NOW (DNOW) distributes energy and industrial products to upstream, midstream, downstream and industrial markets in the United States, Canada and internationally. In this article, I will discuss the key factors that can make NOW a long-term value creator.
As of December 2013, NOW’s revenue was diversified globally, and I believe this is an important factor for the company’s growth in the future. For 2013, 67% of the company’s revenue came from the U.S., 18% from Canada and 15% from international markets.
With the company’s key markets including North Sea and Southeast Asia, NOW has the potential to increase its revenue in international markets and be more diversified globally 3-5 years down the line.
North Sea and Southeast Asia have immense potential when it comes to the oil & gas industry and NOW, being one of the largest distributors to the oil & gas industry globally, is well positioned to take advantage of the growth.
Positive industry trends
The global oil & gas industry trend is positive and will remain positive over the long term. This is certainly good news for NOW as it is one of the largest players serving the industry.
Geopolitical tensions in the Middle East mean that there can be supply constraints and the supply can get worse if the geopolitical tensions escalate. A direct implication of this will be higher oil & gas prices globally.
In order to take advantage of higher oil & gas prices, companies will expand their exploration activities, and this will translate into more business for NOW.
Besides the potential growth from new markets such as North Sea and Southeast Asia, the company will continue to benefit from the oil & gas boom in the United States. Further, the oil & gas industry activity in Canada is also likely to remain robust.
Highly fragmented market offers opportunity
NOW is currently one of the largest distributors to the oil & gas industry worldwide. The global market size NOW’s distributable products exceeds $50 billion and NOW currently has a 19% market share.
However, a large number of smaller or unorganized players have a 49% market share in the industry. I believe that this is a big opportunity for NOW to consolidate the market share through excellence in product offering and through product offering diversity.
NOW already has a comprehensive product offering with the chart below showing a well diversified revenue mix.
This gives NOW an opportunity to penetrate into the unorganized market and boost its revenue. Even if NOW can tap 20%-25% of the unorganized market, the company’s growth potential can be immense going forward.
I am inclined to believe that NOW will acquire the smaller players in the industry to increase its market share. In the last four years, the company has already made six acquisitions, and this trend is likely to continue. Over the last three years, NOW has generated a free cash flow of $650 million, and the company therefore has the financial flexibility to go for acquisitions.
NOW also has very strong fundamentals, and this supports my case for the stock being a good long-term buy. As of March 2014, the company was debt free and was generating an average annual free cash flow of $200 million.
Further, the company also has approximately $100 million of cash and an undrawn credit facility of $750 million. All these combine to give NOW a very strong financial flexibility to go for capital expenditure and acquisitions. I expect that the company will make several acquisitions over the next few years.
Even in terms of EBITDA margin, NOW has maintained a steady EBITDA margin of approximately 5.6% in the last three years. The company now intends to boost the EBITDA margin to 8% over the next few years. I therefore expect free cash flow to get more robust.
NOW, which is a spinoff from National Oilwell Varco (NOV), has strong growth prospects ahead as the company expands into new markets and caters to the strong demand in the oil & gas industry.
The company is currently trading at 0.85 times price to sales and 0.79 times enterprise value to revenue. The valuations are attractive, and the company’s growth prospects are bright. I would recommend that investors consider the stock with a 3-5 year investment horizon. The stock will create value organically as well as inorganically.