Since the oil price crash began in 2014, market commentators have been trying to call the bottom of the market. At the same time, Wall Street equity analysts have been trying to weed out the companies that could be the best plays on a recovering oil price and have what it takes to weather a period of low prices.
One of the companies that has always presented a great contrarian buy is National Oilwell Varco (NOV, Financial).
Founded in 1841, National Oilwell has pulled through multiple oil booms and busts, and more importantly, the company’s management has decades of experience in the oil and gas industry. Clay C. Williams, chairman of the board, president and CEO, has only been the company’s CEO since February 2014 but has worked at the company in one form or another since February 2000. Most of the firm’s other executives have served more than a decade with the business.
The best way to profit
It is said that the best way to benefit from any commodity-driven business is to sell equipment to those who are mining for the product themselves, thus avoiding the high-risk, high-reward nature of commodity production as well as the cyclical character of the business. National Oilwell is a testament to this. The company manufactures and produces products for use across the oil sector and has grown steadily over the past few decades to where it is today; 90% of the world’s oil rigs use National Oilwell’s equipment meaning there’s a huge market for the company’s products.
The group also has an 80% market share of the offshore “floater” rig packages and a No. 1 or No. 2 market share position in almost all products. Before 2015 the company had successfully acquired and integrated more than 200 bolt-on acquisitions in the space of 15 years, and management has continued to buy businesses during the downturn.
During 2015 the group made seven acquisitions for a total of $86 million, and the group’s most recent deal is the $138 million purchase of Fjords Processing, a Norwegian processing systems supplier.
National Oilwell has also kept a clean balance sheet during the boom times, which has allowed the group to fund its acquisition binge through the downturn. While it may be some years before these acquisitions start to pay off, buying at the bottom of the market is a sensible long-term investment strategy.
It’s this long-term outlook that helps National Oilwell stand head and shoulders above its peers.
Based on the last quarter’s financials, the company has net gearing of 11.5%. Debt has increased since 2014 when the company reported a net cash balance of $370 million, but this reflects management’s strategy of buying bolt-on acquisitions at the bottom of the cycle. Management has also authorized $3 billion of stock repurchases during the past two years, an intelligent capital allocation decision as National Oilwell has been able to buy back stock at lows not seen for many years.
For 2015, the company generated $1.3 billion in cash from operations, spent $514 million on CapEx and acquisitions, paid out $710 million in dividends and $2.2 billion in stock repurchases reducing the average number of shares outstanding from 430 million to 376 million (third quarter of 2016).
Long-term price target
Reducing the number of shares outstanding and consolidating is a reasonable allocation of capital by National Oilwell’s management. Assuming the company’s net income returns to its cycle peak of $2.5 billion as reported for full-year 2014, the lower share count will translate into earnings per share of $6.6, up 15.4% from the peak. This is assuming no contribution from acquisitions made over the past two years. If you factor in that the company shares have traded at an average price-earnings (P/E) of around 12 for the previous five years, you get a possible stock price of $79.2 when the oil market returns to normal.
Of course, it remains to be seen when or if the oil market will return to normalcy, but National Oilwell’s strong balance sheet coupled with the business’s experience and bolt-on acquisition strategy will help the group whether any near-term turbulence, helping it to spring back into action and be even better than before when the cycle turns.
Disclosure: The author does not own any share mentioned.
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