David Rolfe of Wedgewood Partners Comments on National Oilwell Varco
The Company's current, and enduring competitive advantage must be credited to the singular foresight and vision of CEO Pete Miller. Miller began his career at the Company in 1996, and was named CEO in 2001. Miller foresaw that the oil service business was woefully wedded in the past philosophy of custom drilling rigs and related custom repair parts and services. His revolutionary view was that manifold advances in oil well productivity and efficiency could be achieved via standardization. Furthermore, the first-mover advantage of the company which could lead the consolidation of this fragmented industry would be uniquely positioned – potentially reaping the benefits of less severe boom-bust orders, capturing a greater percentage of contract bill-of-goods and a concomitant stream of annuity-like service and repair part revenues. Miller and team thus began an orchestrated 15-year string of +300 deals – including nearly $6 billion over the past 18 months alone. Keystone Miller acquisitions include the $2.4 billion acquisition of Varco in 2005 and the $7.4 billion purchase of Grant Prideco in 2007.
Fast forward to late 2012, the Company stands astride the global oil services industry like no other. Leveraging over 800 worldwide manufacturing, sales and service centers, National Oilwell Varco is a global leader in providing major mechanical components and integrated solutions for both land and offshore drilling rigs. Post-Macondo, the Company's integration of deep-sea rig technology, with the magnified emphasis of safety, has put the Company in a class by itself. In addition, with a growing panoply of 139 brands, which include complete land drilling and well servicing rigs, tubular inspection and internal tubular coatings, drill string equipment, extensive lifting and handling equipment, and a broad offering of downhole drilling motors, bits and tools, as well as supply chain services through though the Company's network of distribution service centers, all located near major drilling and production activity, it is literally impossible to drill or operate an oil well or rig without calling Houston. The tale of the standardization-consolidation tape underscores Miller's vision. Little more than ten years ago the Company could only scratch out middling single-digit pre-tax operating margins. Over the past few years the Company has consistently generated pre-tax operating margins of around 19%-20%. The Company has also cut their financial leverage by 25% over the past decade. Returns on equity and invested capital have doubled has well.
The stock was essentially flat in 2012 reflecting the continued decline in North America in both oil and gas rig count. U.S. rig count has doubled since the mid-2009 bottom, plus (according to CFO Clay Williams) an "unprecedented surge" in U.S. oil production has created a "new parsimoniousness…sweeping through the North American oil complex." Rig counts are down over 168 since the beginning of 2012. Due to an over-supplied market and "fierce" price competition the Company's new North American rig orders have ground to a halt.
A notable bright spot in North America is the Company's omnipresent in the booming shale industry – which continues to be a unique American success story. The EIA recently reported that due to the surge in U.S. energy production (led by North Dakota and Texas) net oil imports in 2012 would account for little more than 40% of U.S. oil consumption – the lowest dependence in foreign oil since 1992. The oil production in Texas has doubled over the past three years and has reached a level of output last recorded in 1987. Not to be outdone, Pennsylvania's natural gas production has quadrupled since just 2009. A renaissance is emerging in the cost-competiveness in U.S. manufacturing due to the "flipping of the energy equation" with abundant and cheap natural gas. Credit such cutting edge technology such as expanded horizontal drilling and hydraulic fracturing. National Oilwell Varco is a leader in both technologies. (On a related note: Berkshire Hathaway owned Burlington Northern railroad expects to boost daily crude-oil shipments in 2013 by 40% to 700,000 barrels – in large part from Bakken shale. In addition, Union Tank Car Company – which is owned by Chicago-based Marmon; which in turn is 60% owned by Berkshire – is scrambling to increase their +80,000 fleet of leased tank cars).
However, outside of the gloom in North America, the Company has reported extensive customer activity in nearly every corner of the globe. Key international markets include Argentina, Kuwait, Algeria, Saudi Arabia, Brazil, Oman, Iraq and Indonesia. The Company has increased its investments in Eastern Europe, Russia, Africa and Latin America. The sweet spot for the Company continues to be deepwater offshore. New technologies are driving the fleet growth of next generation large deepwater rigs. Once again, from CFO Williams, "Shipyards are underemployed, hungry, and aggressive on pricing. Deepwater day rates are high and rising. Capital is available and cheap. Construction time is shortening, and execution risk is approaching zero, at least for our customers. Importantly, this situation has been stable for eight-plus quarters, and our deepwater drilling contractor customers seem to be exhibiting a growing confidence with what we hope is a new era."
We remain cognizant that the oil 'bidness is not for the faint of heart – for both companies and investors. We also continue to be of the opinion that the best business models in this industry are the best-in-technology-class service companies. We believe we own two of the very best in both National Oilwell Varco and Schlumberger. That said, when it comes to the shares of such companies, we continue to give wide berth in swings of valuation in our purchase and sales – particularly our purchases. While the valuation of the Company shares are, in our opinion, not demanding at current prices, we require a larger margin of safety to increase our current holdings.
From Wedgewood Partners' fourth quarter letter.