Schlumberger Closes The Year On A Good Note; Expects Drilling Demand To Increase In 2017

by Trefis Team
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Backed by the rebound in commodity prices, and increasing rig count in the last few months, Schlumberger (NYSE:SLB) posted an improvement of 2 cents in its adjusted earnings for the 2016 December quarter, while marginally exceeding the market expectations for revenue of the quarter((Schlumberger Announces Fourth-Quarter And Full-Year 2016 Results, 20th January 2017, www.slb.com)). For 2017, the Houston-based company has an optimistic outlook, and expects to see a gradual recovery in commodity prices as well as drilling demand in the coming quarters. Further, the company believes that the majority of this revival will be driven by the North American shale producers, who are likely to raise their capital budgets by more than 30% in 2017, particularly in the Permian basin. However, since Schlumberger has a limited exposure to the North American markets, unlike its competitor, Halliburton (NYSE:HAL), we believe that it may not be able to leverage this rally to the fullest.

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For the full year 2016, the world’s largest oilfield services company missed the analyst forecast for both the revenue and the earnings by a small margin, due to the weakness in international drilling markets, coupled with the continued pricing pressure in the industry. In consequence, Schlumberger witnessed a 3.5% drop in its stock price since the announcement of the results. That said, the oilfield contractor has shown a remarkable improvement in its stock price over the year, and is currently trading 25% higher than the price at the beginning of 2016.

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Data Source: Google Finance; US Energy Information Administration (EIA)

Key Highlights of Schlumberger’s 4Q’16 Earnings

In line with Schlumberger’s management commentary in the last earnings call, the global rig count continued to grow in the fourth quarter of 2016, enabling the company to post a sequential growth of 1.3% in its top-line during the quarter. Most of this increment came from the double digit improvement in the company’s North American land revenue, augmented by the rising rig count in the region. However, the sluggish demand in the region’s offshore segment pulled down the upswing in land revenue, resulting in an increase of only 4% in the North American revenue for the quarter. In contrast to this, Schlumberger’s international markets, which contribute a large portion of its revenue, witnessed a growth of merely 1% in the last three months. Even though the Middle East markets performed strongly, growing at about 5% during the quarter, seasonal slowdowns in Latin America, and Europe, CIS and Africa region caused a drag on the company’s top-line growth.

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Data Source: Company filings

Driven by the bounce back in commodity prices, Schlumberger’s operating profits, that had bottomed out in the June quarter, showed a drastic improvement during the quarter. The oilfield contractor reported an operating loss of $213 million, as opposed to a loss of $1.1 billion in the same quarter of last year. However, on a sequential basis, the company saw a decline in its operating income, largely due to restructuring charges related to workforce reduction and facility closure, and merger and integration charges. Yet, on an adjusted basis, the largest oilfield services operator managed to generate earnings of 27 cents per share, tenuously higher than the last quarter, meeting the market estimate for the quarter.

On the financial side, Schlumberger generated cash flows of $2 billion from its operations during the December quarter, and $6.3 billion for the full year 2016. The company spent $654 million on capital expenditure in the quarter, and $2 billion for the entire year, down almost 15% compared to 2015, and 50% lower compared to 2014. Further, the US-based company repurchased shares worth $116 million and $778 million for the quarter and full year respectively, contrary to its competitors who have cut down their repurchase programs to conserve their cash flows in the prolonged commodity slump. In addition to this, the company paid an annual dividend of $2.6 billion during the year, or roughly $0.50 per share per quarter. Moreover, the board approved a similar quarterly dividend for the coming quarter, reiterating investor faith in the company and its willingness to share its returns with them.

The Way Forward

Similar to the last quarter, Schlumberger continued to emphasize the improving dynamics of the oil and gas industry. The oilfield provider expects the commodity markets to move forward on the path of recovery in the next few quarters, in turn, attracting higher capital spending on exploration and drilling from large oil and gas players. This reversal in capital spending patterns is likely to be driven by the shale drillers in North America, who are estimated to ramp up their capital spending by more than 30% in the coming year. While this will be notably lower than the peak spending in 2014, it is expected to boost the demand for drilling and other oilfield services, which will provide a push to the oilfield services industry. However, according to the company, while the drilling demand in international markets, and offshore projects will continue remain weak, it will move in the upward direction through the year.

Furthermore, the company’s management plans to enhance its top-line growth by improving the pricing of its services and reducing the concessions that it offered to its customers over the last two years. Also, the company will move away from the workforce reductions and cost cutting measures that it undertook in the last few quarters, and will focus on enhancing its future growth and returns. For this, Schlumberger aims to spend around $2.2 billion in capital expenditure in 2017, approximately 7% higher than 2016.

With the improving future prospects of the oil and gas industry, Schlumberger has managed to win a few new contracts during the fourth quarter, that are likely to boost its top-line in the next year. These contracts include the two 10-year pressure control equipment management service contracts on behalf of Transocean, valued at greater than $350 million, signed by Cameron, a Schlumberger company((Schlumberger Signs Two Long-Term Transocean Service Agreements, 21st December 2016, www.slb.com)). Apart from this, Schlumberger has recently announced the acquisition of Peak Well Systems (Peak), a leading specialist in the design and development of advanced downhole tools for flow control, well intervention and well integrity((Schlumberger Acquires Peak Well Systems, 5th January 2017, www.slb.com)). The deal will enable the company to offer fully integrated well intervention solutions to its customers on electric line, mechanical slickline, or digital slickline, and in turn, strengthen the company’s position in this market.

Thus, we figure that even with the depressed commodity markets through the year, Schlumberger has delivered a solid financial performance for the year, on the back of the bounce back in commodity prices, and the company’s efforts to streamline its cost structure. Going forward, the company plans to focus on its future growth by acquiring companies in growth segments of the industry and enhance the pricing of its services by shedding the concessions it has previously offered.

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