Schlumberger's Earnings Downfall Should Not Concern Long-Term Investors

Jul.23.14 | About: Schlumberger Limited (SLB)

Summary

Schlumberger’s year-on-year revenues jumped 7.8% but net earnings declined 23.87%. However, the adjusted operating and net margins are better than 2Q13’s margins.

The current ratio is below the industry average but the company has a good record of generating substantial free cash flows.

The company has a bright future outlook because of rising drilling and rig activities, increasing energy demand and increasing offshore exploration investments.

Schlumberger Ltd. (NYSE:SLB) has beaten the analysts' estimates in its 11th consecutive quarter but the company failed to strike investors. Schlumberger's sales rose 7.8% to $12.1 billion beating the $11.95 billion estimate. The company earned adjusted per share earnings of $1.37 per share exceeding the estimates of $1.36 per share. However, its net earnings declined significantly by 23.87%.

Financial Performance

Schlumberger manages its business in three groups. Reservoir Characterized Group includes the principal technology involved in finding and defining hydrocarbons. Drilling Group includes the principal technologies involved in the drilling and positioning of oil and gas wells. Production Group includes the principal technology involved in lifetime production of oil and gas reservoirs.

The Reservoir Characterization group experienced a YoY growth of 1% and Drilling Group experienced a growth of 10% due to strong exploration and drilling activities, both offshore and in key international markets. The Production Group experienced a growth of 11% year-on-year primarily due to improving industry utilization of pressure pumping capacity in the US land, strong international Well services activity, increasing Well Intervention coiled tubing activity worldwide and strong international sales of Completion products.

Despite good revenue growth, Schlumberger's YoY operating income in the second quarter of 2014 declined 13% as the company earned a non-recurring gain on the formation of Sub Sea in the second quarter of 2013. This prior year gain considerably hit Schlumberger's operating and net margins in this quarter and in the first six months of 2014.

Source: Earnings Press Release

However, if we adjust the operating and net income for this non-recurring gain and for the impairment and other expenses which incurred in 2Q13 but not in 2Q14, then the margins seem to have improved in 2014. The operating margin in this quarter has jumped around 150 basis points whereas the net margin has jumped around 45 basis points. Similarly, the margins improved in the first half of 2014 compared to the first half of 2013 after adjustment for non-recurring gain and expenses.

The operating and net margins in this quarter improved mainly due to a reduction in cost of revenue as a percentage of sales, which declined by 100 basis points.

Liquidity, Debt and Cash Flows

Schlumberger's liquidity position is weaker than the industry average as indicated by its current ratio showing its loss of ability to pay the short-term liabilities. However, in the first six months of 2014 it has slightly improved its liquidity position as its current ratio is now better than the ratio of December 31st, 2013.

Its debt profile is slightly better than its industry peers. The debt-to-equity ratio in the first half of 2014 remained the same as the figure attained at the end of 2013.

However, Schlumberger's ability to carry its total debt has improved in the first six months of 2014 compared to the first six months of 2013 as indicated by its higher CFO-to-debt ratio at the end of the second quarter of 2014.The company had a ratio of 0.3185 at the end of the first two quarters of 2014 compared to the end of the first two quarters of the previous year..

The company has maintained a solid track record of generating significant free cash flows from its operations reflected in the cash flow growth from 2011. In the last three years, its ability to generate free cash flows has increased to a level that is higher than its main rivals. The free cash flows grew by 35% in the first half of 2014 when compared to the free cash flows in the previous year reflecting Schlumberger's increasing power to satisfy its obligations after making cash investments.

Future Outlook

The company's revenues are substantially dependent on levels of expenditures from the oil and gas industry. The drilling and rig activities in industries in both the U.S. and internationally are expected to continually rise. The growing demand for energy along with the increasing offshore exploration investments are projected to drive the global drilling market to $121.1 billion growing at a CAGR of 10.6% from 2013 to 2018.

Schlumberger's sales and payments are also dependent on the future outlook of oil and gas prices. As the prices are forecasted to be less volatile in 2014, I do not expect there to be any delay or cancellation of projects or any delay in payments by the customers.

Final Takeaway

Schlumberger has shown satisfactory performance in this quarter. Although its net profits have significantly fallen the investors should not be disheartened as the factors which drove down the profits were non-recurring. Apart from those factors, the company has improved its margins.

Its CFO-to-debt ratio and free cash flows ensure that Schlumberger is in a position to conveniently repay its short and long term debt and make dividend payments to investors after making capital expenditures.

The future seems bright for Schlumberger and reflects the fact that the company would continue adding growth to its profits and to investors' profits. Therefore, I suggest buying the stock.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by APEX Financial Consultants. This article was written by one of our research analysts. APEX Financial Consultants is not receiving compensation for this article (other than from Seeking Alpha). APEX Financial Consultants has no business relationship with any company whose stock is mentioned in this article