NOV: A pick & shovel play

March 22, 2018 03:00 PM

With a market cap of $13.5 billion, National Oilwell Varco (NOV) is a leading manufacturer of drilling equipment sold primarily to drilling contractors, marine rig shipyards in Korea and Singapore, and other rig fabricators from plants largely located in Texas. Its revenue is heavily dependent on oil and gas producer and drilling contractor capital spending and the outlook for drilling activity; both of which are sensitive to changes in the price of oil. 

NOV’s growth in the past was aided by well over 200 acquisitions in 17 years and $6.9 billion in acquisitions from 2009 to 2016 compared with capital spending in the same period of $3.5 billion. 

Four long-term trends drive its growth: Unconventional oil and gas recovery technology, replacement of an aging rig fleet with new technology, development of floating production systems and offshore rig construction. 

NOV has an exceptionally strong balance sheet with a debt to equity ratio of 16% and $1.4 billion cash on hand. Capital spending, excluding acquisitions, is estimated at $250 million in 2018 with an operating cash flow of
$1.1 billion. 

During the last 12 months, NOV is down 11%, compared to a 20% decline in the OIH oil service holders ETF, and a 19% increase in the S&P 500. NOV reached a high of $87 per share in 2014 and a cyclical low of $26 in 2016. 

With a multi-year recovery now underway from a likely cyclical low in 2017, the stock has an upside target of $41 per share (+20%) during the next 12 months, assuming its four-year average 14.2x cash flow multiple on 2018 estimate cash flow per share of $2.90. 

NOV thinks an upswing in the oilfield equipment market is at an inflection point. 

The oil price recovery since August provides U.S. producers an excellent opportunity to hedge their 2018 capital program. NOV thinks an upswing in the oilfield equipment market is at an inflection point. While the recovery will gain momentum in 2018, there is significant uncertainty regarding 2019 oil prices. Still, oil prices are likely to remain in the $50s, supported by the approaching decline in conventional oil production and a potential out-year oil supply shortage.

The recovery in oil prices in the second half of 2017 through early 2018 will be positive for production. It should keep inventories elevated for all of 2018, even with the extension of OPEC production cuts through the rest of 2018. It may even undermine OPEC compliance as the cartel could be faced with the “price versus market share” dilemma again.  

Higher crude oil prices also allows producers to hedge 2018 production at a higher price level, which should provide more confidence to increase production further. The recovery in U.S. drilling activity from the low in 2016 is explosive. The cost per well continued to decline in 2017 and wells are now more productive, significantly improving return on investment for producers, and reducing the oil price needed to break even after offsetting the cost of oilfield services inflation.

NOV’s 2017 revenue was relatively flat at $7.3 billion with an operating loss of $277 million, roughly the same as the loss in 2016, excluding a $2 billion impairment that year. It generates 65% of its revenues from land markets and 44% from North America. 

A 15% increase in revenue is anticipated in 2018, paced by a 21% increase in its Wellbore Technologies segment. Revenue in its next largest segment, Completion & Production Solutions is expected to increase 15%.

Total operating income is expected to approximate $580 million, with $385 million from its rig aftermarket segment, which has been consistently profitable through the downturn.

While Q1 2018 results are expected to be essentially flat, as the recovery in drilling activity gains momentum in the United States, NOV expects its short-cycle land business to continue to outpace the growth in the rig count. It also expects modest improvement in international and offshore markets later in the year.

The long-term outlook remains attractive. Deepwater fields have grown from virtually none in 1995 to more than 650 today, representing about 10% of total world oil supply.  Deepwater exploration has been very successful in the past. Major discoveries are being made offshore Guyana, Brazil, Norway, Mozambique, in the eastern Mediterranean, and the Gulf of Mexico. Attractive exploration acreage offshore Mexico will be made available in 2018. 

Expect growth in offshore drilling equipment to be a positive driver for NOV profitability.  

About the Author

Paul Kuklinski is the founder of Boston Energy Research. He also was a partner at Cowen & Co. and a founding partner of Harvard Management Company.