Schlumberger Price Estimate Revised To $124, Here’s Why

We remain bullish on the oilfield services sector, as it is becoming more challenging and expensive to extract hydrocarbon reserves which increasingly lie in unconventional reservoirs, deep waters or fields that are in mature stages of production. In the near to medium term, we believe that  Schlumberger (NYSE:SLB), the world’s largest oilfield services company, stands to benefit significantly given its extensive global footprint and vast product line, which allow it to provide integrated services. Schlumberger’s financial performance has also been strong of late, with earnings beating investors’ expectations over the last four consecutive quarters and its free cash flows steadily trending upwards. During the company’s investor conference conducted last week, management guided for earnings per share growth of around 17% to 20% through 2017, owing largely to margin expansions. Considering the company’s improving performance and prospects, we have increased our price estimate from around $94 to around $124 , which is slightly above the current market price. In this note, we take a look at some of the key trends driving our valuation for Schlumberger and the summary of the model changes.

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Trefis has a $124 price estimate for Schlumberger, which is now slightly ahead of the market price.

National Oil Companies Account For Large Portion Of Revenue Mix: While international oil companies such as BP (NYSE:BP) have been slowing down on their capex and expansion plans to focus on improving shareholder returns, national oil companies – particularly from regions such as Latin America and the Middle East – are playing a key role in driving overall exploration and production spending growth. Schlumberger’s scale and reputation make it the go-to contractor for large national oil companies who seek to explore, develop and produce hydrocarbons from their vast reserves. These state-run firms together control over 80% of the world’s proven hydrocarbon reserves and will require the assistance of skilled oilfield services contractors such as Schlumberger in developing these fields. During its Q1 2014 conference call, Schlumberger indicated that its sales to national oil companies and independent oil companies now account for about 70% of its total revenues, while revenues from international oil companies have remained relatively flat. This shift in the company’s revenue mix should prove beneficial going forward.

Progress In North American Pressure Pumping Market: Over the last two years, the market for pressure pumping services has been beset  by weak gas prices, an oversupply of horsepower and intense competition from smaller companies. This has had an adverse effect on Schlumberger’s North American margins. ^[1]. However, things have been improving of late, and the excess horsepower in the market has been tightening due to higher service intensities, better natural gas prices and growth in unconventional drilling activity in the Permian basin. Schlumberger is likely to gain meaningfully from the recovery, given its initiatives to improve efficiency and its new technology deployments. The company has been able to make market share gains, adding one new pressure pumping fleet during Q4 2013 and another two more fleets during Q1 2014. Although North American margins continue to be dilutive to the company’s overall margins, we believe that they could improve with the recovery of the pressure pumping market, bolstering the company’s EPS.

Rising Middle East And Asia Activity: Activity in Asia-Pacific and the Middle East has been one of the key drivers behind the earnings growth in the oilfield services sector over the last year. During Q1 2014, Schlumberger’s revenues from the geomarket were up by around 19% year-over-year, while profit before tax margins expanded from around 23% to about 26%. Schlumberger could see its business from the region rise further in the long term, spearheaded by spending by national oil companies in the Middle East and higher activity in the Asia Pacific region. In Saudi Arabia for instance, the company has been mobilizing additional resources in order to meet demand. The overall average rig count in the Middle East is up by around 14% year-over-year. In the Asia-Pacific region,the company’s earnings could be aided by strong deepwater activity in markets such as Australia and by some of its production management contracts for mature fields in Malaysia. Schlumberger also expects to see growth in China, owing to new technology deployments and project management services.

Summary Of Key Model Changes: We have increased our long-term revenue forecasts for the company from our  previous estimate of $70 billion for FY 2020 to around $78 billion, to account for market share gains that would allow the company’s revenues to outpace the broader growth in exploration and production spending worldwide. This translates to a revenue growth of roughly 8% per year, while the broader market is expected to grow by roughly 6%. We have also increased our adjusted EBITDA margins forecasts to grow to around 34% by FY 2020, compared to around 32% previously. The company’s working capital outflows and capex forecasts have also been reduced in our model, to factor in better capital and operational efficiency.

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1. Oilfield Services Factbook, Howard Weil, March 2014 [↩]