Schlumberger (OP/A): 35% upside to $108 fair value - Goldman Sachs - October 23, 2005
We are raising our 2006-07 EPS estimates for SLB to $4.40/ $5.00 from $4.30/ $4.90 as we've raised 2006 E&P spending growth to 20% from 15% (still 8% in 2007), which boosts revenue growth for SLB. Our offshore driller estimates already reflect this change + we will be making similar changes for other service stocks. We rate SLB OP/A w/ 35% upside to our $108 fair value estimate + see SLB among the most attractive service stocks for the following reasons:
(1) premier franchise outside N. America, where pricing improvement still appears under-appreciated by consensus,
(1a) upside to incremental margins as revenue growth will be more price than volume in 2006+,
(2) highest exposure to exploration activity among peers,
(3) among best positioned to counter wage inflation given global labor access/ development + raw material inflation given higher service vs mfg orientation.
3Q2005 EPS AHEAD OF EXPECTATIONS EX-HURRICANE IMPACT
SLB recurring 3Q2005 EPS ex-hurricane impact of $0.92 was ahead of our estimate + consensus of $0.86, which included minimal or no adjustment for hurricane impact. Seismic was the star performer with revenue/ pretax income 17%/ 45% ahead of our estimates. This has positive implications for BHI, which owns 30% of SLB's seismic company. SLB oilfield revenue/ pretax income were 4%/ 5% above our estimate, w/ stronger results in all regions, most notably N. America + Europe/ Africa/ CIS. Incremental margins ex-hurricane of 47% y-y and 35% sequentially were strong, though we believe even stronger incrementals are likely in coming quarters as pricing continues to rise. Cash flow and balance sheet items were in line.
IMPLICATIONS FOR THE INDUSTRY HURRICANE HEADLINE RISK.
Despite a larger than expected impact from hurricane ($0.06 vs $0.01-0.02), SLB reported EPS of $0.86 was in line. We believe investors inclined to add to positions on recent weakness have been waiting for indications that hurricane impact would not drive bad 3Q earnings headlines for service/ equipment stocks before wading back into the sector, which is down 10-15% since late September. SLB result confirm that headline risk is probably not going to be a major broad-based issue.
SEISMIC.
Stronger than expected 3Q performance in seismic is also positive for BHI + also VTS, PGS, TGS and CGG, though we believe it is clear that SLB's Q-seismic technology is differentiating performance relative to the competition. SLB also indicated that the normal seasonal jump in US Gulf data library sales may be somewhat muted this year given oil company focus on spending to repair damaged production facilities.
RAW MATERIAL COST INFLATION.
SLB indicated that it has been able to build price escalators into new contracts for raw material cost inflation since May. We suspect other companies are doing the same, and at the margin, this reduces risk that margin expansion in the service/ equipment sector will disappoint for these pressures. Still, we believe this remains a critical issue to watch and point out that investors can avoid this risk by focusing more on the offshore drillers. Labor inflation is a common theme across the entire industry (+10-15% in 2006), but already assumed in estimates, in our view. Among service/ equipment companies, we believe SLB's greater mix of service revenue gives it a lower risk profile.
SLB'S OTHER INCOME WAS ABOVE EXPECTATIONS - POSITIVE FOR SII.
SLB reported $35 mln of other income vs our estimate of $30 mln. This item is primarily (but not solely) SLB's 40% equity interest in its fluids joint venture with Smith Int'l. All else equal, this suggests SII may have stronger than expected 3Q EPS.
REGIONAL MARKET OUTLOOK.
At the margin, SLB commentary suggests potential upside to our assumptions for the 2006 market outlook for L. America (Venezuela) and Russia.
WHAT TO WATCH FOR 4Q EPS OUTLOOK.
In 4Q, SLB expects to recover $0.03-0.04 from activity in the US Gulf returning to normal following hurricane impact. We also estimate that underlying improvement in N. American drilling will add $0.02-0.03, with the same in Middle East/ Asia and L. America geomarkets adding $0.01-0.03. However, seasonal weakness in the N. Sea and Russia should cost $0.02-0.03.
SEISMIC J.V.
On December 1st, SLB/BHI's seismic joint venture agreement allows either party to propose a sale of its interest to the other for the first time. The receiving party has the option to sell its interest back to the instigating party at the same price. While neither party is obligated to do anything - and can propose anything outside the existing agreement as well - BHI has indicated it does not view its 30% interest as core long-term. However, we estimate a sale at this point in the cycle would be dilutive to 2006 EPS for BHI without a large simultaneous share repurchase. SLB indicates the business is core, but we do not think BHI is interested in earnings dilution at this point in the cycle. Bottom line, there is potential nothing happens, but the issue bears watching.
E&P BUDGET ANNOUNCEMENT SEASON IS AROUND THE CORNER.
Many E&P companies will announce 2006 capex plans over the balance of 2005, with December a particularly active month historically. All signals point to growth of 20-25% in 2006, but E&Ps are also sensitive to investor perception of capital discipline and often under-state plans at this time of year. Though most investors heave learned to take these announcements with a grain of salt, low-balling of budgets nonetheless can create concerns that oil service estimates are too high.
ARRIVAL OF WINTER WEATHER OFTEN STIMULATES A TRADING RALLY.
Oil service stocks have often rallied in October as investors anticipate the start of winter and improved commodity price psychology. Given that the group has sold off 10-15% over the last 3-4 weeks on fears of oil demand destruction, the onset of cold weather (or the anticipation of it) in the US could again be a catalyst.
NOVEMBER IS HISTORICALLY A BAD MONTH FOR OIL SERVICE STOCKS
November has historically been a bad month for oil service stocks as
(1) the stocks often rally in October in anticipation of winter,
(2) US + N. Sea rig counts often begin to weaken seasonally, causing investors to become nervous about 4Q-1Q estimates, and
(3) investors anticipate headline risk from E&P budget low-balling.
Each of the analysts named below hereby certifies that, with respect to each subject company and its securities for which the analyst is responsible in this report, (1) all of the views expressed in this report accurately reflect his or her personal views about the subject companies and securities, and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report: Jason Gilbert, Terry Darling. |
