After the BP Macondo oil spill, well service providers have become, unfortunately, associated with recklessness, at best, and corruption, at worst. Whether it be associating Halliburton (HAL) with important political connections to lamenting industry-wide cost cutting measures, the discussion has swung so far to the extreme that few are valuing concerned businesses for their relevant fundamentals. National-Oilwell Varco (NOV), Baker Hughes (BHI), and Weatherford International (WFT) are all undervalued, trade at low multiples, and are well positioned to appreciate from an improved media image. Below, I review the fundamentals of each company.
NOV is rated a "strong buy" on the Street according to data from FINVIZ.com and for good reason. Petrobras recently gave approval to build 6 semis at BrasFELS yard. Around five months ago, the oil & gas firm has approved leases to 26 newbuild floaters and, with greater certainty that 6 of them will be built at BrasFELS yard, NOV will likely receive a nice stream of income that was not originally anticipated. It certainly will not be the only new business that NOV receives: backlog is trending towards an expansion of approximately 50% over the next few years. Construction in Brazilian yards lack visibility since many have not been constructed.
During the second quarter earnings call, management revealed stellar operating results. Diluted EPS came out to $1.46 while revenue rose to a record $4.7B. This confirms not only a strong underlying business story but also that M&A has been accretive after all. For example, the acquisition of Wilson Distribution from Schlumberger has yielded $190M in just a few quarters. Management also announced a quarter-ending backlog of $11.3B--$2.2B of which were in organic new orders.
But, most importantly, NOV is a solid investment for the long-term. It generates consistent cash flow and, while accruing $6.2B worth of goodwill on the balance sheet, M&A has led to double-digit growth. Analysts forecast the firm to grow 13.2% over the next 5 years on an annual basis, but the stock nevertheless trades at just 14.3x and 11.1x forward earnings.
Baker Hughes is yet another solid oil well service provider to invest in. While the company may have had poor execution of late, the firm has started to drastically improve pressure pumping. During the second quarter, management solidly beat expectations with EPS of $1 versus the $0.77 consensus estimate. Going forward from the second quarter, North American margins in non-pumping should improve from a Canadian seasonal recovery.
With the company restructuring operations to a more geographic-focused business model, I also optimistic that future results will be favorably "backdropped" against an improving economy. Certainly, US rig activity is normalizing while international activity is rising. Sequential improvements abroad have complemented domestic efforts to add efficiency to pressure pumping. North American margins grew 110 bps to 13.4%, meaningfully beating expectations. Europe, Africa, and Russia have done particularly well in terms of margins and earnings.
While the land market will face pricing challenges in pressure pumping in the near-term, but guar costs are coming down and margins are expected to improve in the Gulf of Mexico. The main point to grasp here is revenue and margins are all guided to expand in the third quarter with chief momentum coming from Middle East, Africa, and Latin America. Under such an optimistic context, excellent past execution, and compelling multiples, Baker Hughes easily merits a "strong buy" rating.
Weatherford trades at 8.2x forward earnings and a PEG ratio of 0.53. This indicates that future growth has yet to be fully factored into the stock price. In fact, analysts forecast 52.7% annual EPS growth over the next half decade. Should the company grow at only a fraction of that amount, say 20%, and trade at a 15x multiple and 10% discount rate, the stock price should be approximately twice current levels. However, there is considerable uncertainty over such a projection, hence the speculation evident in the beta of 1.8. Analysts are, accordingly, received on the stock and rate it around a "hold" (source: FINVIZ.com).
There is considerable uncertainty, for example, over internal tax accounting. A few months ago, the company reported $500M worth of tax accounting issues. A pending Foreign Corrupt Practices Act investigation further adds to the corporate governance woes. Aside from diminishing shareholder confidence in management, these errors also make the company more of a regulatory target. Below-average returns on capital in the past have, however, undervalued the future growth story. And, at the end of the day, it is the latter that matters--not the former.
During the second quarter, Weatherford had in-line EBIT of $421M. While the North American business has basically perform as expected, investors are seeing nice momentum abroad. Weatherford is more of a turnaround play in the sense that it is shifting from a domestic operator to a global operator. While there have been concerns as to how much efficiency Weatherford will have to sacrifice in its pursuit of greater scale, I believe that, in the long-term, growth will increase margins by spreading out fixed costs. Accordingly, I recommend buying a speculative stake in Weatherford.
Additional disclosure: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.