National Oilwell Varco - Drilling Activity And Spin-Off Might Drive Value Going Forward

| About: National Oilwell (NOV)

Shares of National Oilwell Varco (NYSE:NOV) jumped up on Friday after the supplier to the oil and gas industry released a solid set of third quarter results.

With renewed prospects for stabilized or increasing margins, driven by a recovery in US drilling activity, shares might be an interesting long term investment. Shares trade at relative cheap relative valuation multiples while the spin-off next year could unleash even more value.

Third Quarter Results

National Oilwell Varco generated third quarter revenues of $5.69 billion, up 6.9% on the year before, in line with consensus estimates at $5.68 billion.

Operating earnings rose by 6.3% to $945 million as net earnings increased by 4.4% to $636 million, coming in at $1.49 per share.

Adjusted earnings, excluding one-time items totaled $573 million, or $1.34 per diluted share, beating consensus estimates by two cents.

CEO and Chairman Pete Miller commented on the progress made during the quarter, "Outstanding execution enabled the Company to achieve solid results again this quarter. All three segments posted higher sequential revenues and margins, and collectively reduced the Company's working capital requirements, which ultimately led to a quarterly record of $1 billion in cash flow from operations."

Looking Into The Results

National Oilwell saw growth in all of its three business units. Revenues at the rig technology business were up by 11.6% to $2.84 billion. The petroleum services & supplies unit reported a 5.4% increase in revenues to $1.89 billion. The distribution and transmission business saw its revenues increase by 2.0% to $1.34 billion.

Despite revenue growth across the board, gross earnings were under pressure partially due to margin compression, with gross margins falling by 270 basis points to 23.8% of total sales. The shortfall in mostly to blame to the petroleum services & supplies business where operating margins fell by 460 basis points to 17.9% of total sales. Note that overall margins improved copmared to the second quarter.

The fact that GAAP earnings rose was thanks a $102 million gain from the settlement from outstanding legal claims.

The backlog continues to look healthy as the rig technology business saw net orders of $3.31 billion, for a book-to-bill ratio of 1.17, adding to the $15.15 billion backlog.


National Oilwell Varco ended its third quarter with $2.74 billion in cash and equivalents. The company operates with $3.75 billion in total debt, for a net debt position of around $1.0 billion.

Revenues for the first nine months of the year came in at $16.59 billion, up 15.5% compared to last year. Net earnings fell by 8.1% to $1.67 billion in the meantime. At this pace, annual revenues of $22.5 billion and earnings of around $2.3 billion should be attainable.

Factoring in gains of 4%, with shares trading around $82 per share, the market values National Oilwell Varco at around $35 billion. This values equity in the business at around 1.6 times annual revenues and 15-16 times annual earnings.

The company currently pays a quarterly dividend of $0.26 per share, after doubling its dividend earlier this year, for a dividend yield of 1.3%.

Some Historical Perspective

Long term holders in National Oilwell Varco have seen tremendous returns. Shares traded at nearly $10 per share back in 2004 to peak in their mid-80's by 2008, ending that year at merely $20 per share.

Shares swiftly recovered again to trade mostly in a $50-$80 trading range over the past few years, currently trading at the high end of that range.

Between 2009 and 2012, National Oilwell increased its annual revenues by a cumulative 50% to just over the $20 billion mark. Earnings increased by some 70% to $2.5 billion in the meantime.

The Spin-Off

Back in September, National Oilwell announced its intentions to spin-off its distribution business into a separately publicly traded company. Through the acquisition of Wilson Supply and C.E. Franklin, the distribution company has sufficient scale to compete effectively.

The spin-off is expected to occur in the first half of 2014 and would allow both businesses to fully focus on their respective activities. Although no financial details and or ratios have been determined yet, investors are enthusiastic. Previous spin-offs in the industry, that of Phillips 66 (NYSE:PSX) from ConocoPhillips (NYSE:COP), and that of Murphy USA (NYSE:MUSA) from Murphy Oil (NYSE:MUR) ,have paid off handsomely for investors.

Note that the distribution segment make up roughly a fifth of total revenues and was the slowest growing business over the past quarter, freeing up capital for the firm to focus on the assets with the highest returns.

Investment Thesis

The better than expected performance has been driven by better than expected results at the rig technology business, being the largest business of the firm. This business has been suffering for a while amidst weak drilling activity on the back of lower gas prices.

Actually margins rose in all three businesses, at least on a sequential basis, as competitors have seen a recovery as well, which appears to mark the end of the American softness. A recovery in the US market which could help overall margins, combined with the expected spin-off of the distribution business might spur share price returns in the coming 6 months.

Trading around 15-16 times earnings the valuation for National Oilwell Varco seems fair, especially compared to some of its larger competitors which trade at earnings multiples closer to 20 times. With the continued long term rosy outlook for the industry, including that for National Oilwell Varco, shares might be a great long term investment, even after witnessing decent 20% year to date returns.

I looked at National Oilwell back a year ago when shares were still trading around $75 per share, concluding that shares were a perfect addition to any portfolio. Today I reiterate that stance.

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.

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