- After a brutal downturn of oil prices, there is a cyclical recovery since January 2015 as seen in Brent Crude Oil prices.
- NOV rode through this period with increasing profitability due to strong backlog of superior products and services.
- NOV is the lowest priced among its peer and it is currently on a slow recovery.
According to Exxon Mobil, the world population is set to grow from 7 billion to 9 billion from 2010 to 2040, and the economic growth is expected to more than double during this period. This will increase the global demand for energy by 35% along the way with technological improvement. This puts the current decline in oil prices in context. The cause for the decline of oil prices from over $100 in June 2014 to $42 in January 2015 has been due to the supply glut mainly from U.S. shale oil.
As a result, upstream oil companies began to rationalize their production in response. This has cascaded down to their suppliers servicing them as they pass on the effects of the shrinking revenue.
Cyclical recovery of oil prices
This has caused all oil-related stocks to plunge downward as their revenue is challenged. However this cyclical downturn in oil prices appear to be ending soon as seen in the price of weekly Brent Crude Oil below.
The weekly chart helps to put things into perspective as it shows the period before the start of the plunge. The median oil price was around $111 then and it shows the depth of the plunge. As we can see in this Bloomberg article, we are currently witnessing a significant reduction in oil supplies with various cuts along the way.
It is during a cyclical downturn that we can identify the true winners and survivors. After several rounds of careful selection, I have come to the conclusion that National Oilwell Varco (NOV, Financial) is currently the most suitable of major oil services company for addition into a diversified portfolio.
Let me do a brief introduction about NOV before we look at their financial figures. NOV is in the oil and gas equipment and services sector which means to say that their specialty is to provide goods and services to oil exploration companies. NOV is a major player in its field and it is the top 5 oil services company based in the United States according to market capitalization.
Its competitors include well known stewards such as Schlumberger (SLB, Financial), Halliburton (HAL, Financial) and Baker Hughes (BHI, Financial) with approximate market capitalization of $118 billion, $40 billion and $29 billion respectively. NOV comes in fourth with $21 billion of market capitalization with Cameron International (CAM, Financial) rounding up fifth with $9 billion.
Strong products
NOV has 4 divisions known as Rig Systems, Rig Aftermarket, Wellborne Technologies and lastly Completion and Production Solutions. Rig System builds rigs according to client’s specifications while Aftermarket covers all the support that explorers require after their rig need such as spare parts, equipment optimization and repairs. The Wellborne division contains the cutting-edge technology.
and it is constantly testing new and improved methods of production to bring about greater efficiency. Lastly the Completion division is a system integrator that makes sure all the different components, new technologies work seamlessly well with each other.
In its latest fourth quarter results, I was surprised to find out that NOV was able to restrict the pain to its Rig System division. This was inevitable given the industrywide cutbacks, but this was mitigated by the presence of a strong backlog of orders accumulated before the oil plunge. Hence Rig System’s revenue drop by 4% in Q4 compared to Q3 to $2.56 billion but it is still a 7% increase compared to Q42013. Backlog revenue accounts for $2.27 billion. Operating profit is at $511 million.
The other three divisions all posted unqualified growth compared to its previous quarter and previous year. This is impressive as oil companies were looking at a freefall of oil prices last quarter without any reasonable support which only materialize in January this year. They responded by cutting expenses across the board, but NOV managed to grow its revenue in such challenging circumstances.
This impressive growth can be seen from its income statement for the past three years from 2012 to 2014 as extracted from Yahoo! Finance.
Source: Yahoo! Finance
It is worthy of applause that NOV grew its revenue and net income in the difficult year of 2014. It had growing revenue for three consecutive years, and last year it went on to surpass its net income for 2013.
While it is true that the bulk of the Rig System revenue comes from legacy backlog, it also shows the capability of management to negotiate and secure airtight contracts which forced their clients to commit during this period.
“For both Rig Systems in Completion and Production Solution segments, we are glad to be able to carry strong backlogs into this downturn. Except for minor exceptions the firm contracts governing our backlog projects do not permit cancellation for convenience.”
Clay Williams, chairman, president and CEO, made this following comments at the Q42014 earnings report on 03 February 2015. With its revenue secured, NOV went on to pressure its own suppliers to control cost when its client asked for steep discounts. This is why it went on to produce better net income. NOV dealt with this downturn by asking for better payment terms from its own supplier and we see that its accounts payable rose by 8.2% from $6.67 billion to $7.22 billion. NOV on the other hand reduced its accounts receivable by 0.99% from $6.8 billion to $$6.7 billion. NOV cash flow increased by $100 million last year.
NOV is currently in a strong position to emerge into this up cycle financially. Its ability to bind customers to terms more favorable to itself than the customers shows that their clients need NOV more as its products and services are more superior than it can find outside. Hence it stands to reason that NOV would be well positioned to gather more business when its client's revenue goes up as oil prices improves.
NOV –Â cheaply valued
Among its peers, NOV is the most attractively priced at 9.67 times earnings and with the highest dividend yield of 3.34%.
This low price-to-earnings ratio shows that the market has not "discovered" NOV yet compared to the four other peers. Even Cameron that doesn’t pay any dividends commands a higher multiple.
We can see from the chart below that the technical upwards momentum is currently at the nascent stage for NOV.
NOV is a highly liquid stock with over 4 million of transactions daily. While the market has priced its peers up, it is only starting to recognize the potential of NOV. It is only on the verge of a breakout as it just cleared the $55 neckline and set for higher potential earnings with the oil recovery. It should be noted that NOV maintained its quarterly dividend of $0.46 throughout the oil downtrend until March 2015 after raising it from $0.2344 in March 2014.
So if you are considering riding the oil recovery, NOV would be a good name to add to your portfolio at this stage. Given its strong fundamentals, it would not stay at this price of $55 for long. It is worth saying that, according to the Graham value investing theory, buying a security at a lower price means lesser risk to the acquirer and NOV is definitely NOT a lemon.
