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Summary

  • As management continues to balance concerns regarding oversupply -- which has caused customers to scale back on orders -- National Oilwell's revenue is poised to outperform its bigger rivals.
  • Helped by strong growth on land drilling, management achieved operating margin of 18.2%. These positive comps have to remove fears about the company's long-term outlook.
  • On the basis of margins expansion and free-cash-flow growth, which should boost buybacks and dividends, these shares should reach $95 in the next 12 to 18 months.

National Oilwell Varco (NYSE:NOV) will release second-quarter earnings Tuesday. The stock closed Friday at $85.17, down 0.33%. Shares are up roughly 20% on the year to date, outperforming the energy sector by almost 4-to-1. Investors want to know if National Oilwell Varco has enough oomph to surge higher, especially in the face of growing competition from the likes of Weatherford International (NYSE:WFT) and General Electric (NYSE:GE).

To that end, investors have to be encouraged by how the company's overall business operations continue to improve. That and the fact that oil producers are now rushing to build equipment and commence drilling projects should spur revenue growth for National Oilwell. And during Tuesday's conference call, the direction of the stock will be determined by the extent to which management can demonstrate enough confidence in the next couple of quarters with its guidance.

That said, details like revenue and gross margins are not the driving forces of this stock. Not unlike, say, the tech or financial sectors. What matters most in this industry are the volume of orders received. In that regard, National Oilwell continues to stand out from its peers, both on a relative and absolute basis.

From my vantage point, this makes National Oilwell, which continues to grow margins, a worthwhile risk. With the stock trading around $85 per share, I project fair value to reach $95 in the next 12 to 18 months. This is just $5 shy of analysts' highest target of $100. The reason for my bullishness is simple.

Consider, in the most recent quarter, helped by (among other things) rising domestic and international demand, National Oilwell posted $1.40 in earnings per share, when excluding transaction costs. Although estimates had come down ahead of the earnings report, this was good for a 1-cent beat, even though earnings arrived down 3% year over year.

Revenue, meanwhile, was stronger-than-expected, jumping 9% year over year to $5.7 billion, topping last year's mark of $5.3 billion. Revenue beat estimates by more than 6%. Remarkably, National Oilwell has now averaged double-digit revenue growth in each of the past five quarters. During that span, the company has also benefited from expanding margins.

On a segmental basis, the company posted 15% year-over-year jump in rig technology revenue. This is while revenue out of backlog reached $2.2 billion, while posting a 14% year over year jump in operating profit to $635 million. Note, that operating margin expanded to more than 21%, this is where demand looks even more impressive.

Not to be outdone, the company posted a better-than 5% year-over-year revenue increase in Petroleum Services & Supplies revenue, reaching $1.7 billion. Helped by strong growth on land drilling, management achieved operating margin of 18.2%. These positive comps have to remove fears about the company's long-term outlook.

Investors' fears about General Electric and Cameron International (NYSE:CAM) capitalizing on their larger capacity and infrastructure to support higher production proved misguided. National Oilwell overcame competitive pressures and demonstrated qualities as a strong player in the energy equipment space. To date, the company's strong backlog serves as some assurance of future revenue.

The only question is to what extent can management service the increase demand. And in any industry this is a great problem to have. Investors will find out on Tuesday.

Wall Street will be looking for earnings per share of $1.44 on revenue of $5.51 billion, which will represent year-over-year earnings increase of 8.2%. Revenue is projected to decline 1.6%. Full-year earnings calls for $5.97 per share on revenue of $22.48 billion.

As management continues to balance concerns regarding oversupply -- which has caused customers to scale back on orders -- National Oilwell's revenue is poised to outperform its bigger rivals. Plus, when investors combine the company's order growth and margin expansion, it paints a clear picture of not only National Oilwell's market share gains, but also operational efficiency.

All told, this is a well-run energy operator and patient investors can certainly do well here. On the basis of margins expansion and free-cash-flow growth, which should boost buybacks and dividends, these shares should reach $95 in the next 12 to 18 months.

Source: Why National Oilwell Varco Is Heading To $95