Schlumberger: It Is Just A Question Of How Long

| About: Schlumberger Limited (SLB)
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Summary

It's been a rough few years for the oil sector but SLB weathered the storm.

Q4 earnings are out and I discuss the implications.

The CEO summarizes the outlook nicely.

What to expect from shares.

It's been a rough few years for the oil sector, including Schlumberger (NYSE:SLB), my favorite oil service stock. Even with the pain SLB's stock has slowly rebounded as oil has moved a bit higher off the decade lows while the company has utterly slashed expenses. Despite being hammered over the last year amid the decline in oil prices, the company has managed to increase its payout to shareholders to $0.50 quarterly. Despite the pain in oil that last few years we have to think long-term even though it has been a struggle. Still back in Q2 the company saw what they claimed was a bottom in the sector and that call has been correct thus far. That said the stock is only a few points off of a 52 week high and the decline in oil has given opportunity to add to holdings for the long-term. It's just a question of how long oil prices will stay depressed. Will it be months? Several quarters? Several years? Your guess is as good as mine, but the risk continues to be to the upside from here. That said, we need to examine the company's performance and look to expectations in the present low price environment.

Just this morning the company reported its Q4 results that show a top line beat and bottom line that met analyst consensus estimates. The company reported fourth-quarter revenue of $7.11 billion. Not surprising given the drop in oil prices, this was down 8.1% year-over-year. Declining revenue hurts, but at least oil prices have been on the mend into 2017. It also beat estimates by $40 million. As a whole, earnings came in at $0.27 per share. This is down a whopping 58% year-over-year. That said, these earnings met the consensus mark. With that said, some have argued the stock is pricey here. I still have to agree, given the earnings and the fact that oil still hasn't had a real forward catalyst.

This is the reality. There hasn't been a real catalyst, even with M&A activity that should move the name much higher. There are bets that things will improve and perhaps production cuts from OPEC and producing nations will drive up prices. I see a Trump Presidency as only helping increase oil supply, though with international relations this all remains to be seen. But, the point is that the only catalyst should be if oil prices really move. The dramatic drop in earnings is eye-popping for such a large company, but given oil prices it is more than expected. The fact that Schlumberger is meeting and beating estimates was good news and is a testament to the extreme cost savings measures the company is putting into place. Now, there is no way you can cut expenses to the point where the company could maintain or expand margins with revenues falling this much. As such, margins were also down, despite efforts to cut costs. But they weren't down as dramatically as one would imagine. Total pretax operating margin was about flat from Q3 coming in at 11.4%, but are down substantially from a year ago. What is a strong positive is that the cost of revenue dropped from $6.3 billion last year to $6.2 billion in the present year's quarter. Cost cutting continues, but as far as margins go, there really isn't much that can be done when the commodity falls so dramatically from years past. Chairman and CEO Paal Kibsgaard said the following:

"We expect the growth in investments to initially be led by land operators in North America, where continued negative free cash flows seem less of a constraint, as external funding is readily available and the pursuit of shorter-term equity value takes precedence over full-cycle return on investment. E&P spending surveys currently indicate that 2017 NAM E&P investments will increase by around 30%, led by the Permian basin, which should lead to both higher activity and a long overdue recovery in service industry pricing.

In the international markets, operators are more focused on full-cycle returns and E&P investments are generally governed by the operators' free cash flow generation. Based on this, we expect the 2017 recovery in the international markets to start off more slowly, driven by the economic reality facing the E&P industry. This will likely lead to a third successive year of underinvestment, with a continued low rate of new project approvals and an accelerating production decline in the aging production base. These factors together are increasing the likelihood of a significant supply deficit in the medium term, which can only be avoided by a broad-based global increase in E&P spending, which we expect will start unfolding in the later parts of 2017 and leading into 2018.

Against this backdrop and following nine consecutive quarters of relentless workforce reductions, cost cutting, and restructuring efforts, we are excited to restore focus on the pursuit of growth and improving returns. As we navigated this downturn, we have streamlined our cost and support structure, continued to drive the underlying efficiency and quality of our business workflows, expanded our offering through maintaining investments in R&E, and made a series of strategic acquisitions. The combination of these actions has enabled us to further strengthen our global market position during the downturn, which will enable us to maintain and extend our well established margin and earnings leadership in both North America and in all parts of the International markets going forward.

While earnings growth continues to be a very important financial driver for us, full-cycle cash generation is even more critical, and here, we remain unique in the industry. Over the past two years of this downturn, we have generated $7.5 billion in free cash flow, which is more than the rest of our major competitors combined. Furthermore, we have returned $8.0 billion to our shareholders through dividends and share buy-backs. This clearly demonstrates the full-cycle robustness of Schlumberger, the careful management of our business, and the strength of our executional capabilities."

These comments suggest the company is on the upswing but much of this is already priced into the stock. I have long been a fan of SLB management as this team is still among the best. They are pulling out all the stops to block the bleeding of cash and quell the decline in revenues. Costs have been cut like never before. Even with the cost cutting and the pressure on revenues, the company continues to pay its dividend and bought back another 1.5 million shares at an average price of $78.21 this quarter. Take home message? We need help from oil prices, but this is a solid hold. Prices of commodities ebb and flow, and when they do rebound more strongly, shares are going much higher. Should oil reverse lower however, the stock will tank.

Note from the author: Christopher F. Davis has been a leading contributor with Seeking Alpha since early 2012. If you like his material and want to see more, scroll to the top of the article and hit "follow." He also writes a lot of "breaking" articles, which are time-sensitive, actionable investing ideas. If you would like to be among the first to be updated, be sure to check the box for "Real-time alerts on this author" under "Follow."

Disclosure: I am/we are long SLB.

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.