National Oilwell Varco has been sitting on my watch list for a long time now. I remember it trading around $50 apiece in Oct 2011. Sadly, I let that opportunity slide and have been forced to track it passively while the stock has kept climbing and is now sports a price tag of $77 apiece. At this price, the upside is a tad too limited to for me to open a position.
This is why I chose this stock as my “Stocks to buy on dips” series.
The Business: NOV has an easy to understand business. It manufactures land based and offshore drilling rigs, as well as the mechanical components for such rigs. The products of the company are so pervasive that they can be found on more than 90% of the rigs around the globe. The product portfolio of NOV is so extensive that it is known as “one-stop-shop” and is also nicknamed “No Other Vendor”. The company also performs services such as inspections and is the world leader in supply chain management for the oil industry through its distribution network which has around 900 locations across six continents.
Products include all the heavy hardware for oil well drilling as well as drilling instrumentation and controls and drilling power generation and control. Partial list of heavy hardware includes top-drives, rotarys, drawworks, derricks, BOP's (blowout preventers), mud pumps, riser equipment, and complete drilling rigs. Products also include instruments and controls required on the rig floor for the drilling operation. This includes sophisticated electronics for precise control. Cyberbase is a such sophisticated control system. Further, NOV produces control electronics for power generation and control of drilling motors, and MCC's (motor control centers) for AC motor control. - from wikipediaThe nice thing about the business is that NOV sells tools and components for the industry. There is a lot of competition as to which oil driller is the best value (among Haliburton, Transocean, Weatherford, Schlumberger, Ensco) and which oil producers are cheap (BP, Total, Petrobras, Statoil). But regardless, they all buy/depend on equipments bought from NOV. NOV does compete with some of the oil services firms like Haliburton, Transocean and Schlumberger but its main competitors are smaller companies like Smith International, Cameron Corp and FMC Technologies.
Segments and sales: The company splits its sales in the following segments.
Rig Technology contributes more than 50% of the sales and another 40% is contributed by the Petroleum Services and Supply segment.
The petroleum services and supply segment provides a variety of consumable products and services used to drill, complete, and workover oil and gas wells. It also rents and sells variety of products and equipments for drilling operations. It also makes inspection of the pre-existing equipments of the oil and gas rigs. The sales of this segments are highly dependent on the level of activity in the field.
The Rig technology segment, which offers complete systems for drilling, and servicing for the oil and gas wells have a very lumpy sales. The sales here depend on the capital spending plans of the oil drilling contractors, oilfield service companies; and behind the scenes on the general level of activity in the sector.
The sales of the company have improved consistently during the last decade. It has made strategic acquisitions and the boom in the oil prices have acted as a tailwind on the performance. Revenue has grown from $1.5b in 2002 to $14.6b in 2011. The 10Y compounded growth rate in revenue has been around 15%, 5Y around 8% and in the last year it was 14%. We also see that the growth in sales has not decreased the net margin, in fact, the net margin has been creeping up, slowly but surely.
Profitability: NOV is a highly profitable company. The large growth in the sales has not marred the profitability and the gross as well as the net margin has gone up in the last decade. In fact, the net margin has almost tripled from 4.8% in 2002 to 13.6% in 2011 (meanwhile, the tax rate has remained around 32% during the entire period).
Balance sheet: In the fiscal year 2011, the company had $3.5b in cash and $159m in long term debt. It has an $17.7b equity with $10.2b of intangible assets. Given total liabilities of $7.8b, the tangible book value is (equity-intangibles-total liability = 0). Given that the interest expense was $40m in 2011 as opposed to operating income of $3b, the interest is quite well covered. The following chart shows the development of cash vs long term debt on the balance sheet of NOV.
Free cash flow: The company has a very aggressive acquisition strategy and have acquired a fair number of companies in the last 10 years. During the last two year itself, it has acquired Wilson, CE Franklin and Robbins & Myers. This has taken a toll on its FCF. But since 2006, the FCF has been positive and has been going up.
Management: From the numbers, the management seems to be handling the business quite well. I am also happy that they do not get paid exorbitantly for their services. The total executive compensation is given in the chart below.
Risks: I give here a list of factors which are worth investigating before you make a buy decision. I in the meantime plan to learn more about the company.
- There has been a significant increase in the drilling activity as well as the number of operating oil and gas wells in the recent years. The increase in oil prices is one of the reasons behind this boom. The company and the management has managed this quite well. The downside (collapse in the oil price) needs to be investigated. Obviously, as long as oil is being drilled, NOV will continue selling equipments, but their might be a significant loss in margins and sales. The question to ask is: why were the margins around 4-9% during 2002-2006.
- The current CEO is in place since 2000. This is a good amount of time to judge him on the performance. A cursory glance reveals that the company has been quite well managed. They recently announced dividends and have been paying them since 2009. Reading the annual reports and mainly conference calls will be a good idea.
- The effect of renewable energy is unknown at this moment. So, we will ignore it, even though it can significantly handicap our long term value thesis.
- The total outstanding shares has increased quite a bit. It went from 163m in 2002 to 424m in 2011. Granted that the per share book value has increased from $5.76 to $41.57 during the same period, it still needs investigating. Following is the current number of options outstanding (Dec 2011).
I do not find the management compensation as the culprit. The acquisition history needs to be checked to determine if the share count has increased because of the aggressive acquisition strategy.
Valuation: The current market cap of $32b (with almost no debt). Given that the company has generated around $1.5b in FCF, I see this price as a tad too high from a DCF perspective. The current price reflects (with a 15% discount), 8.5% growth rate in the FCF. I would be more comfortable with a price around $50.
Disclosures: I am sharpening my teeth for this one. I bit as soon as it goes down around my buying range.