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Schlumbereger (SLB) -- Driller Extraordinaire

|Includes: Schlumberger Limited (SLB)

Its lengthy and distinguished history of oil/natural gas field service work results in widespread familiarity with the contours of its business, but nonetheless an overview summary is deemed advisable here at the outset.  Accordingly:

  - Oil Field Services:  SLB delivers subsurface evaluations, directional drilling, flow rate measurements, well maintenance and completion, along with production enabling pumps and associated equipment;
  - WesternGeco: offers such computer driven services as imaging, reservoir description, surveys and seismic data.

All put another way, SLB offers hydrocarbon drillers and explorers avenues to reduce dry hole risk.  Successive period outcomes are inherently prone to volatility, but in recent years Oil Field Services has generated 85-90% of Revenue, a percentage point or two higher in Pre-Tax Income.  If there is a region on Earth in which hydrocarbon based energy exploration and production is pursued, SLB has located it and performs its work in it.  

Things to like about an investment in the stock include: 

    - solid balance sheet with Equity standing around 57% of book assets, and Operating Income Interest Coverage Ratios consistently above 20 Times;
    - net liquid short term assets straddling $5 a share;
    - small but steady increases notwithstanding, a dividend payout ratio (based on my estimates for 2011 Results) either side of 25%.  Threats to investor well being in this Stock do indeed exist (as outlined below) but a reduction or cessation of the Dividend is not plausibly among them;
     - however measured but most notably against other Industry participants and the S&P 500 itself, a very low share price when scanned over the recent two year stretch, a marked contrast to its consistent prior year history of outgunning the Energy Group and overall market averages.

Like every other option beckoning investor capital, SLB common comes with its own set of risks.  In my estimation these include:

    - a recently completed stock swap (i.e., non-cash) acquisition of Smith International (SII), in which SLB issued 177 million additional shares in what amounted to a 37% premium over the antecedent SII market price.  To put it gently it remains to be seen if Smith's arsenal of completion technology, bottom hole assembly improvements and drill bits will deliver satisfactory returns.  Also wheeled into the SLB fold are 23,000 SII employees to join SLB's existing 87,000 FTE headcount.  No indications have yet emerged that SLB senior management contemplates material head count reduction;
     - results at Western GECO have yet to take flight.  Order backlogs are essentially unchanged from year end 2009, and First Half 2010 operating results have served to drag down overall company performance;
     - the moratorium on additional E&P action in the Gulf of Mexico has removed income and cash flow generating opportunities from SLB's menu, and its extension into the future is altogether uncertain;
     - ubiquitous concerns about health and sustainability of global economies extend in this case to energy prices.  SLB believes --- corroborated in discussions with the E&P companies themselves --- that West Texas Intermediate prices roaming from $60-90/bbl are optimal for drilling activity and by association SLB's revenue streams.  It cannot be denied, nor should it be ignored by the marginal investor dollar, that oil prices having extended lease terms at $20-40/bbl would essentially eliminate upstream efforts and along the way eradicate forward estimates of SLB's profitability.  

As this is written consensus estimates for 2011 center on after-tax earnings of $3.78 a share, and the prudently careful investor will note that the number is surrounded by an unusually wide range of $3.35 to $4.50.  Modeling work to which I am attracted --- most conspicuously because I did it --- comes to a 2011 guess ranging from $3.50 - $3.60.  The principal difference between me and current Street consensus has to do with share repurchase and resulting shares outstanding as the divisor in the final number.  In place is a $5.7 billion share repurchase authorization, which at current market prices would skim 100 million off the market.  My guess is that management is aggressive in this market at prices of $55 and under, less eager at $60 and above.  It is a not insignificant wild card.    
Even if my lower number proves out year 2011 Free Cash Flow would pile on in excess of $2 billion, whether $1.65 or $2.00 a share again hinging on final shares outstanding.

On any market price dip below $55 the stock would be taken down at just under 16 Times Earnings, a small margin above the 5 year median S&P multiple.  SLB's more extended history is to trade materially (1.4 Times the market P/E, to be precise), so at least in the historic sense --- itself far from a guarantee --- value would be obtained.  Laying on sensible guesses for Market to Revenue multiples points to a 12-18 month future share price flirting with $80, all by itself a 45% capital gain on top of the 150 basis point entry yield.  Worth the risks?  I believe so, while wishing all comers only the best of good fortune.      


Disclosure: No positions