Schlumberger Q1 Review: Was It Really That Bad?

| About: Schlumberger Limited (SLB)

Summary

Schlumberger has reported a large drop in first quarter profits and painted a grim outlook for the future.

The company's revenues dropped in all regions while North America's earnings slipped into the red.

But a closer look reveals that Schlumberger's performance wasn't that bad.

Schlumberger (NYSE:SLB), the world's leading vertically integrated oilfield services company, released its first quarter results on Thursday in which its profits plunged while the company painted a grim future outlook. That triggered a 4.5% drop in Schlumberger stock during after-hours trading. Clearly, the brutal environment is making its mark on Schlumberger, but a closer analysis reveals that the company's results weren't that bad.

During the first three months of this year, revenues fell 36% from last year to $6.52 billion while net income, excluding extraordinary charges, decreased 63% to just $501 million, or $0.40 per share. The pre-tax operating margin also slumped by 563 basis points to 13.8%. The results were, however, slightly better than analysts' consensus estimate of a profit of $0.39 per share from revenues of $6.51 billion, according to data compiled by Thomson Reuters.

North America region

With persistent weakness in drilling activity, Schlumberger's North America region slipped into the red. The segment's revenues dropped 55% from a year earlier to $1.46 billion while it swung from a pretax operating profit of $416 million to a loss of $10 million. The earnings remained under pressure due to reduced drilling activity, unending pricing pressure, project delays and the impact of Canadian spring break-up which happened sooner than expected.

A weak performance from North America was expected since the region has witnessed one of the steepest declines in drilling activity in the world. The loss was, however, surprising, considering Schlumberger's North America unit managed to remain profitable during the previous down cycle. But Schlumberger is holding its ground in its home market.

The drilling activity in North America continues to deteriorate. According to the latest report from Baker Hughes for the week ending April 15, the US oil rig count has dropped to 351 - its lowest level since Nov. 2009 - while there were just 89 gas rigs working in the country. The US land rig count dropped 31% between Q4-2015 and Q2-2016, but in this period, Schlumberger's revenues decreased by only 25%. In this context, Schlumberger actually delivered a decent performance.

International markets

In the international markets, however, Schlumberger has remained profitable. The company's revenues decreased 28% to $4.97 billion while pretax operating profit was down 36% to $1.06 billion. Here, Schlumberger is struggling with drop in spending from E&P customers, activity disruptions, seasonal factors and weakness in Russian currency. However, the drop in revenue and earnings was significantly smaller when compared against North America.

What's particularly impressive, however, is that Schlumberger's profit margin in the international markets continues to stay north of 20%. In the previous quarter, the pretax operating margin clocked in at 21.3%, down from 24.1% a year earlier, but still highly profitable.

Clearly, international markets, where state sponsored oil companies play a big role, have been far more resilient than North America. We've seen a similar trend in the all the previous quarterly results of every oilfield services company with international exposure. This puts Schlumberger in a better position to weather the storm since it has the greatest exposure to international markets than its peers, such as Halliburton (NYSE:HAL), Baker Hughes (NYSE:BHI), Helmerich & Payne ( HP) and Patterson-UTI Energy ( PTEN) which rely mostly on the North American market.

Cash flows

Schlumberger usually generates one of the highest levels of free cash flows in the industry, but in the previous quarter, its free cash flows came in at negative $103 million.

This was, however, largely driven by $597 million of SPM investments and of $167 million of multiclient seismic data costs. Excluding those, Schlumberger spent $549 million on capital spending and $629 million on dividends. If it weren't for SPM and multiclient, the company's operating cash flow of $1.21 billion could have easily covered the capital expenditure and dividends. This shows that despite the negative number, the company continues to generate enough cash to fully fund the organic capital expenditure and dividends.

Meanwhile, Schlumberger continues to focus on cost cutting measures. It has reduced the current year's capital spending budget from previous estimate of $2.4 billion to $2 billion. The company also hinted at further reductions. Meanwhile, it has reduced its workforce by 2,000 employees from the end of last year to around 93,000. The capex reduction and additional cost cutting measures is going to bolster Schlumberger's ability to generate free cash flows moving forward.

Outlook

Schlumberger's CEO Paal Kibsgaard, however, painted a gloomy outlook which is probably what spooked Mr. Market. The downturn, Kibsgaard said, has already reached "unprecedented levels" and the industry appears to be operating in "full-scale cash crisis," but this environment could further deteriorate in the coming quarters. As a reminder, last month, Kibsgaard said on the backdrop of an energy conference that the drilling activity is not going to rebound as quickly as oil prices. In fact, Kibsgaard is not expecting a turnaround this year.

Bottom-line

However, Schlumberger's North America revenues have been holding up well when compared against the drilling activity, its margins in international markets - where Schlumberger has a bigger footprint than any of its peers - remain strong, while it continues to generate strong cash flows. I believe this is the kind of oilfield services company investors should stick with in the downturn. Moreover, earlier this month, Schlumberger also closed the Cameron International merger, which puts it in a great position to emerge even stronger from the down cycle.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.