- Schlumberger posts solid second quarter results.
- Investors hardly react to the numbers, they are focused on oil and gas price developments amidst international tensions.
- The company recently issued a strong 2017 long term target, providing a roadmap for investors.
Investors in Schlumberger (NYSE:SLB) hardly reacted to the company's second quarter results. Instead, they focus on all the international geo-political developments which can directly impact the company's operations in geo-political hotspots, and indirectly by influencing international oil and gas markets.
The long term 2017 roadmap provides visibility for investors, for as long as the scenario of solid global GDP growth remains intact. Not having enough margin of safety at current levels, I am a buyer in the $90-$100 region, paying 10 times anticipated earnings for 2017.
Second Quarter Highlights
Schlumberger posted second quarter sales of $12.05 billion over the past quarter, representing 8% growth on an annual basis. Revenues came in above consensus estimates at $11.94 billion.
Reported earnings to shareholders came in at $1.59 billion which was down sharply from $2.10 billion reported last year. Take into account that the company recorded a $1.03 billion gain on the formation of OneSubsea last year, partially offset by $364 million in impairment charges.
On a GAAP basis, Schlumberger posted earnings of $1.21 per share for the quarter. Non-GAAP earnings came in at $1.37 per share, beating consensus by a penny.
Looking Into The Quarter
Schlumberger posted annual sales growth in each of its three major divisions. Growth was however driven by the drilling and production businesses of the company.
Drilling revenues rose by nearly 10% to $4.65 billion as operating earnings approached the billion mark, showing great operating leverage on the higher sales. Production revenue growth approached 11% as sales came in at $4.34 billion with again operating earnings improving rapidly to $725 million.
Lagging in all of this was the less than 1% reported growth as reservoir characterization with sales coming in at $3.10 billion. This unit remains incredibly profitable however, posting operating earnings of $918 million.
Overall gross margins came in at 23.1% of sales up a full percent point compared to last year. While this appears rather slim, note that companies like Schlumberger have a very low operating cost basis. Research & engineering expenses total merely 2.6% of sales while general & administrative costs came in at just about 1.0% of sales.
In terms of geographical distribution, North America remains the most important market, making up 32% of total sales. Sales growth of nearly 16% to $3.89 billion was impressive as well amidst the energy revolution.
More modest growth was seen in Europe and Africa as well as the Middle-East and Asia. Results were driven by strong demand in Saudi Arabia while Russia emerged from a harsh winter. Despite being smaller than the North American operations, reported profits of these geographic regions are actually higher in dollar terms. Only the activities in Latin America posted a decline in sales while earnings held up relatively well.
By the end of the quarter, Schlumberger held $6.70 billion in cash and equivalents. Offsetting was the substantial total debt position of about $13.25 billion which results in a roughly $6.6 billion net debt position.
On a trailing basis, Schlumberger has now posted sales of $47 billion on which it earned little over $6.5 billion. With shares trading at $112 per share, equity is valued at $146 billion. This values equity in Schlumberger at 3.1 times annual sales and 22-23 times annual earnings.
Very Strong Historical Performance, Even Better Days Ahead
Over the past decade, Schlumberger has grown its operations at a very strong and impressive pace. Revenues have grown at a compounded growth rate of more than 15% from just $11.5 billion in 2004 to $47 at this moment. Margins have been volatile year-over-year, but remained stable throughout the cycle. This is as the total share count has only risen by 5-10% over this time frame.
The company has taken on some debt in the last years, partially used to repurchase shares, but the overall debt position is largely contained. The strong past performance has resulted in a big pay day for long term investors with shares having risen from $30 in 2004 to highs of nearly $120 per share in recent weeks. Timing is of course a big issue in this cyclical, but structural growth story. In 2008 shares peaked at $100 to fall back to $30 a year later during the recession. Of course this was followed by a steady recovery and the momentum in 2014.
Earlier this month, the company released an ambitious set of long term targets. Part of this is the $9-$10 earnings per share target for 2017, calling for a 17-20% compounded annual growth rate in earnings. This is driven by margin gains, topline growth and improved usage of capital, boosting the company's possibilities to return free cash flows to investors.
Capital allocation, notably recent share repurchases have turned out to be very wise investments. During the quarter, the company repurchased 11.5 million shares at favorable average prices of $101.85 per share.
Schlumberger's sales have fallen by about 5% from their highs in recent weeks. Falling natural gas prices are to blame as well as increased geo-political risks. Political uncertainty might be good for oil prices, but are not necessarily good for Schlumberger which operates directly in geo-political hot spots.
When detailing the long term targets earlier this month, I last checked out the prospects for the company. I concluded that investors liked the aggressive long term targets, which furthermore provide a roadmap and valuation benchmark going forwards. If attained, shares trade at less than 12 times earnings per share for 2017, which appears appealing.
Yet plans are plans, and the rapid and unexpected events in the world over the past week just demonstrate how quickly things can change. As such the visibility adds to the outlook and share price, until the external environment changes so much that the plans can be thrown into the garbage can.
Therefore I urged to be cautious, with shares still trading at 22-23 times current earnings. This is despite the structural growth story in a still cyclical industry. Even after the recent correction towards $112 per share, shares are still up 25% this year which implies quite some momentum.
As such I would like a greater margin of safety before stepping in. I reiterate my $90-$100 target entry point based upon 10 times anticipated earnings for 2017.