansion and buybacks should all drive the accretion in earnings per share. Underlying these ambitious plans is the target to achieve a return on capital which exceeds 20%, driven by improved profitability, greater working capital efficiency and overall improved capital discipline.
Ambitious Targets, But Realistic?
While the stated future targets are ambitious, Schlumberger has reported a CAGR in earnings per share of 17% in the relative difficult environment between 2011 and 2013. This is as many oil majors were cutting back their capital expenditures.
Improved capital efficiency should allow for a four percent point improvement in return on capital employed from current levels around 16%. In 2011 the company introduced a management incentive system, which links performance for operational managers to relative performance, is a key driver in this.
With 75% of earnings being targeted to convert into free cash flows, to be used for future dividends and share repurchases, this should be great news to investors.
Current And Future Valuation
Back in April, Schlumberger released its first quarter results, ending the quarter with $7.1 billion in cash and equivalents, while carrying $12.5 billion in total debt. This leaves the firm with a net debt position of about $5.4 billion.
On a trailing basis, Schlumberger has posted revenues of $47.2 billion on which it net earned $7.1 billion.
Trading at around $117 per share, Schlumberger is valued at roughly $153 billion. This values equity in the business at roughly 3.2 times sales and 21-22 times annual earnings. The quarterly dividend of $0.40 provides investors with a 1.4% dividend yield in the meantime.
Given the future growth ambitions, revenues by 2017 could come in around $60-$65 billion, while earnings are seen around $9 per share at the lower end of the guided range. This would value the company at 12-13 times projected earnings four years into the future.
Given that the company has a very strong track record, it is not unthinkable for Schlumberger to achieve these targets. Between 2004 and 2013 the company quadrupled its revenues from $11.5 billion to $46.5 billion. Earnings grew even quicker to $6.7 billion while cumulative dilution was limited to less than 10%.
The strong comments by management in a very detailed and informative presentation sent shares about 10% higher in the time-frame of just two days. Higher oil prices and uncertainty about a slowdown has sent shares already 30% higher this year, and up nearly 60% over the past year.
It should be noted that the company still operates in a cyclical industry, but shares have set fresh all time highs on the back of the analyst presentation. Still, investors who stepped in around $100 in 2008 have lost about 60-70% of their investment within a year's time as the recession resulted in steep earnings and revenue declines during the recession.
Investors might have a great margin of safety at current levels given the much greater revenue and earnings base at his point in time, resulting in a less challenging valuation to start with.
That being said, an unexpected slowdown in the world's economy could still send the 2017 targets into the garbage can. Yet the current share price is largely based upon those targets, with investors already discounting the high targeted shareholder payouts.
This improved visibility has pushed up the current valuation, while there are of course still risks to these targets. Furthermore, the general valuation based on short-term earnings is not that appealing after this year's momentum.
I will keep the stock on my radar if a potential correction in oil prices or general stock markets provides me with an interesting entry opportunity around $90-100 per share. That would translate into a 10-times earnings multiplier four year's ahead in time in a world-class player.