Key Metric To Watch For Schlumberger’s Stock Recovery

After gaining 56% since the lows observed in March, at the current price of around $19 per share we believe Schlumberger’s stock (NYSE: SLB) has reached its near-term potential. As economies re-open with eased restriction measures, a decline in global crude oil inventory levels is the key metric to observe for the stock’s recovery to pre-crisis levels. The company has taken a slew of cost control measures such as lowering variable costs, closing facilities, curtailing capex, and slashing dividend payout. Schlumberger’s stock has outperformed broader indices in recent months primarily due to a quick recovery in Brent and WTI benchmarks after production cuts by OPEC (Organization of the Petroleum Exporting Countries) and allies.

The company has a diversified presence across the world with North America, Middle East & Asia, and Europe contributing 33%, 24%, and 31%, respectively. While the broader markets have completely recovered, the low industrial and transportation demand has been a drag on the overall oil & gas industry. Interestingly, integrated oil majors such as Exxon, Chevron, BP, and Royal Dutch Shell have planned a 30% capex reduction for the full year. Therefore, a decline in crude oil inventory levels in the U.S. and OPEC countries is the key metric that will prompt upstream producers to revisit their capital expenditure plan and propel Schlumberger’s Revenues.

Per recent reports, the U.S. and OECD (Organization for Economic Cooperation and Development) crude oil inventories (excluding SPR) have increased by 13% and 13.5% since the beginning of this year, respectively. Thus, oil field service firms such as Schlumberger and Halliburton are expected to observe revenue contraction until the inventory pressure eases. Consistent with stable demand and rising prices, Schlumberger’s revenues increased by a modest 8% since 2017. However, the adjusted margins have remained relatively flat as the negative impact of impairments is excluded from the margin calculation. Thus, the adjusted net income increased fairly in-line with the revenues.

While the company has observed moderate revenue and earnings growth over recent years, its P/E multiple has continuously declined due a reduction in operational rigs across the world. We believe the stock is unlikely to see a significant upside in the near-term due to a low production environment which is expected to last until a vaccine reaches the final production stage. Our dashboard What Factors Drove -70% Change in Schlumberger’s Stock between 2017 and now? provides the historical trends in revenues, margins, and P/E multiple. SLB’s P/E multiple decreased from 40.6 in 2017 to 26.5 in 2019. While the company’s PE is now 12.5 there isn’t much of an upside considering the growing crude oil inventories across the globe.

So what’s the likely trigger and timing for an upside?

Per recent STEO (Short-Term Energy Outlook), EIA expects that the demand for crude oil is likely to pick up during Q3 as lockdown restrictions ease across major economies. To lighten inventory pressure on benchmark prices, the demand is expected to exceed supply (upstream production volume) for the rest of the year. Moreover, OPEC and allies have extended the 9.7 mb/d production cut for July. While the trajectory of demand recovery depends on the new Covid-19 cases in the U.S. and other major economies, a sudden surge in demand could prompt upstream oil producers to revisit their capital expenditure plans.

As oil producers and service providers face the coronavirus storm, are utility stocks a better bet? Shares of NextEra, Duke, Dominion & Southern are down by 10% compared to steep declines in the oil & gas sector.

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