SLB - Schlumberger: International Markets Providing Support

2024-01-11 15:15:36 ET

Summary

• Even in the face of softening oil markets, Schlumberger's business could continue to benefit from investments offshore and in international markets.
• Economic weakness in Europe and China, along with an end to OPEC supply cuts, pose threats to Schlumberger's business though.
• Schlumberger appears fairly valued given near-term risks but should do well if economic conditions remain resilient.

While oil markets are currently precariously positioned, energy security is top of mind for many, which is potentially supportive of investment independent of economic conditions going forward. In particular, long-cycle investments continue to be made offshore and in international markets, both of which are supportive of Schlumberger's ( SLB ) business.

While Schlumberger's stock could do well if economic conditions remain stable and activity continues to pick up, there is downside risk. Economic weakness in Europe and China, along with an end to OPEC supply cuts, are threats to Schlumberger's business. This is likely why the stock has performed poorly over the past year.

Long Duration Cycle

With fundamentals currently strong for service companies and valuations reasonable. The investment case for Schlumberger is largely dependent on how long current conditions last. If the current cycle is durable and continues to demonstrate greater breadth, Schlumberger could benefit significantly.

The market is currently being supported by long-cycle developments and the recognition of natural gas as a vital energy source. Offshore markets have also demonstrated momentum recently. For example, appraisal activity in the Eastern Mediterranean has been sustained, with customers trying to confirm finds for FID in 2024 or 2025. The breadth of exploratory activity has also improved, with strength across regions like Southeast Asia, the Middle East, Africa and South America.

While economic weakness could undermine this, Schlumberger believes that upstream spending is currently independent of near-term demand and expects double-digit annual CapEx growth in coming years.

OPEC Cuts

The current cycle is largely dependent on the willingness of OPEC to support oil prices. Investment in the Middle East could pressure the unity of OPEC, though. Many countries have the stated goal of expanding production and are often supporting this through long-term contracts. Schlumberger expects capacity expansion in the Middle East, across both gas and oil. This goes beyond Saudi Arabia, to countries like Kuwait, Iraq and Egypt. Angola has already elected to leave OPEC, stating that the organization doesn't provide it with any benefits.

Saudi Arabia may not be willing or able to shoulder the burden of supply cuts indefinitely. Current cuts are already weighing on the country's GDP, and their impact on prices has been modest. While Aramco is highly profitable with prices at current levels, Saudi Arabia is trying to diversify its economy, meaning a solid fiscal budget is necessary to support Public Investment Fund spending. Progress on diversifying the economy has been limited so far, though, with the Saudi economy still heavily dependent on oil prices and production.

Offshore

Offshore investment is also proving resilient, particularly in Africa, Brazil and Scandinavia. Schlumberger expects over 500 billion USD of offshore FIDs between 2022 and 2025. Schlumberger offers end-to-end services and is known for managing large and complex offshore projects. Offshore is a strength for Schlumberger, something the company hopes to build on with the recent closing of its OneSubsea Joint Venture with Aker Solutions and Subsea7.

Venezuela

The easing of sanctions on Venezuelan oil product exports could also provide Schlumberger with a boost if maintained. Venezuela has been a fairly large market for Schlumberger in the past, and the company has maintained a presence there. Venezuela's oil production was up around 11% YoY in November to 794,000 bpd .

Venezuela's issues go well beyond the impact of sanctions, though, with production prior to the introduction of sanctions in 2019 down around 1.9 bpd compared to 2013. This decline has been attributed to political persecution and government intervention in PDVSA. While it is unlikely, if Venezuela's production were to meaningfully recover, it could further add to supply pressure and test the resolve of OPEC.

Schlumberger

Schlumberger divides its business into three main segments: Core, Digital, and New Energy.

Core

Schlumberger's Core business consists of Reservoir Performance, Well Construction and Production Systems. Schlumberger believes that its Core business will see solid growth on the back of operators making long cycle investments offshore. Evaluation activity is supporting Reservoir Performance. Subsea, Surface and Artificial Lift are driving Production Systems growth.

Digital

While Schlumberger's Core business currently dominates performance, its Digital business is growing and has a favorable margin profile. This business should be supported by rising adoption of cloud computing, digital transformation initiatives and the rising capabilities of AI. Digital revenue is expected to reach 3 billion USD by 2025.

DELFI is a cloud solution, which enables enterprise data management, autonomous operations and AI driven insights. DELFI registered a 49% increase in users YoY and an 86% increase in compute hours in the third quarter. Schlumberger's connected and autonomous drilling solutions completed 60% more feet in Q3 2023 compared to Q3 2022.

New Energy

Schlumberger's New Energy segment is an attempt to future proof the business and provides additional sources of growth. Schlumberger is pursuing a range of low carbon opportunities which are both material and adjacent to its existing business. This includes reducing methane emissions, carbon capture and storage, hydrogen generation, energy storage and geothermal.

Financial Analysis

Schlumberger is profitable and growing across segments, with the Reservoir Performance business registering particularly strong results in Q3. International revenue increased 12% YoY, while North America revenue was up 6%. North America is being impacted by the lower rig count. Schlumberger's Middle East and Asia business grew 22% YoY in the third quarter, led by Saudi Arabia, the United Arab Emirates, Kuwait, and Egypt. Russia still contributes around 5% of Schlumberger's revenue and is expected to decline over time.

Schlumberger expects high-single digit sequential revenue growth in the fourth quarter, with the OneSubsea JV contributing to growth. The Aker subsea business will likely add 400-500 million USD of incremental revenue in the fourth quarter. Excluding this impact, revenue growth is likely to be fairly flat sequentially.

Schlumberger's margins continue to improve on the back of high-quality international growth. While the US could drag on margins going forward, Schlumberger expects profitability to remain at least at current levels.

Like most service companies, Schlumberger is focused on margin expansion rather than growth. Also, like most service companies, Schlumberger believes that technology led differentiation will support higher margins. Absent a large shift in revenue mix, I am not a believer of this. Margins are only likely to remain elevated as long as oilfield service markets remain tight.

Conclusion

Schlumberger's valuation is currently towards the lower end of its historical range. I find this reasonable given recent pressure on oil prices and the fact that profitability has been elevated by oilfield service market tightness. If oil price weakness begins to impact activity levels, Schlumberger's profits could be hit, causing its valuation to appear far less attractive. If current activity levels are maintained (or pick up) for any length of time, Schlumberger's stock is likely to do well. This really hinges on the willingness of OPEC to cede market share in return for higher prices, and for operators to continue to invest in the face of potential weakness.

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