Schlumberger's Q4 - Good, Bad Or Ugly?

| About: Schlumberger Limited (SLB)

Summary

US results did worse than International results.

Rig count could bottom in 2016, which means that the worst may be behind the company.

Schlumberger's cash generation and utilization remains good.

Shares have upside to fair value and offer strong dividend yield.

Schlumberger (NYSE:SLB) reported fourth quarter and full year results today, beating estimates for the bottom line but slightly missing top line expectations. In this article I'll take a look at the results, Schlumberger's shareholder returns, valuation and outlook.

Schlumberger grossed revenues of $7.74 billion in the fourth quarter, which is a vast decrease of 39 percent versus the prior year, but just slightly below the estimate of $7.77 billion. Revenues were down nine percent quarter to quarter. Revenues for the full year came in at $35.5 billion, which is 27 percent below 2014's number.

With net income coming in at $820 million Schlumberger's earnings per share (from continuing operations, excluding charges) came in at $0.65, seventeen percent below the Q3 level and almost sixty percent below last year's number.

International revenues held up pretty well, declining six percent quarter to quarter and 30 percent yoy, whereas US revenues crashed 14 percent quarter to quarter and 55 percent year on year. Schlumberger's International operations also contributed 90 percent of the company's operating income and, we could say, saved the quarter for the company.

The reason is pretty simple: US oil production is more sensitive to price changes than oil production in most other countries. In the last few years, when oil was expensive, the US have seen production growth unlike any other country. Now, with almost no one being able to produce for a profit any more, oil producers in the US seem to cut back the fastest, too. Actual production did not really decrease yet (since production from existing wells is still positive for cash flows), but drilling activity has dropped immensely.

The US rig count is down slightly more than sixty percent over the last twelve months, according to Baker Hughes' data (using a rig count of 650 for January 2016 and a rig count of 1680 for January 2015), this vast decline in drilling activity explains Schlumberger's US revenue drop of 55 percent pretty well.

(source: oilprice.com)

On the other hand, the global rig count is down about forty percent over the last year, when we exclude the rig count reduction in the US the global ex-US rig count declined from roughly 2000 to roughly 1400 over the last year, a decline of thirty percent, which correlates very well with Schlumberger's International revenue decline of thirty percent yoy in the fourth quarter.

With Schlumberger's results tied to drilling activity (or, more generally, oilfield activity), where should we expect revenues to bottom out? We can look at what Raymond James & Associates assumes for this year's rig count numbers: The advisory firm expects US rig counts to bottom in June around 550 (which would mean a further rig count decline by 100) and a year end number of 750. This means that US rigs could average about 650 for the year, which is around the current level, but below last quarter's average, thus Schlumberger's US revenues could fall further. The positive is that RJ&A expects a steep rig count increase towards a level of about 1000 in 2017, thus Schlumberger's revenue trough might be dealt with in two years, a positive for long term holders for sure.

When we take a look at Schlumberger's shareholder returns, the first positive we see is that the company is able to cover all of its dividend payments. The company's diluted adjusted earnings per share for 2015 came in at $3.37, which is 170 percent of the company's dividend of $2.00 a year (or $0.50 quarterly). Looking at the company's cash flows, we see that Schlumberger produced free cash flows of $4.96 billion in 2015, more than twice the total dividend amount of $2.42 billion. We can say that unlike the dividends of a lot of other energy related companies, including most pure upstream operators, Schlumberger's dividend looks very safe despite the downturn in global oilfield activity.

In addition to dividends, Schlumberger also returns cash to shareholders via stock repurchases: Over the last twelve months Schlumberger has bought back shares for $2.2 billion, which is equal to three percent of the company's market capitalization at the current price. Reducing the number of shares by three percent a year is obviously not enough to keep earnings stable, but it should have a substantial positive effect on the company's earnings per share growth rate in the long term. By reducing the number of shares now, as long as they are rather low priced, Schlumberger's shareholders will see ample returns once oil prices are higher and Schlumberger's operations see more activity again. Both dividends and share repurchases together are still covered by free cash flows, unlike other companies who borrow to buy back shares Schlumberger thus doesn't endanger the company's financial health with its shareholder returns. Schlumberger also announced a new $10 billion buyback authorization, enough to reduce the number of shares by thirteen percent at the current price. Since the company has more than $13 billion in cash, Schlumberger could use the currently low share price and buy back a massive amount of shares over the next months.

Schlumberger's valuation is low when we look at the company's cash generation instead of the company's earnings performance. Since the company's cash flows decide how much a company can return to its shareholders (e.g. via dividends), I believe this is the more important metric. Schlumberger's trailing free cash flow multiple is 10.4, which gives the company an immense free cash flow yield of 9.6 percent. Schlumberger's price to operating cash flow ratio of 7.5 is very low as well. Both metrics are at multi year lows, over the last five years Schlumberger's free cash flow yield hasn't been this high, despite the fact that the environment was easier for the company pre 2015.

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Using the finbox.io valuation model I got to a fair value range of $67 to $92, with the middle scenario leading us to a fair price of $77 per share, which means upside of about 25 percent from the current price. The assumptions I made -- moderate revenue growth in the next three years and a terminal FCF growth rate of two percent -- seem conservative enough, I believe. Together with the low valuation we see when looking at the company's other valuation metrics and high dividend yield of 3.3 percent I believe this justifies saying that it looks like a good time to think about adding Schlumberger to a portfolio.

Takeaway

Schlumberger's fourth quarter saw further substantial earnings and revenue declines yoy and quarter to quarter, with International results holding up better than US numbers.

With rig counts looking to bottom out during 2016 the worst could be behind Schlumberger, at least we can say that further huge declines seem unlikely.

With strong cash generation, high shareholder returns and cost saving measures on the way the company doesn't look bad fundamentally.

Schlumberger trades at a low valuation and has double digit upside to fair value, I believe, which, in addition to the company's high dividend yield, makes the company attractive right here.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in SLB over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.