Schlumberger’s Tough Q1 Numbers Set The Tone For A Difficult Year Ahead

Oilfield services bellwether Schlumberger (NYSE:SLB) reported a tough set of Q1 2015 numbers that were impacted by a sharp decline in North American land drilling activity, service price deflation and foreign currency headwinds in Russia and Venezuela. The company’s quarterly revenues fell by 9% year over year to about $10.25 billion, while adjusted net income fell by about 15% to about $1.36 billion. ((Schlumberger Q1 2015 Earnings Press Release)) The near-to-medium term outlook for the company remains challenging, as oil and gas firms have meaningfully dialed back on their exploration and production spending plans for this year and we believe that the full impact of these cutbacks will only be fully visible in the quarters to come as higher-priced contracts potentially end and as new contracts are negotiated at lower rates. That said, Schlumberger has been responding aggressively to align its cost structure to the current realities of the oil market. The company announced that it would be cutting an additional 11,000 jobs, bringing its total headcount reductions to 20,000 (about 15% of its Q3 2014 employee base). Here are the key takeaways from the company’s earnings release.

Trefis has a $95 price estimate for Schlumberger, which is about 4% ahead of the current market price. We are currently updating our valuation model and price estimate for the company to account for the earnings release.

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North America Drags Down Results, Recovery Will Take Time

Schlumberger’s North American revenues fell by about 13% year over year while pre-tax margins fell to about 13% from about 18.5% a year ago, impacted primarily by lower pressure pumping activity and increased pricing headwinds. The North American services market is primarily driven by tight oil activity, which has higher marginal costs of production and shorter planning horizons that allows operators to respond to the commodity cycle more quickly. North American capital spending is expected to fall by about 30% in 2015 and the U.S. oil rig count is already down by about 50% since the beginning of the year. While there has been a modest recovery in crude oil prices over the last few weeks – amid lower rig activity and reports that tight oil production from the most productive U.S. shale formations could decline on a sequential basis next month – things will remain challenging in the near-to-medium term for oilfield services players, since prices are still likely to be below break-even (estimated at upwards of $60 per barrel) for most tight oil producers. ^[1]

There are other trends in the land drilling market that could impact services firms as well. For instance, the inventory of drilled but uncompleted wells has been rising in the United States, potentially reducing future demand for drilling services and resulting in a delay in the completions and stimulation cycle. Additionally, the trend of re-fracking has been gaining prominence, and this could reduce the demand for drilling services. (related: Recent Trends In The U.S. Land Drilling Market: Re-fracking, Growing Well Inventory, Lower Rig Counts)

International Operations Prove More Resilient

Schlumberger’s international revenues fell by about 8% year over year to $6.89 billion, while pre-tax operating income fell by about 3%. The company’s business is geared towards international markets (two-thirds of revenue comes from overseas versus just about 50% for its biggest two competitors) and this could provide some respite in the current downturn. International activity is likely to prove more resilient  since it is driven by conventional land and offshore drilling that has lower break-even prices. Additionally, unlike the North American market, which has seen growth driven partly by highly-leveraged independent drillers, participants in the international upstream space are typically larger and better capitalized. That said, activity is trending lower in most regions. Revenues from Schlumberger’s Europe/CIS/Africa segment (25% of total revenues) declined on decelerated spending in the U.K. North Sea, lower activity in East Africa and Nigeria, and currency headwinds in Russia. Activity in Latin America was also weak, owing to budgetary cuts in Mexico, Brazil and Colombia, and also due to negative exchange rate effects in Venezuela. However, the Middle East proved a bright spot for the company, driven by new projects and higher activity. Per-barrel production costs in the region are among the lowest in the world and the near-term outlook remains positive as core OPEC producers continue to pursue market share at the expense of non-OPEC part of the international supply base.

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1. Shale oil boom goes bust as expected production dips for first time in years, Fortune, April 2015 [↩]