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Richard Pzena vs Warren Buffett: Oil & Gas Equipment

November 03, 2013 | About:
When making a long-term investment, profits lay at the second-tier companies. In other words, bidding on the winner always pays smaller dividends. The same reasoning applies to horse track betting: the worse the odds of winning, the bigger the reward for betting. Here, however, we avoid gambling altogether and make an informed decision. In the oil & gas equipment industry, Baker Hughes (BHI) and National Oilwell Varco (NOV) fight for the third place in the industry, and have plenty of room for growth.

The comfortable third place

Baker Hughes continues to improve performance and exceeding some values reached during 2011. For example, in the last quarterly report, revenue for the North American region reached $2.9 billion, exceeding 2011 levels. Opposite, operating margin stood at 10.3%, well behind 2011´s 22%. Nevertheless, the trend remains positive thanks to greater technology penetration, improved utilization and efficiencies, and management efforts to smooth-out the supply chain.

In the short-term, Baker Hughes expects the operations in the Middle East, thanks to efficiencies improvements in Iraq, and Europe to continue driving revenue growth year-over-year. And the Latin American region is expected to recover previous performance levels, once debt related issues are resolved. Overall, debt continues to decline, while growing exploration and production spending for 2014 and cost reduction policies should improve margins in the near future. That, should be enough to offset the headwinds associated with the newly integrated drilling services in Norway.

For the long haul, Baker Hughes will fight for a bigger share of the international market in the back of a strong portfolio and a wide product offering. The introduction of the AutoTrak Rotary Steerable System has given the firm a strong reputation, strengthening prospects with respect to deepwater activities in the Gulf of Mexico. Management however, continues to place a strong bid on Saudi Arabia and Iraq for future growth, and has recently expanded activities to Norway, another region expected to see an important growth in the following years.

The balance sheet for Baker Hughes is moderate due to a rising debt and declining cash flow. The stock currently trades at 24.1 times its trailing earnings, packing an 8% discount to the industry average. Guru Richard Pzena holds the largest stake in the company and has increased his position throughout 2013. However, with stock price currently experiencing a steep climb I prefer to remain on the sidelines and wait for a better window opportunity for a long-term investment.

Going for deepwater and safety

In addition to offering a comprehensive line of equipment, National Oilwell Varco provides distribution services, which include maintenance, spare parts, and repair services for its equipment. The firm is the product of the 2005 merger between National Oilwell and Varco International. National Oilwell Varco, and currently separates activities among three segments: rig technology, petroleum services & supplies, and distribution & transmission. And much of the recent growth has been pushed by the operations in the Middle East and Brazil.

National Oilwell Varco’s healthy backlog and strength in international operations are two important characteristics for future growth. Management made an important decision amid the tight scrutiny environment surrounding the industry that is the acquisition of Robbins & Myer, expanding its blowout preventer product line. Nevertheless, the greatest catalyst to the firm remains the increasing deepwater production and exploration tendency, given that rig technology contributed with almost 60% of revenues during 2012.

Growing search for oil into new deepwater frontiers, like Brazil, and the revival of the Gulf Region, offers National Oilwell Varco great prospects as demand for rigs continues to increase. Also, changing market synergies have pushed for the introduction of new technologies capable of working at previously unthinkable depths and extreme weathers. The conditions are ripe for the company to do well in the long-term, and the announced separation of its distribution business may free additional potential growth. On the downside, new competitors have entered the game negatively impacting pricing power.

Financially, National Oilwell Varco is strong amid a raising debt related to recent acquisitions. Currently trading at 15.4 times its trailing earnings, the stock carries a 30% to the industry average. Frank Sands and Warren Buffett, the gurus holding the two largest positions in the firm, have increased their stake throughout 2013. I share their optimism because current market synergies have greatly improved future prospects.

Drilling or Safety

Baker Hughes has put its weight behind drilling innovation, and results back the decision. National Oilwell Varco looked at safety measures for future growth. The difference is that National Oilwell Varco has the winning hand in front of current market synergies because it owes rigs and manufactures the spare parts. Additionally, the stock trades at a discount and a possible spin-off of the distribution segment can unlock further growth. My only concern is the recent sudden rise on stock price, closing the gap to historical highs.

Disclosure: Vanina Egea holds no position in any of the mentioned stocks.

About the author:

vaninaegea
A fundamental analyst at Lone Tree Analytics

Visit vaninaegea's Website


Rating: 3.1/5 (8 votes)

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