Early in the earnings season, energy services leader Schlumberger (SLB) - Get Report delivered mixed-fourth quarter results. Judging by the slightly bullish reaction following the print, however, investors seem to have welcomed the rare improvement in margins and cash flow, even if revenues continued to lack traction on the back of a struggling North America market.
Playing Defense in North America, Offense Elsewhere
The divide between the company’s North America business, which represents 30% of Schlumberger’s fourth quarter revenues, and the international businesses could not have been clearer. As reasonably expected, drilling and reservoir characterization did well relative to production, given the segments’ heavier exposure to international markets. In addition to achieving top-line growth in Latin America and the Middle East, Schlumberger seems to have also benefited from a milder winter in Europe.
North America land, however, showed no early signs of regaining its footing. The exploration and production (E&P) space continues to be budget-constrained, and lower activity (particularly onshore) led Schlumberger to reduce fracking capacity and shed underperforming businesses. OneStim, for example, suffered from lower demand and pricing pressures, and is a prime target for further fleet stacking and restructuring. The snowball effect of low E&P capex and Schlumberger’s early moves to scale back its onshore operations resulted in North America revenues dropping a sizable 14% sequentially.
The better news is that growth internationally combined with a defensive stance in North America led to rare margin expansion in the fourth quarter. Non-GAAP operating margin landed at 9.5%, a 75-basis point improvement year over year. As a result, operating profits in the fourth quarter increased by nearly 10%, and free cash flow of $3.7 billion for the full year improved over 2018 levels. Healthy margins and cash generation is probably at the center of cautious investor optimism, as a challenging 2019 came to a close.
A Typical Second-Half Story
Schlumberger also presented the outlook for the next twelve months, and the management team made its vision clear: 2020 will be a year to prioritize returns over growth.
Therefore, shareholders should expect more top-line pain in North America, which is projected to decline in the high-single to double-digit percentage range. On the other hand, the company is committed to expanding margins in the region through portfolio high-grading, divestitures and technology franchising. Meanwhile, offshore activity around the world should pick up the pace, reflecting increased investments in oil and gas production to replenish global reserves.
Whether Schlumberger’s efforts in the home continent will pan out and international activity will remain strong in 2020 will probably remain an open question until the second half of the year. As a result, investors will be tested on their patience once again -- as they have since the start of the energy down cycle, in 2014.
Despite The Challenges, a Stock Worth Considering
Given the results of Schlumberger’s most recent quarter and outlook for the new year, I do not think that pound-the-table bullishness is easily justifiable. However, despite the challenges, it is undeniable that the Houston-based company has been doing a fair job at protecting its margins, while managing to grow cash reserves in an adverse environment.
Considering the stock’s rich valuation of 23 times earnings, I do not believe that share price will climb much over the next six months. More significant upside could come later in the year, if and when Schlumberger manages to deliver on its 2020 guidance. But it's worth noting that the stock currently yields an enticing 5% per year, and the dividend seems to be well protected by a solid balance sheet and strong cash flow.
Therefore, within the context of a balanced portfolio, Schlumberger may be an energy service stock worth considering at current levels. Patience and a bit of tolerance for stock price volatility, however, may be required.