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We are of the opinion that the financial position of Schlumberger (NYSE:SLB) is strong at the moment and have a positive outlook on the company. The profitability of the company will increase through technological advancement in products and services offered by the company, which include the launch of its latest exploration software 'IsoMetrix'. In addition, we are positive on the company because of its shift from gas to liquids-and-oil-shale production in the U.S., which requires higher levels of service intensity and offers higher profitability to oil service companies.

Additionally, as per industry estimates, Upstream Oil and Gas spending will continue to grow due to high demand and oil prices, and this will be beneficial for the Oil Service Industry.

However, a key risk that remains to our thesis is oil prices, which have dropped almost 20%, and a further decline will be detrimental not only for the Oil Exploration and Drilling Industry, but the Oil Service Industry as well.

Industry Introduction

Oil and Gas Service companies assist Oil Drilling companies in setting up oil and gas wells. In general these companies provide services and products to the Energy Industry with regards to the exploration, development, and production of oil and natural gas. These companies manufacture, repair and maintain equipment used in oil extraction and transport.

The services provided by these companies include 'Seismic Testing', in which the Oil Service Company utilizes its technology to assist drilling companies in exploration. The services offered also include 'Transport Services', since rigs need to be moved around occasionally. The company also offers 'Directional Services', assisting drilling companies by guiding them to the most suitable direction for drilling oil for extraction.

Major Oil Service companies offer services to clients in the U.S and internationally. However, they drive a significant portion of their revenues through their activities in the latter.

Industry Drivers

Oil and Natural gas prices reflect global demand and directly affect the level of exploration, development, and production activity of the Oil Drilling Industry. The activity of Oil Drilling companies affects demand for the services and products offered by Oil Service companies. Therefore, high oil and gas prices translate into increased drilling activities, which increase the demand for the products and services offered by Oil Service companies.

Industry Risk

The operations of service companies are subject to political and economic instability, and are under the risk posed by government actions that could have a material adverse effect on the operations and the profitability of these companies.

A downward trend in estimates of production volumes or prices, or an upward trend in production costs for oil and gas, both would have an adverse effect on the profitability of service companies.

Outlook

As per the upstream spending report published by IHS Inc, it is expected that the total upstream CAPEX and OPEX are expected to reach $1.23 trillion for 2012 and expected to rise to $1.64 trillion in 2016. Onshore CAPEX continues to have the largest share of CAPEX, but offshore CAPEX is expected to continue to outpace it in terms of growth and is expected to grow at a pace of 58% as compared to 39% for onshore drilling.

It is also expected that exploration and drilling growth will be driven by interest in the Gulf of Mexico (U.S.), Brazil (Latin America), Saudi Arabia and Iraq (Middle East), Norway (Europe), Eastern Africa, and the Western Gulf of Guinea.

Company overview

Schlumberger Limited provides a wide range of products and services from exploration through production. The company supplies technology, integrated project management and information solutions to customers in the Oil and Gas Industry globally. The company's operations include three segments being the Reservoir Characterization Group, Drilling Group and Reservoir Production Group.

Financial Performance

SLB reported EPS of $ .98/share for 1Q2012, which increased 42% as compared to EPS of $ .69/share for 1Q2011. The results were almost in line with analyst expectations.

Following is the revenue earned

 

1Q2012

1Q2011

% Change

Revenue

   

Oilfield Services

9,918

8,122

22%

Distribution

693

594

17%

Source: 10Q

 

1Q2012

1Q2011

% Change

Oilfield Services

   

Reservoir Characterization

2,586

2,193

18%

Drilling

3,785

3,112

22%

Reservoir Production

3,539

2,808

26%

Eliminations & other

8

9

-11%

 

9,918

8,122

22%

Distribution

713

601

19%

Eliminations

(20)

(7)

186%

Total

10,611

8,716

22%

Source: 10Q

Oilfield Services

The revenue of $9.9 billion for 1Q2012 was 22% higher than the $8 billion fo9r 1Q2011, largely due to the improved activity exploration and drilling activities. A reason for the increased revenues from North America is due to the depressed prices of natural gas which has tilted the production interest towards the higher margin liquid fuel drilling and improved activity in the US Gulf of Mexico.

Reservoir Characterization Group

Revenue of $2.6 billion for 1Q2012 was 18% higher than the $2 billion for 1Q2011, led by increased offshore revenues from the U.S. Gulf of Mexico, due to increased licensing permits and strong performance internationally from Latin America, Middle East and Africa.

Drilling Group

Revenue of $3.8 billion for 1Q2012 was 22% higher than the $2.8 billion for 1Q2011, primarily due to significantly drilling activity in North America, Europe and Africa.

Production Group

Revenue of $3.5 billion for 1Q2012 increased by 26% from the 1Q2011 revenue of $2.8 billion, with prominent growth in North America, due to a combination of capacity additions and increase in asset optimization.

Net Debt and cash flow

The company's net debt reported for 1Q2012 was $5.8 billion, which increased by 45%, as compared to $3.9 billion for 1Q2011.

Cash flow from operating activities of $732 million for 1Q2012 decreased by 12%, as compared to $836 million for 1Q2011, due to increased working capital requirements. Also, the CAPEX of $961 million for 1Q2012 increased by 25% as compared to $770 million for 1Q2011.

Stock performance

The stock price performance has witnessed a decline of 14% in the previous three months, a decline of 5% YTD and a decline of 19% in the last one year.

IsoMetrix

The company recently announced the launch of IsoMetrix marine technology, along with other related marine seismic products. This technology enables more efficient exploration, higher resolution for near-surface characterization, and unmatched 4D repeatability. The company also claimed that field trials last year proved the technology's high accuracy.

According to the company, a new range of applications are being developed based on IsoMetrix technology to address currently difficult exploration and development formations, while also improving productivity.

U.S. Oil Industry

Recently, there has been a shift in the U.S. from gas to liquid-and-oil-shale production, which increases the service intensity and increases the profitability of companies that provide services related to the extraction of unconventional fuels like SLB.

International Oil Industry

It is expected that the volume of installed rigs will increase internationally due to improved macroeconomic trends and improved oil and natural gas prices internationally. Also, it is expected that there will be more interest in unconventional hydrocarbons in the international industry. SLB is expected to benefit from the above mentioned developments, since it derives the majority of its revenues from the international Oil Industry.

Competitors

SLB's major competitors include Halliburton Co (NYSE:HAL)., National Oilwell Varco Inc. (NYSE:NOV), and Baker Hughes Inc (NYSE:BHI).

Recommendation

We are of the opinion that the financial position of the company is strong at the moment and expect the profitability of the company to improve going further, based on technological improvements (IsoMetrix), superior service quality, increased CAPEX and OPEX by oil drilling companies, and a shift from gas to liquids-and-oil-shale production in the U.S.

The stock is trading at a P/E ratio of 15.3x and offers a dividend yield of 1.68%. We have a positive outlook on the stock given that once the current debt crisis in Europe is resolved and economic growth in the U.S and China picks up, drilling activity will undergo a positive change and benefit the company.

We recommend a Long position in Schlumberger Ltd. and Short OIH Services ETF (NYSEARCA:OIH).

 

 

 

HAL

SLB

NOV

BHI

Industry

P/E

8.69

15.31

11.23

10.88

21.38

P/B

1.88

2.7

1.53

1.07

1.63

PEG

0.42

0.85

0.62

0.53

0.63

P/FCF

53.05

96.88

20.28

-

27.54

Dividend Yield

1.28%

1.68%

0.73%

1.52%

2.17

Total Debt/Equity

34.82

31.43

2.77

27.91

37.81

EPS growth 1Q2012

46%

41%

44%

-1%

-

EPS growth expected 2012

10%

9%

14%

-14%

-

3 month performance

-16%

-14%

-19%

-19%

-

YTD performance

-14%

-5%

-6%

-23%

-

52 Week Performance

-37%

-19

-3%

-43%

-

Source: Buy Schlumberger To Benefit From The Upstream Oil And Gas Spending Cycle