Edited By Marianna Avilkina
Schlumberger Limited (SLB) has been one of the world's leading oilfield service providers for the last 80 years. Founded in 1926, the company specializes in seismic drilling and information services, as well as subsea production and intervention expertise. Since its inception, SLB has focused primarily on research and innovation. Forbes ranked Schlumberger 44th on the list of most innovative companies for 2011. The stock performed well in the last quarter, returning about 20 percent since June.
As of September 21, 2012, SLB stock was trading at about $75, with a 52-week range of $54.79 - $80.78. It has a market cap of about $100 billion. The trailing twelve-month P/E ratio is 18.9, whereas the forward P/E ratio is 14.7. P/B, P/S, and P/CF ratios stand at 3.1, 2.4, and 18.5, respectively. The operating margin is 16.8% while the net profit margin is 12.6%. The company has only minor debt issues, as the debt/equity ratio of 0.2 is far below the market average.
Schlumberger pays consistent dividends - the trailing yield of 1.46% is the same as the forward one. Upcoming dividends are about $.275 per share in Q4 2012. Over the last five years, the company has boosted its quarterly dividend amount by 57%. The five-year dividend history suggests that Schlumberger is a satisfactory and steadfast dividend payer.
SLB has a 3-star rating from Morningstar. Out of four analysts covering the company, all of them have a "buy" rating. This is good reason to suppose that Wall Street primarily holds a positive opinion about the company's future. The average five-year annualized growth forecast estimate is 20%. What is the fair value of Schlumberger given the forecast estimates? We can determine SLB's fair value using the discounted earnings plus equity model, as follows.
Discounted Earnings Plus Equity Model
This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:
V = E0 + E1 /(1+r) + E2 /(1+r)2 + E3/(1+r)3 + E4/(1+r)4 + E5/(1+r)5 + Disposal Value
V = E0 + E0 (1+g)/(1+r) + E0(1+g)2/(1+r)2 + … + E0(1+g)5/(1+r)5 + E0(1+g)5/[r(1+r)5]
The earnings after the last period act as a perpetuity that creates regular earnings:
Disposal Value = D = E0(1+g)5/[r(1+r)5] = E5 / r
While this formula might look intimidating for many of us, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate, and the discount rate. To be as objective as possible, I use Morningstar data for my growth estimates. You can set these parameters as you wish, according to your own diligence.
Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate. In order to smooth the results, I will also take the average of ttm EPS along with the mean EPS estimate for the next year.
E0 = EPS = ($3.99 + $5.12) / 2 = $4.56
Wall Street holds diverse opinions on the company's future. While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average five-year growth forecast is 20%. Book value per share is $24.72. The rest is as follows:
Fair Value Estimator
Fair Value Range
(You can download FED+ Fair Value Estimator, here.)
I decided to add the book value per share so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5-year discounted-earnings-plus-book-value model, the fair-value range for SLB is between $95 and $119 per share. At a price of about $75, Schlumberger is trading at a solid discount. The stock has at least 26% upside potential to reach its fair value.
While there are many companies in the oil services industry, Halliburton Company (HAL) is probably the closest competitor of SLB. My FED+ valuation suggests that extremely undervalued Halliburton has at least 105% upside potential to reach its fair value. In contrast to SLB, HAL stock is trading at a relatively low ttm P/E ratio. While both companies offer reliable dividends, Halliburton currently does have a substantially better outlook in terms of both profitability and current entry point. However, Halliburton offers a comparably poor dividend yield.
Baker Hughes Inc.
Return on Equity
Unlike Schlumberger, another competitor - Baker Hughes Inc. (BHI) - is trading at a considerable discount (i.e., it has 140% upside potential to reach its fair value). In addition, Baker Hughes has been paying a constant dividend amount of $.15 over the last five years. In the volatile business environment, the Baker Hughes investment looks safe. Moreover, these days Baker's stock is providing a rather attractive entry point.
Current Economic Outlook
Over the past year, oil prices have risen to $116 per barrel, later dropping to $89 per barrel. Currently, oil prices are increasing on a rebound and the oil services sector stands to benefit from the uptrend. Most of the demand for oilfield services is in North America, a region that is struggling with production. Unlike its competitors, SLB relies much less on the North American market for the demand of its services. The company's stock is less susceptible to industry shocks and risks because of its geographical diversification. This has also allowed it to reap a growth in revenue of 16.3% from the prior year. Furthermore, the company's innovative Hydraulic Fracking system has brought drilling costs down by utilizing much smaller amounts of sand, water and transportation equipment. Normally, these aspects of drilling and extraction comprise up to 50% of the total expenditure.
Pacwest Consulting predicts that the demand for Hydraulic Fracking will increase by 41% in the period from 2012-2016, especially outside North America. This is good news for SLB as it has a larger share of operations outside the U.S. While interest in gas exploration and extraction continues to remain low, SLB is primed to capitalize on extraction of oil as more companies emphasize this venture. Furthermore, the oil sector is more service-intensive than gas extraction.
Nevertheless, based on historical valuation metrics, SLB stock looks undervalued with at least 27% potential to reach its fair value. SLB remains a market-leading stock along with its primary competitor, Halliburton. While the demand for oil extraction and drilling remains more or less the unchanged this year, SLB's competitive advantage of low-cost solutions puts it in prime position to outperform its rivals.