After the market’s rally over the last two weeks, we’re approaching all-time highs again for the major averages. In general, this means that stocks are becoming expensive with attractive value coming few and far in between.
Yet, on Wednesday the VanEck Vectors Oil Services ETF (OIH) , which has been traded publicly since 2002, fell nearly 5% to hit an all-time low. Schlumberger (SLB) is by far the largest individual holding within the oil services ETF, making up more than 21% of the fund’s net assets.
Schlumberger shares bounced a bit on Thursday in response to the tanker attacks in the Gulf of Oman, but they’re still trading down some 70% from the 2014 highs. It wasn’t all that long ago that Schlumberger was viewed as a market darling and a premier name in the energy sector. However, the stock has had a really tough couple of years and with it hitting lows not seen since 2005 it begs the question: has this demonized oil services company finally fallen too far?
For decades, Schlumberger has been the envy on the oil services segment. This company has a renowned management team and a strong moat that has allowed it to produce unique profits in a wide variety of market conditions. Yet, in recent years it appears that some of that cachet has been eroded by management’s inability to predict an oil recovery and the 2016 Cameron acquisition that appears to have shown a lack of fiscal discipline, which is out of character for this leadership team.
Investors fears that Schlumberger may have misplaced its focus on international opportunities rather than the U.S. shale boom. It is Schlumberger’s international scale that made it attractive to investors for years and in the event of an oil resurgence worldwide, this company will likely be one of the major beneficiaries. However, we’ve been in this “lower for longer” trend with regard to the prices of crude since the crash in 2014 and because the trade is dominating the supply and demand dynamic, outside of a resolution to the U.S./China trade war, there isn’t a likely catalyst for oil to return to those prior highs.
Geopolitical headlines could create volatility in the oil space in the short-term, yet that won’t solve the long-term headwinds that oil faces. Government agencies, industry think-tanks and energy companies themselves have come up with various models regarding the long-term demand for fossil fuels. Some say that we’ve already reached peak oil. Some say it’s coming shortly and others believe that we’re still decades away.
This is the type of thing that will only become clear with the added benefit of hindsight. Either way, the overwhelming trend remains: we’re headed towards a future with lower oil demand and this secular headwind doesn’t bode well for energy service names like Schlumberger.
Regardless of whether we’ve reached peak oil or not, however, it’s going to be decades before that energy source becomes irrelevant to mankind. It’s not fashionable to invest in fossil fuel names at the moment. Alternative, renewable sources are all the rage and who can blame portfolio managers because that’s where the secular tailwinds are. Production costs are falling and production rates are rising across the board for renewables, yet if you’re looking for profits, the lion’s share continue to be found in the oil & gas space.
Schlumberger’s cash flows are much smaller today than they were five years ago, but they still cover the company’s debt interest and dividend obligations. In 2014, when oil was trading at more than $100/barrel, Schlumberger’s free cash flow was more than $7.2 billion. In 2018, that figure fell to just $3.5 billion and it’s looking like 2019’s total will be smaller still.
Schlumberger’s precipitous share price declines have come alongside earnings-per-share contraction, so the stock doesn’t appear to be cheap when using backwards looking price-to-earnings multiples. Right now, shares are trading for 23x trailing twelve month earnings. But on the bright side, analysts are calling for strong bottom-line growth in 2020 and 2021 and if you’re a believer in the potential for a turnaround in the oil patch, this company could be trading cheaply.
The current consensus estimate for 2021 earnings is $2.60 and at the stock’s current $36 price point, that represents a 14x forward multiple. That’s not a bad price for a blue chip name. For investors who’re interested in a contrarian, deep value name, Schlumberger could be a perfect fit.
Furthermore, this company offers investors a 5.6% dividend yield, meaning that investors could be paid handsomely as they wait for a turnaround. This yield continues to be covered by diminished earnings-per-share totals. Schlumberger’s payout ratio continues to rise, though, and it’s worth noting that in the first quarter, Schlumberger posted negative cash flow per share, which obviously doesn’t cover the $0.69 dividend. Yet, if the double-digit EPS growth estimates come to fruition, it doesn’t appear that this high dividend will be an any danger.
Schlumberger doesn’t offer the type of yield that is meant for widows and orphans; however, this is a company that hasn’t cut its dividend in three decades and while the past doesn’t predict future results, that should offer some peace of mind to investors who’re willing to bet on a rebound in the energy services industry.
SLB shares fell $0.03 (-0.08%) in after-hours trading Friday. Year-to-date, SLB has gained 2.18%, versus a 16.25% rise in the benchmark S&P 500 index during the same period.
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