Schlumberger: Profitability Analysis

Oct.31.12 | About: Schlumberger Limited (SLB)

Looking at profitability is a very important step in understanding a company. Profitability is essentially why the company exists and a key component in deciding whether to invest or to remain invested in a company. There are many metrics involved in calculating profitability, but for this article, I will look at Schlumberger NV (NYSE:SLB) earnings and earnings growth, profit margins, profitability ratios and cash flow.

Over the past 5 years the economy and subsequently energy prices have been hit hard. Through the above-mentioned four main metrics we will get an idea about the company's profitability over past 5 years. We will also get an idea how hard Schlumberger NV was hit by the crisis and how well the company is recovering. By comparing this summary to other companies such as Halliburton (NYSE:HAL), Baker Hughes (NYSE:BAK) and Weatherford International (NYSE:WFT) who are in the same sector, you will be able see which has been the most profitable.

All material is sourced from Morningstar, and the Company webpage.

Earnings and Earnings Growth

1. Earnings = Sales x Profit Margin

  • 2010 - $27.447 billion x 6.43% = $4.267 billion
  • 2011 - $39.540 billion x 7.91% = $4.997 billion

Schlumberger's earnings increased from $4.267 billion in 2010 to $4.997 billion in 2011, an increase of 17.51%.

2. Five-year historical look at earnings growth

  • 2007 - $5.177 billion, 39.54% increase over 2006
  • 2008 - $5.435 billion, 4.98% increase
  • 2009 - $3.134 billion, 57.66% decrease
  • 2010 - $4.266 billion, 36.12% increase
  • 2011 - $4.997 billion, 17.13% increase

In looking at Schlumberger's earnings over the past five years, you can see how the economic crisis affected the earnings in 2009. As Schlumberger's business is greatly dependent on the economy and energy prices, the 2009 company's earnings decreased by 57.66%. Even though the earnings decreased by over 50 percent the earnings still held up quite well with the company posting earnings of $3.134 billion.

In 2010 the earnings began to rebound. The earnings rebounded due to a recovery based on a large increase in oil demand. In 2011, consumption grew by a more modest 0.7 million barrels per day but revenues increased led by the company's oilfield services. In 2011 the company's oilfield services increased by 82% in North America. In 2011, the company reported earnings of $4.997 billion.

The 2011 reported earnings of $4.997 billion is still behind the 2008 peak reported earnings of $5.435 billion.

Profit Margins

3. Gross Profit = Total Sales - Cost of Sales

In analyzing a company, gross profit is very important because it indicates how efficiently management uses labor and supplies in the production process. More specifically, it can be used to calculate gross profit margin. Here are Schlumberger's gross profits for the past two years:

  • 2010 - $27.447 billion - $21.843 billion = $5.604 billion
  • 2011 - $39.540 billion - $31.418 billion = $8.112 billion

4. Gross Profit Margin = Gross Income / Sales

The gross profit margin is a measurement of a company's manufacturing and distribution efficiency during the production process. The gross profit tells an investor the percentage of revenue/sales left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors and industry is more efficient. Investors tend to pay more for businesses that have higher efficiency ratings than their competitors, as these businesses should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).

In reviewing Schlumberger's gross margin over the past five years, we can see the impact the financial crisis had on the company's margin. The 5-year low for the gross margin was reported in 2010 with a margin of 20.42%. The 5-year high for the margin was in 2008 with a margin of 30.17%. The 2011 gross profit margin of 20.52% is below the 5-year average of 24.54%.

  • 2007 - $6.706 billion / $23.277 billion = 28.81%
  • 2008 - $8.196 billion / $27.163 billion = 30.17%
  • 2009 - $5.183 billion / $22.702 billion = 22.83%
  • 2010 - $5.604 billion / $27.447 billion = 20.42%
  • 2011 - $8.112 billion / $39.540 billion = 20.52%

As the gross margin is below the 5-year average this implies that management has been slightly less efficient in the company's manufacturing and distribution during the production process over the past 5 years.

5. Operating income = Total Sales - Operating Expenses

The amount of profit realized from the operations of a business after taking out operating expenses - such as cost of goods sold (COGS) or wages - and depreciation. Operating income takes the gross income (revenue minus COGS) and subtracts other operating expenses, then removes depreciation. These operating expenses are costs that are incurred from operating activities and include things such as office supplies and heat and power.

  • 2010 - $5.156 billion
  • 2011 - $6.338 billion

6. Operating Margin = Operating Income / Total Sales

Operating margin is a measure of the proportion of a company's revenue that is left over after paying for variable costs of production, such as wages, raw materials, etc. A healthy operating margin is required for a company to be able to pay for its fixed costs such as interest on debt. If a company's margin is increasing, it is earning more per dollar of sales. The higher the margin, the better.

Over the past five years, Schlumberger's operating margin has been declining. The 2011 operating margin of 16.03% is well below the peak margin of 28.20% reported in 2007.

  • 2007 - $6.565 billion / $23.277 billion = 28.20%
  • 2008 - $6.852 billion / $27.163 billion = 25.22%
  • 2009 - $3.934 billion / $22.702 billion = 17.33%
  • 2010 - $5.156 billion / $27.447 billion = 18.79%
  • 2011 - $6.338 billion / $39.540 billion = 16.03%

The 2011 operating margin of 16.03% is below the 5-year average of 21.11%. This implies that there has been less of a percentage of the total sales left over after paying for variable costs of production such as wages and raw materials compared to the 5-year average.

7. Net Profit Margin = Net Income / Total Sales

A ratio of profitability calculated as net income divided by revenue, or net profits divided by sales. It measures how much out of every dollar of sales a company actually keeps in earnings.

Profit margin is very useful when comparing companies in similar industries. A higher profit margin indicates a more profitable company that has better control over its costs compared to its competitors. Profit margin is displayed as a percentage; a 20% profit margin, for example, means the company has a net income of $0.20 for each dollar of sales.

Like the Operating Margin, Schlumberger's net profit margin revealed a strong dip in 2009. The 2011 net profit margin of 12.64% is below the 5-year average of 16.84%.

  • 2007 - $5.177 billion / $23.277 billion = 22.24%
  • 2008 - $5.435 billion / $27.163 billion = 20.00%
  • 2009 - $3.134 billion / $22.702 billion = 13.80%
  • 2010 - $4.267 billion / $27.447 billion = 15.55%
  • 2011 - $4.997 billion / $39.540 billion = 12.64%

As the 2011 net profit margin of 12.64% is below the 5-year average of 16.84%, this implies that there has been a decrease in the percentage of earnings that the company is able to keep compared to the company's 5-year average.

The profitability margins are revealing a few different results. They are showing that over the past 5 years the company's profitability has decreased. One of the reasons for the decrease in profitability is the reduction in energy prices. In 2011 the reduction in profitability was impacted due to "economic concerns in the OECD countries, lower growth in the emerging economies, the year's geopolitical unrest, and the global economic uncertainty that reemerged late in the summer." (Company website) Even though the company's revenues are increasing the margins have decreased.
As these variables have reduced the potential for profits, they are realized in the company profit margins.

Profitability Ratios

8. ROA - Return on Assets = Net Income / Total Assets

ROA is an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment."

The 2011 ROA of Schlumberger reveals a decline over the past 5 years. The 2011 ROA of 9.05% is below the 5-year average of 12.44%.

  • 2007 - $5.177 billion / $27.853 billion = 18.59%
  • 2008 - $5.435 billion / $31.991 billion = 16.99%
  • 2009 - $3.134 billion / $33.465 billion = 9.37%
  • 2010 - $4.267 billion / $51.767 billion = 8.24%
  • 2011 - $4.997 billion / $55.201 billion = 9.05%

As the 2011 ROA of 9.05% is below the 5-year average of 12.44%, this implies that management has been less able to use the company's assets to generate earnings compared to its 5-year average.

9. ROE - Return on Equity = Net Income / Shareholders' Equity

As shareholders' equity is measured as a firm's total assets minus its total liabilities, ROE reveals the amount of net income returned as a percentage of shareholders' equity. The return on equity measures a company's profitability by revealing how much profit it generates with the amount shareholders have invested.

  • 2007 - $5.177 billion / $14.876 billion = 34.80%
  • 2008 - $5.435 billion / $16.862 billion = 32.23%
  • 2009 - $3.134 billion / $19.120 billion = 16.39%
  • 2010 - $4.267 billion / $31.226 billion = 13.66%
  • 2011 - $4.997 billion / $31.263 billion = 15.98%

Like the rest of the margins and ratios Schlumberger's ROE has revealed a strong dip in 2009. Over the past three years, the ROE remained about the same. As the ROE has remained about the same over the past three years, this reveals that there has been an increase in how much profit has been generated compared to the amount that shareholders have invested.

Cash Flows

10. Free Cash Flow = Operating Cash Flow - Capital Expenditure

A measure of financial performance calculated as operating cash flow minus capital expenditures. Free cash flow (FCF) represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. Free cash flow is important because it allows a company to pursue opportunities that enhance shareholder value. Without cash, it's tough to develop new products, make acquisitions, pay dividends and reduce debt.

It is important to note that negative free cash flow is not bad in itself. If free cash flow is negative, it could be a sign that a company is making large investments. If these investments earn a high return, the strategy has the potential to pay off in the long run.

Over four of the past five years, Schlumberger's free cash flow has remained positive.

  • 2007 - $6.259 billion - $3.191 billion = $3.068 billion
  • 2008 - $6.961 billion - $4.068 billion = $2.893 billion
  • 2009 - $5.266 billion - $2.625 billion = $2.641 million
  • 2010 - $5.494 billion - $3.240 billion = $2.254 billion
  • 2011 - $6.169 billion - $4.305 billion = $1.864 billion

Over the past 5 years Schlumberger has had positive cash flow. This indicates that Schlumberger has enough cash to develop new products, make acquisitions, pay dividends and reduce debt.

11. Cash Flow Margin = Cash Flow from Operating Activities / Total Sales

The higher the percentage, the more cash available from sales.

If a company is generating a negative cash flow, it shows up as a negative number in the numerator in the cash flow margin equation. This means that even as the company is generating sales revenue, it is losing money. The company will have to borrow money or raise money through investors in order to keep on operating.

As Schlumberger's cash flow margin is positive, it does not have to take the above measures to continue operating.

  • 2007 - $6.259 billion / $23.277 billion = 26.89%
  • 2008 - $6.961 billion / $27.163 billion = 25.63%
  • 2009 - $5.266 billion / $22.702 billion = 23.20%
  • 2010 - $5.494 billion / $27.447 billion = 20.02%
  • 2011 - $6.169 billion / $39.540 billion = 15.60%

Summary

In looking at Schlumberger's earnings over the past five years, you can see how the economic crisis affected the earnings in 2009. As Schlumberger's business is greatly dependent on the economy and energy prices, in 2009 company's earnings took a hit and decreased by 57.66%. Even though the earnings decreased by over 50 percent the earnings still held up quite well with the company posting earnings of $3.134 billion.

In 2010, the earnings rebounded along with the rise in energy prices. The earnings rebounded due to a recovery based on a large increase in oil demand. In 2011 the demand for oil slowed as consumption grew by a more modest 0.7 million barrels per day. Revenues still increased led by the company's oilfield services. In 2011 the company's oilfield services increased by 82% in North America. In 2011, the company reported earnings of $4.997 billion.

The 2011 reported earnings of $4.997 billion is still behind the 2008 peak reported earnings of $5.435 billion.

The profitability margins are revealing a few different results. They are showing that over the past 5 years the company's profitability has decreased. One of the reasons for the decrease in profitability is the reduction in energy prices. In 2011 the reduction in profitability was impacted due to "economic concerns in the OECD countries, lower growth in the emerging economies, the year's geopolitical unrest, and the global economic uncertainty that reemerged late in the summer." (Company website) Even though the company's revenues are increasing the margins have decreased.
As these variables have reduced the potential for profits, they are realized in the company profit margins.

The ROA and ROE indicate similar results in that both the ROA and ROE are showing similar results as the profit margins.

With free cash flow and the free cash flow margin both displaying positive cash, Schlumberger has enough cash to develop new products, make acquisitions, pay dividends and reduce debt without having to borrow or raise money to maintain operations.

The analysis of Schlumberger's profitability indicates a strong company that is recovering from its 2009 lows. Even though the margins have decreased over the past 5 years, the trends show strong signals for the future as Schlumberger has a strong amount of free cash at hand, which means the company will likely continue to grow for the foreseeable future.

Looking forward, analysis are predicting cautious growth over the next couple of years as they are estimating EPS for 2012 at $4.23, for 2013 at $4.91 and strong growth for 2014 at $6.10. (Company website)

For more information on Schlumberger NV read my articles:

Analyzing Schlumberger's Debt And Risk and Schlumberger Limited: Inside The Numbers

Disclosure: I 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.