The largest oil and gas service company in the world has lost nearly two-thirds of its market value since the start of the multi-year "energy bear", in June 2014. But the nosedive can not be fully explained by the sharp drop in crude oil, whose price reached a bottom in January 2016 and has since rebounded about 60%.
Risk-off Attitude Sends Share Prices Tumbling
The market has not quite found the courage to stand behind energy service players, despite the long-awaited recovery in commodity prices. The stock of Schlumberger's key peers, Halliburton (HAL) - Get Report and National Oilwell Varco (NOV) - Get Report , in fact, have not fared well either, since reaching their peak levels of five years ago.
But where there is fear there can be opportunities. Schlumberger's stock breached its previous post-2008 Great Recession low in December, but appears to have found a bottom. It does not hurt that oil prices, following the moods of the market and dropping sharply in the fourth quarter of 2018, have started to head north once again on the back of production cuts by OPEC+ members. This is good news for short-term stabilization of Schlumberger's stock price, as well as for a potential improvement in the E&P spending outlook for the rest of the year.
Beyond the Ups and Downs of Oil Price
The case for owning shares of the Houston-based company, however, goes beyond the macro forces that often exert significant influence over the entire energy sector. In the case of Schlumberger, a leaner cost structure that resulted from the initiatives put in place during the long-lasting oil and gas down cycle, as well as a solid balance sheet, help to support the bull thesis.
With the decline in crude oil prices between 2014 and 2016, it is no surprise that Schlumberger experienced a sizable 42% peak-to-trough dip in trailing-twelve month revenues from $48 billion in 2015, as demand for drilling and production stagnated. However, the company's management team has been competent enough to adapt quickly to the new, much more challenging O&G environment.
Over the past four years, Schlumberger has been taking action to reduce its workforce, retire assets and exit less profitable businesses. The positive earnings impact of cost containment carried through the oil and gas bear period, resulting in adjusted operating margins that stayed near or above the 10% mark, while many other players in the industry struggled to remain profitable. It helped that Schlumberger's operations are more geographically diversified than those of its main peers, with pockets of strength in certain global markets partially offsetting weakness elsewhere.
The company's balance sheet ended up bearing the brunt of the uninspiring financial performance over the years, with a net debt position of $13.3 billion in 2018 comparing unfavorably to $4.4 billion at the end of 2013. But the cash bleed seems to have stopped, with slightly improving results last year helping to produce $2.5 billion in free cash flow -- a 48% increase over prior-year levels.
Should macro fundamentals in the oil and gas space improve in the next couple of years, it is plausible that Schlumberger's lean cost structure and robust financial position might enable strong earnings growth and send the stock price substantially higher.
Jim Cramer's Action Alerts Plus portfolio owns shares in Schlumberger, and its analysts believe that "Schlumberger is the best of breed name in the oil services industry. Although the company's earnings power is dependent on the timing of the upstream investment cycle, management has a strong reputation in execution as well as a good handle in understanding the supply/demand dynamic of the industry."
A Good Stock at a Good Price
Schlumberger's shares are likely to remain at the mercy of crude oil price movements in the short term, as is the case of virtually all names in the energy sector. Volatility should also be expected to remain the norm, mainly due to political and macro-economic risks on the supply and demand sides, respectively.
But over the longer term, this stock may also prove to be a welcome addition to a diversified portfolio, given the robustness of the company's fundamentals and the shares' de-risked valuation.
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The author has a long position in SLB.