SLB - International Business Remains Key To Schlumberger's Fortune

2023-05-22 15:27:10 ET

Summary

• International revenue to drive SLB's growth.
• Shale drilling globally to help further add impetus to growth.
• Financials remain solid.

Article Overview

Schlumberger's ( SLB ) first-quarter results were much better than expected, with revenue increasing by 30%, YoY. Cash flow from operations came in at $330 million, with margins also remaining quite healthy. But, going into the second quarter, growth may slow down more than expected, with a growing number of headwinds, both in North America and internationally. Rig counts have been contracting across North America, which is a worry, although international rig counts remain at a much healthier level, especially as demand from Asia continues to support rig activity.

North American activity

Rig count across North America continued to decline, mainly as U.S. shale producers struggled with lower commodity prices (specifically oil & natural prices). Rig activity continues to face two main headwinds, firstly the price of energy and secondly increasing interest rates.

Rates Increases and Falling Commodity Prices Affecting Rig Activity

Increasing interest rates are not as big an issue as they were in 2014 when the price correction in oil & gas led to many shale producers going bankrupt. Today the total E&P debt stands at around $217 billion, which is reasonable considering debt to equity remains relatively low. Since debt levels are more manageable today than in previous years, rating agencies such as Moody’s have upgraded their ratings for several oil & gas producers. Therefore, despite the recent price drops and increasing interest payments that most of these producers face, their overall outlook remains relatively safe, this despite the currently prevailing low energy prices.

But, economic activity and outlook remain relatively modest. And a big part of the current trend to keep debt manageable is to cut rig activity as soon as prices come down. For now, management expects an activity plateau in North America.

International

International sales make up a much larger percentage of the company’s overall sales, but now that OPEC+ is looking to reduce output, the outlook is more uncertain. The recent reduction in output by 3.6 million barrels recently is likely to further dampen revenue as we head toward the end of 2023.

Despite the cut in activity related to oil, there is an increasing level of activity related to natural gas on the international front, in part due to the Russia-Ukraine conflict. As a result, capital expenditure from natural gas should improve the company’s well construction, completion, and production, which presents an opportunity for Schlumberger to pick up business.

Other services such as subsurface characterization should remain steady as well, as the overall outlook in the long term remains steady. Characterization services also have a relatively brighter future as we increasingly head towards peak oil, and a greater percentage of cash flow is likely to be spent on finding new resources.

In addition, the ability to ensure proper subsurface mapping, to orderly drill new wells, and ensure proper resource analysis, is key to shale operations, and larger scale drilling operations, where such activity can be costly without proper execution. Therefore, Schlumberger is perfectly positioned to take advantage of the potential upcoming demand for such a service.

Schlumberger has been increasingly investing in technological solutions to drive revenue in the recent past. Its fit-for-basin solution, which is a tailored approach to drilling depending on the region, has been the key driver of its technological revenue. Moving forward a lot of the technology that has been adopted, especially ever since the new CEO took over, technology that integrates software and digitization to improve overall revenue. The combination of digital revenue, combined with hardware solutions, will be key for regions such as the Middle East, where a significant amount of shale formation lies. Shale remains an important source of resources for the Middle East’s energy future, especially as the current energy resources start to deplete.

Schlumberger should see its revenue growth remain steady for the future after it, scored some significant contracts in the Middle East, including contracts such as ADNOC contract valued at $4 billion, which should keep growth at a steady pace. The contract will include 5 years of operations and will cover integrated drilling fluid services. The company also recently received contracts to expand on the ACE base by providing characterization and drilling services.

In addition, countries such as Saudi Arabia are expected to invest over $100 billion in shale , which could be quite lucrative for oilfield companies. Schlumberger will be a significant role in the Middle East shale revolution, where there is a significant amount of ‘technically recoverable' resources. Middle East shale is also quite often deeper at 9-10 thousand feet, compared to US shale, which is usually drilled at 3-4 thousand feet.

Latin America and Central America are also expected to be a significant source of revenue, and output from these regions will play a much larger role in 2023, in terms of driving revenue growth. Recently the company signed a range of contracts in the region including contracts with Petrobras and Enauta.

"We're seeing very positive trends in Brazil, Norway, and other Latin American basins," Le Peuch told analysts during a quarterly earnings call. "The appraisal of Colombian offshore gas and opportunities in Suriname will be complemented by further activity in Africa and Asia. The number of subsea trees is growing visibly ... and this is setting market conditions to support higher prices," he added.

Both Guyana and Suriname have significant energy resources, and Schlumberger is expected to play a significant role in providing services to operations in the region. Guyana's future is especially bright in terms of energy resources, after the recent oil fund, and the subsequent oilfield contracts should be equally lucrative, should Schlumberger get them.

Revenue Still Below Historical Levels

Despite the recent growth, Schlumberger’s revenue is still below that of its pre-COVID levels, and with the current headwinds, it might be still a while away until it hits those levels. These headwinds largely stem from fewer contracts and from output cuts, with an increasing number of OPEC+ countries hoping to push the price of oil up towards $100 per barrel, to balance their fiscal spending.

For example, Saudi Arabia needs around $80-81 to meet its spending. ( Source ) Therefore, cuts to output may continue by OPEC+ countries, at least until there is a better balance between price and output, which could therefore affect Schlumberger’s operations.

Regardless, the current valuation isn’t very rich, at 16x P/E, and with a forward P/E of potentially 12-14x, investors will remain relatively positive despite the global risks, i.e. a slowdown in oil & gas demand. E&P isn’t a problem on the international side of operations, although rising interest rates could affect North American operations, where although the current debt situation is not as bad as it once was, still is an issue.

Investors can benefit from the long-term trends towards shale, and the increasing need for digitization by investing in the company, but could face the negative effects from short-term headwinds. Overall, Schlumberger remains a steady investment with few negatives that would impede the investibility over a more reasonable period. Stock Rating: BUY.

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