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INITIATING COVERAGE REPORT
William C. Dunkelberg Owl Fund February 13, 2014
Michael Kollar: Lead Analyst [email protected] Maxime
Berin: Associate Analyst [email protected] Shady Botros:
Associate Analyst [email protected]
COMPANY OVERVIEW Schlumberger Limited (SLB) is the largest
company in the midstream, oil & gas equipment & services
industry of the energy sector. The company has 120,000 employees,
with operations in 85 different countries, and delivers technology,
integrated project management, and information solutions to oil and
gas explorers and producers. Schlumberger continues to thrive by
delivering efficiency to customers in the form of advanced
processes and technology that reduces the cost of extracting oil a
need that will persist as oil reserves deplete and new reserves
become most costly to drill. Schlumbergers revenue can be broken
down into three business segments; reservoir production (27% of
revenue), drilling (38% of revenue), and production (35% of
revenue). Schlumberger operates globally with operations in North
America (32%), Latin America (18%), Europe, Russia and Africa
(27%), as well as the Middle East and Asia (22%).
INDUSTRY OVERVIEW The United States recently became the largest
producer of
hydrocarbons in the world (surpassing Russia), and the
energy
industry continues to transform along with constant
developments in oil, gas, and renewable energy. The oil &
gas
equipment & services industry remains sensitive to the
supply
and demand of oil. Demand is impacted by macroeconomic
headwinds and tailwinds, most notably: a plodding US
economy, the European debt crisis, and emerging market
growth. Supply is influenced by global production levels and
political unrest in the Middle East, such as Libya and
Egypt.
Although rebounding, Iran, the third largest oil exporter in
the
world, saw its exports cut after the US House of
Representatives passed a bill levying sanctions on it in July
of
2013. This resulted in a $40 billion loss of total industry
revenue in 2012. Despite short-term turmoil, oilfield
service
companies remain bullish on growth in the Middle East and
emerging markets such as Asia, given the increased demand
for
oil & gas from their developing economies. Innovation
and
new technology for fracking and deepwater rigs continues to
catalyze growth across the industry. National oil and gas
E&Ps
En
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Schlumberger, Limited Exchange: NYSE Ticker: SLB Target Price:
$115.16
Sector Outperform Recommendation: BUY Key Statistics: Price
$90.03 52 Week Low $69.08
Projected Return
30% 52 Week High $94.91
Shares O/S (bn) 1.31 Yield 1.8% Market Cap (bn) $118.75
Enterprise Value $1,230mm
Earnings History: Earnings Date EPS Revenue YoY Price
1Q13 $1.01 1% -1.48% 2Q13 $1.15 7% 5.43% 3Q13 $1.29 9% 2.80%
4Q13 $1.35 7% 1.81%
Earnings Projections: Year Q1 Q2 Q3 Q4 Total
2011 $0.71 $0.857 $0.967 $1.098 $3.613
2012 $0.960 $1.006 $1.040 $1.078 $4.164
2013 $1.053 $1.149 $1.290 $1.350 $4.750
2014 $1.235 $1.371 $1.508 $1.615 $5.706
All prices current at end of previous trading sessions from date
of report. Data is sourced from local exchanges via CapIQ,
Bloomberg and other vendors. The William C. Dunkelberg Owl fund
does and seeks to do business with companies covered in its
research reports.
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have continued to increase capital expenditures in
unconventional,
ultra-deepwater drilling as onshore reserves mature. Its
estimated
that offshore production will equal onshore production in the
next
15 years. Because offshore drilling is more expensive,
companies
place a premium on efficiency. Offshore drillers continue to
replace
older rigs with newer, more technologically advanced rigs,
particularly in challenging drilling environments such as the
North
Sea. As a global leader in the equipment and services
industry,
Schlumberger is well-positioned to capitalize on this trend.
INVESTMENT THESIS The energy sector has seen a sell-off
recently, leaving many
companies at attractive prices. In an environment where
commodity
prices are forecasted as being flat through 2014, a company
deriving
its revenue through services, rather than the sale of
commodities
themselves, will perform well. Schlumberger is the worlds
largest oil
services company and a staple of the energy sector. Schlumberger
is
an excellent addition to the Funds portfolio because will give
it
exposure to a less volatile segment of the sector. Schlumberger
is
the premium company in its peer group and is currently trading
at a
8.5% discount to its implied average EV/EBITDA multiple.
Going
forward, Schlumberger will continue to see revenues and
earnings
rise as more international oil E&Ps make capital
expenditures in
onshore, ultra-deep and deep water oil well services and
drilling
equipment in 2014 and 2015. Also, the company is poised to
capture
new growth as the natural gas boom sweeps Asia.
Schlumbergers
HiWay fracturing equipment and StethoScope technology, which
increase natural gas production efficiency, will drive top line
growth.
The company also has a broad geographic footprint allowing it
to
continue to service the increasing oil demand around the
world,
especially in emerging markets.
CATALYSTS
While domestic oil companies may trim back capital expenditures
in the near term, these are primarily on larger, infrastructure
investments. Schlumberger provides well services and E&P
spending will not be curtailed as much because of the foremost goal
of efficiency and recovery. National oil companies from the Middle
East and Latin America are expected to raise their exploration and
production spending by 14% in 2014. These investments will benefit
Schlumberger moving forward and will also help the company to find
even more reservoirs such as Pre-salt region off the coast of
Brazil, Norway, US Gulf of Mexico. These new sources of energy will
help counter the effect of oversupply in North America due to
seasonal effects and overcapitalization.
There is serious potential demand for oil-services China. The
shale gas output in China for 2013 was ~200 million cubic meters.
By 2015, they are expected to increase to 6.5 billion cubic
meters,
Economic Moats
Economy of scale: SLB is the largest company in a capital
intensive business with high barriers to entry. SLB is able to
leverage its size, 70 years of expertise, and global network of
resources to continually expand margins and deliver value to
customers.
Proprietary technology: SLB maintains a massive portfolio of
patents which guarantees a diverse and unique product offering not
available elsewhere.
Research & Engineering Centers: SLB operates 125 R&E
centers which drive innovation and shortens product development
cycles
Positives
$10 billion share buyback program launched in 2013, the largest
buyback program of its peer group.
Risks
Commodity Prices: Short-term volatility in
pricing of oil and natural gas can adversely
impact customer margins and consequent
capital expenditures, and SLBs modest
production business of 150,000 barrels/day.
Geopolitical: SLB has operations in the
Middle East, including Iraq, which although
stable in the near term, may become politically
unstable from terrorist attacks and
insurgencies.
Weather: SLB operates in many challenging
environments across the globe and adverse
weather conditions, such as hurricanes, can
affect operations at these locations
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resulting from capital investments in excess of $65 billion.
These incredible statistics have already attracted major intergated
oil companies such as Exxon Mobile and Chevron. The demand for
shale gas YOY has increased by 15%. Schlumbergers StethoScope
technology has already been implemented by Energy Development
Corporation China and provided a 50% increase in production yield
of its natural gas wells.
Schlumbergers new HiWay fracturing technology will also have a
strong, positive impact on the market share of SLB and on natural
gas E&Ps. This pumping technology creates stable channels
within fractures and has already delivered increased natural gas
well production levels while minimizing proppant and water use.
According to Schlumberger, HiWay can increase production by +20%
while using 40% less proppant per project, and 60% less water. With
natural gas prices forecasted as remaining flat through 2014, gas
E&Ps will look to Schlumbergers HiWay system to deliver
value.
Revenue
Schlumbergers revenue is driven by
capital expenditures of large national
oil companies in the US and abroad.
FY2013 revenue grew 8.5% YOY
reaching $45.3 billion. The most
recently reported 4Q2013 revenue
came in at $11.91 billion, slightly
missing estimates by 0.57%.
Revenue Generation:
Reservoir Characterization: Imaging, monitoring, and development
services; wireline technology; E&P pressure and flow-rate
measurement services; information solutions including software,
consulting, data management, and IT infrastructure specific to the
oil & gas industry.
Production: Well services comprising pressure pumping (HiWay),
well cementing, stimulation, and intervention; well completion
services and equipment, such as packers, safety valves, and sand
control technology; artificial lift; coiled tubing equipment and
services; slickline services for downhole mechanical well
intervention, reservoir monitoring, and downhole data acquisition;
subsea solutions; and geological storage solutions, including
storage site characterization for carbon dioxide, as well as
engages in the development, management, and environmental
protection of water resources.
Drilling: Designing, manufacturing, and marketing of drill
bits and drill fluid systems; geo services; supplies
engineering support; directional-drilling, measurement-
while-drilling, and logging-while-drilling services;
provides
bottom hole assembly drilling tools, borehole enlargement
technologies, impact tools, and tubulars and tubular
services; and dynamic pressure management solutions.
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EBITDA Margins
Schlumberger has kept its
EBITDA margin fairly consistent
and is expected to expand margins
going forward into 2014. In a
recent investor presentation
(12/3/2013), President of
Operations mentioned a
reorganization of global
distribution, warehousing, and
maintenance.
Return on Assets
Schlumberger remains
efficient at generating
stable returns on its
assets. While its peer
group has seen
deterioration since
2012Q1, Schlumberger
has been increasing its
returns through prudent
execution and deploying
over 150,000 mobile
assets to better serve its
broad geographic base.
Debt
Total Debt: $13.2 Billion Debt/Equity: 33.2% Interest Coverage
Ratio: 22.36
Schlumberger enjoys an A+ credit rating from S&P. The nature
of Schlumbergers capital intensive business is usually
indicative of very high levels of debt, however, its operational
goals of efficiency extends to its balance sheet. The
company is very solvent, as evidenced by total outstanding debt
of a mere $13.2 billion affording it a total debt to equity
ratio of 33.2%. As a result, Schlumberger has negligible default
risk and ample room to raise debt to finance additional
expenditures. When asking IR about increasing leverage, they
stated they have considered it, but have determined that
maintaining a clean
balance sheet is the
best way to deliver
ROIC to shareholders.
However, they did state
they may lever up for
strategic reasons, such
as M&A.
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Free Cash Flow
Schlumberger has a Price / FCF of 28.85, the highest of its
peer group. Unlevered free cash flow continues to rise as
Schlumberger balances expenditures and grows revenue.
Free cash flow is one of the major strengths of
Schlumberger. In 2012, their free cash flow is twice that of
their main competitor, Halliburton.
Dividend
Schlumberger provides a 1.77%
dividend yield and is expected
to increase this by 13.64% over
the next year. This is the leading
dividend yield of its peers and
demonstrates effective
management execution and its
commitment of passing returns
onto shareholders.
Comparable Analysis
Target Price
($ in millions except per share)
Growth Leverage
Stock Equity Enterprise Total Gross EBITDA Debt/
Price Market Market ROE ROA ROC Revenue Margin Margin Equity
Company 2/11/2014 Value Value LTM NFY LTM NFY NTM NTM NTM NTM
LTM LTM MRQ
Halliburton 53.84$ 46,084$ 51,305$ 16.12 13.58 10.18 7.03 14.5%
7.5% 11.4% 8.1% 14.9% 20.5% 57.4%
Baker Hughes 60.49$ 26,740$ 29,793$ 22.96 15.02 8.17 6.30 6.3%
4.0% 5.6% 8.4% 17.0% 16.3% 24.5%
Weatherford 13.90$ 10,740$ 19,715$ 25.74 21.25 8.03 7.26 -8.6%
-3.6% N/A 7.2% 22.1% 16.1% 108.3%
Mean 21.61 16.62 8.79 6.86 4.1% 2.7% 8.5% 7.9% 18.0% 17.6%
63.4%
Median 22.96 15.02 8.17 7.03 6.3% 4.0% 8.5% 8.1% 17.0% 16.3%
57.4%
Schlumberger 90.37$ 118,750$ 122,949$ 18.66 15.84 10.24 8.79
18.1% 10.5% 14.3% 9.3% 22.1% 26.6% 33.2%
*Data as of 2/11/2014
P/E Multiple EV/EBITDA
SCHLUMBERGER (SLB) Comparables Analysis
Capitalization Valuation Multiples Ratios Margins
Consensus NFY EBITDA 13,930.21$
Target EV/EBITDA 11.15X
Enterprise value estimate 155,355$
- Debt outstanding (MRQ) 13,176$
+ Cash 8,370$
Equity value 150,549$
No. Shares (Millions) 1,307
Target price 115.16$
E ( r ) 28%
Dividend Yield (1.3%) 1.77%
Total Return 30%
EV/EBITDA Target Price
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Schlumberger historically trades at a premium to its peer group
of Halliburton, Baker Hughes, and Weatherford. To
arrive at a target EV/EBITDA multiple we did a relative
valuation based on the historical ten year spread of
Schlumberger to each peer. By choosing a ten-year time period,
idiosyncrasies of the cyclical nature of business due to
commodity prices are effectively taken into account. After
applying a mean factor to each peers current EV/EBITDA
multiple, we averaged the sum of the Implied multiples of its
peers. We determined a target multiple of 11.15x. Using
this multiple we reached a target price of $115.16/share. After
accounting for a 1.77% dividend yield, we expect a 28%
return.
Appendix: Ten Year Historical Spreads on Each Peer
Baker Hughes (BHI)
Halliburton (HAL)
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Weatherford (WFT)
Correlation to Crude
Correlation to Natural Gas
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Onshore vs. Offshore rig count over the last five years
Analyst Consensus
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DISCLAIMER
This report is prepared strictly for educational purposes and
should not be used as an actual investment guide.
The forward looking statements contained within are simply the
authors opinions. The writer does not own any
Schlumberger Limited stock.
TUIA STATEMENT
Established in honor of Professor William C. Dunkelberg, former
Dean of the Fox School of Business, for his
tireless dedication to educating students in real-world
principles of economics and business, the William C.
Dunkelberg (WCD) Owl Fund will ensure that future generations of
students have exposure to a challenging,
practical learning experience. Managed by Fox School of Business
graduate and undergraduate students with
oversight from its Board of Directors, the WCD Owl Funds goals
are threefold:
Provide students with hands-on investment management
experience
Enable students to work in a team-based setting in consultation
with investment professionals.
Connect student participants with nationally recognized money
managers and financial institutions
Earnings from the fund will be reinvested net of fund expenses,
which are primarily trading and auditing costs
and partial scholarships for student participants.