National Oilwell's performance will get stronger in the long run
National Oilwell Varco (NOV) provides equipment and technology to the upstream oil and gas industry. I do not expect NOV to produce steady returns in the short-to-medium term. But in the long-run, NOV has the depth and breadth in its portfolio to capture market share in its international operations. NOV's joint venture with Saudi Aramco has turned out to be a growth catalyst as a result of steady energy activity in the Middle East. NOV now focuses on deploying its innovative solutions for the downhole tools market as it expects the rate of well completion to increase in the coming months.
However, overcapacity in the OFS industry, the lack of demand for hydraulic fracturing and pressure pumping activity, and infrastructure constraints in some of the key U.S. shales will take its toll on NOV's top and bottom line in Q1 2019. If the crude oil price stays above $50, NOV's management believes an international market recovery can offset much of the headwinds forming in the North America energy market. In the past year, NOV's stock price has gone down by 17% and outperformed the VanEck Vectors Oil Services ETF (OIH) which declined by 43% during this period. OIH represents the oilfield equipment & services (or OFS) industry.
NOV's Q4 performance reflects growth
From Q3 2018 to Q4 2018, National Oilwell Varco's 11% revenue growth reflects a balanced increase among the Wellbore Technologies, Completion & Production Solutions, and the Rig Technologies segment. NOV's most recent performance suggests while the current headwind in the completion activity has affected the Completion & Production Solutions segment, the company was relatively resilient in protecting that part of the business (7% up quarter-over-quarter in Q4). The most active growth driver for NOV in Q4 was the Rig Technology segment (26% up quarter-over-quarter). NOV's international market accounted for the majority of the growth, while North America, which accounted for 42% of its Q4 revenues, improved marginally.
What were Wellbore Technologies segment's drivers?
In this segment, a 60% higher drilling motors sales over the past year was made possible by NOV's technical improvements in reliability and performance. Many upstream customers chose NOV's products over the assembled products sourced from other downhole service providers to improve the performance of the drilling motors. This benefited NOV's products sales in this category. The other product that saw strong growth in Q4 was the drill pipe. NOV's premium delta drill pipe connection, which accounts for 25% of NOV's drill pipe revenue mix, have performed better than the industry average in reducing upstream customers' operating costs. Despite market share gains, the sharp pricing decline in the pressure pumping market decreased revenues from this product line.
Completion & Production Solutions and Rig Technologies segment drivers
NOV's genesis coil tubing unit can access the deeper wells and the longer laterals. Both of these features are necessary for horizontal drilling in the unconventional shales. On top of that, NOV's cementing units saw steady demand throughout Q4 in the U.S. NOV's NOVOS control system offers drilling process automation, which leads to improvements in drilling performance, efficiency, and reliability. The growing need for rig upgrades among the drillers led to higher demand for NOV's DC to AC land rig convergence. This is because the day rates are now higher for the super-spec rigs as compared to the mechanical legacy rigs.
The pleasantly surprising element to NOV's steady performance was from the offshore business growth. The offshore business accounted for 37% of the company's total revenues in Q4. In Q4, NOV's flexible subsea pipe demand went high in Brazil. Elsewhere, subsea flexible pipe business is gaining traction from the brownfield developments and tiebacks.
NOV's management views on the industry
National Oilwell does not have a specific opinion on the direction the crude oil price will move. According to WFT's management, if the crude oil price holds above $50 per barrel, the upstream activity level in the international and offshore markets can continue to recover, while the adverse effects on the oilfield services activity would not be significant in the U.S. While the crude oil price can gradually improve by the end of 2019, the Q1 2019 is likely to witness a decline in revenues for NOV. This is what NOV's management discussed in the Q4 earnings call:
As we look forward into 2019, candidly, none of us know precisely yet the impact of the sharp oil price downturn. Having been through a few downturns, there's typically a three or four month lag before we see the meaningful response, but it inevitably moves directionally oil prices. And as our oil field service customers look to their E&P customer spending plans for clues as to what to invest in, in equipment sets, their mood is very cautious as well.
The adverse effect on NOV would be prominent in Q1 because some of the company's customers accelerated shipment during Q4 when they were fulfilling their 2018 capex budget. This means the Q1 volume can fall lower than the prior quarter. On top of that, the fall in the crude oil price and an expected 2019 capex budget cut can translate into significant declines for NOV's products and services in Q1. Let us see how the industry indicators have fared during Q4. From September-end until December in 2018, the West Texas Intermediate (or WTI) crude oil price was down by 38%, while the average rig count in the U.S. increased marginally (~4% up). Not only the completion activity has slowed down in the past quarter, but the overall drilling activity has also started to reflect the downside risks in the energy market environment. The number of drilled wells in the key U.S. unconventional shales was down by 1.5%, while the drilled but uncompleted wells (or DUC) in the EIA-designated key shales went up by 8.5%. This affected hydraulic fracturing activity and reduce demand for pressure pumping services.
Drilling business outlook in North America and international markets
This gives the context to discuss the drilling business outlook in North America and in the international markets. The drilling contractors have become more cautious on new drilling because the surge in DUC wells means the upstream operators can allocate an increasing proportion of their capex budget on completion activities. The day rates for the super-spec rigs can continue to move up because of these rigs' ability to accommodate complex drilling at a lower cost compared to the legacy mechanical rigs. It is possible that some of the drilling contractors will find the economics of upgrading old rigs into newbuild super-spec more profitable, and this trend could become more visible in the international markets, thus increasing demand for NOV's equipment products.
A case in this point would be NOV's joint venture with Saudi Aramco - one of the largest operators in the Middle East. In 2018, NOV announced a deal to build 50 high-spec rigs with Saudi Aramco. Now the rigs built out of the Saudi facility can encompass Aramco's joint venture with Rowan for a 20 newbuild rigs. In any case, NOV's JV project is set to provide equipment around the region and to support the growing rig fleet there.
NOV's technology drivers
NOV has a pipeline of new technology-based products to offer in 2019, particularly in coiled tubing. A coiled tubing unit drills out bridge plugs needed to stimulate a horizontal well. In recent years, the drilling laterals have lengthened. This has increased the requirement for the coiled tubing unit due to the need to convey tools downhole and to drill out completion plugs. In Q4, NOV delivered its first Genesis coiled tubing unit, which carries a large tubing load from a single trailer unit. According to NOV's management, its QT-1400 is the highest tensile strength coiled tubing on the market.
The company also plans to deliver the new HR 6120 injector head - a completion & production solutions application. It combines the ability to handle heavy-wall coiled tubing having higher strength with increased pull and snub capacity.
Recently, NOV introduced the TRUE-TAPER XR string design, which extends the limits for which coiled tubing can be used. The model has been used by one of NOV's customers in horizontal drilling.
NOV's Q1 segment guidance
NOV's management expects the Wellbore Technologies segment revenue to decline by 5% to 10% in Q1, with a 40% decremental margin. The guidance assumes lower beginning-of-the-year sales in the Eastern Hemisphere, decreased activity levels in the U.S., and reduced drill pipe and capital equipment deliveries. In Q4, the adjusted EBITDA margin in the Wellbore Technologies segment was 17.5%.
NOV's management expects the Completion & Production Solutions segment revenue to fall by ~15% in Q1, while the decremental segment margin would be 30%. In Q4, the adjusted EBITDA margin in the Completion & Production Solutions segment was 14.2%.
The completion of many offshore projects and the lack of capital commitment in the offshore sector can lead to 16% to 17% revenue decline in Q1 in the Rig Technologies segment, while the segment operating margin can see 25% to 30% decremental margin in Q1 2019. Adjusted EBITDA margin in Q4 in this segment was 12.7%.
NOV pays a $0.05 quarterly dividend per share, which amounts to 0.7% forward dividend yield. In the past five years, its dividend has decreased by ~22%. Baker Hughes's (BHGE) forward dividend yield (2.95%) is higher compared to NOV. In November, NOV announced a share repurchase program of up to $500 million, which reflects NOV's free cash flow generation and its ability to make repayment to the shareholders.
NOV's FCF, capex, and debt
In FY2018, NOV's cash flow from operations (or CFO) was $521 million, which was a steep decline over the CFO in FY2017. Despite the rise in revenues in the past year, NOV's CFO deteriorated on account of adverse changes in the working capital. In FY2018, NOV spent $244 million in capex (excluding the acquisitions). This resulted in free cash flow (or FCF) of ~$200 million. In FY2019, NOV expects to increase capex by $100 million compared to FY2018. The increased capex would be spent on constructing NOV's new rig manufacturing facility in Saudi Arabia.
Regarding capex and balance sheet, here is what the management had to say in the Q4 call:
Still first and foremost is our efforts to make sure that we have sort of the ideally optimized balance sheet structure. Next is investments in high return organic capital opportunities. Then we also look at compelling M&A and then a little further on down that list is the return of capital to our shareholders.
NOV has a relatively low debt-to-equity ratio (0.19x) compared to its peers' average. Nabors Industries' (NBR) leverage was 1.4x as of September 30, Superior Energy Services' (SPN) leverage was 1.2x, while Baker Hughes, a GE Company's leverage was 0.2x as of December 31, 2018.
What does NOV's relative valuation say?
National Oilwell Varco is currently trading at an EV-to-adjusted EBITDA multiple of 13.7x. Based on sell-side analysts' EBITDA estimates, as pulled from Thomson Reuters, NOV's forward EV/EBITDA multiple is 11.8x. NOV's EV/EBITDA multiple was very high in FY2016 as a result of low EBITDA. Excluding the extreme figure, between FY2013 and FY2018, NOV's average EV/EBITDA multiple was 9.1x. So, NOV is currently trading at a premium to its past average.
NOV's forward EV-to-EBITDA multiple contractions versus its adjusted trailing twelve months EV/EBITDA is steeper than the industry peers' average multiple compression, as noted in the table above. This is because analysts expect NOV's EBITDA to improve more sharply compared to the rise in the peers' average in the next four quarters. This would typically reflect in a higher current EV/EBITDA multiple compared to the peers' average. NOV's TTM EV/EBITDA multiple is higher than its peers' (SPN, NBR, and BHGE) average of 7.4x.
Analysts' rating on NOV
According to data provided by Seeking Alpha, ten sell-side analysts rated NOV a "buy" in February (including strong buys), while 14 of the sell-side analysts rated NOV a "hold". Four of the sell-side analysts rated NOV a "sell". The analysts' consensus target price for NOV is $33.3, which at NOV's current price yields ~18% returns.
What's the take on NOV?
National Oilwell Varco's Q4 2018 financial performance held firm compared to some of its peers in the industry. Despite the industry headwinds, the completion activity slowdown effect was less visible on NOV. Although its U.S. operations were muted in Q4, international activity growth more than made it up. The Rig Technology segment delivered solid revenue growth in Q4 following higher demand for the AC rigs in the market. NOV's joint venture with Saudi Aramco has turned out to be a growth catalyst as a result of steady energy activity in the Middle East. NOV now focuses on deploying its innovative solutions for the downhole tools market as it expects the rate of well completion to increase in the coming months.
However, overcapacity in the OFS industry, the lack of demand for hydraulic fracturing and pressure pumping activity, and infrastructure constraints in some of the key U.S. shales will take its toll on NOV's top and bottom line in Q1 2019. The recovery in the crude oil price holds the key to the OFS sector. If the crude oil price stays above $50, NOV's management believes an international market recovery can offset much of the headwinds forming in the North America energy market.
NOV has a strong balance sheet with positive free cash flow. In the current environment, NOV will not produce steady returns for investors. But in the long-run, NOV has the depth and breadth in its portfolio to capture market share in the international markets.
Disclosure: I/we 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.