The industry in which Schlumberger (NYSE:SLB) has been operating, Oil & Gas equipment and services, is largely dependent upon the capital expenditure of the Oil & Gas exploration and production (E&P) industry. During 2011 and 2013, the Oil & Gas exploration and production industry witnessed an increase of 9% - 10% in the capital expenditure. However, in 2014, the growth was reduced to 6% - 7% as the companies focused on improving returns and cash flow. Going forward, the company set a target of average annual growth of 6% - 7% up until 2017. Schlumberger expects its exploration budget to be spent in 2015 and will remain quiet as the industry focuses on cash flows and evaluates new prospects. However, from 2016 and onwards renewed industry focus on exploration is expected.
The growth is primarily driven by deepwater field development. Deepwater field development is the most complex and capital intensive. The company expects the deep water market to gain solid growth momentum as Brazil gradually recovers. Similarly, the activities in Sub-Sahara Africa, the US Gulf of Mexico, and several other frontier regions continue to grow.
Source: Executive Management Presentation
A large part of the company's business is generated from conventional fields which make up approximately 70 percent of global oil production. The North American shale liquids will be the main activity drivers. In addition to the North American shales, the international shale plays led by Argentina, Saudi Arabia, and China are also expected to report strong activities. With the strong growth in drilling and rig-less activity in almost all of the important conventional basins, there is an increasing demand for the company's high-end technology and integration capabilities.
What to Infer from Recent Results
The Reservoir Characterization Group experienced a YoY growth of 1% while the Drilling group witnessed a growth of 10% primarily due to strong exploration and drilling activities both offshore and in key international markets. Similarly, the Production Group experienced a growth of 11% year-on-year primarily due to improving industry utilization of pressure pumping capacity in 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 from the formation of subsea in the second quarter of 2013. This prior year gain hit Schlumberger's operating and net margins considerably in this quarter and in the first six months of 2014. It shall be desirable to discuss the future outlook of these segments.
What about the Future?
Over the past three years the company has steadily improved its financial performance. Between 2011 and 2013it delivered earnings per share growth at a CAGR of 17%. The increase is primarily driven by topline growth. In addition, margin expansion and a reduction in share count also contributed to the earnings growth. Similarly, the company is determined to grow its earnings per share at a CAGR of 17%and this will deliver earnings within the range of $9 - $10 per share. The increase reflects an increase of approximately 100 percent from the current level of $4.75 in 2013.
In addition to increased earnings, the growth projects mentioned above will be reflected in higher return on capital employed. Currently, the company is delivering a return on capital employed of 16%. However, with the continuous improvement in the net income and improved capital efficiency, the company expects to post approximately 20% return on capital employed.
Currently, the company has been trading at a dividend yield of 1.41% reflecting dividends of 1.60 per share. However, going forward, I believe that Schlumberger will continue to increase returns to its shareholders. While the growth prospects mentioned above will secure better earnings, the company is determined to return value to its shareholders. Schlumberger plans to convert approximately 75% of its earnings to free cash flows. The higher free cash flows will allow the company to continually return cash to its shareholders.
The company has been witnessing growth in all of its operating segments. Its ability to outperform is primarily driven by its technological ability, reliability and efficiency. The company's strengths will pave the way for further improvements in its financial performance.
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