SLB - Schlumberger: Steady With Upside

2023-12-05 05:38:41 ET

Summary

• SLB (formerly Schlumberger) has seen solid growth in 2023, creating a fair value situation with potential upside.
• The company's fortunes are closely tied to the oil and gas industry, and it has faced headwinds in the E&P sector.
• SLB has regained profitability and is focusing on climate change initiatives, but year-over-year growth is slowing down.

SLB ( SLB ) , formerly known as Schlumberger, has long been a leader in the oil service industry, but like so many peers, it has seen a few very tough years. After energy prices spiked in 2022, with the world economy recovering from the pandemic, and amidst the war between Russia and Ukraine, I believed that the company was starting to pump profits late last year.

The company has seen solid growth so far in 2023, creating a rather fair value situation, with potential levers to the upside.

Creating Some Perspective

SLB has long been regarded among the most advanced oil & gas service providers, perhaps the leading firm in its area, but its fortunes are closely related to the oil and gas industry.

This meant that the company's fortunes peaked alongside the US shale boom around 2014, now nearly a decade ago. Operating momentum and rosy prospects pushed shares of SLB comfortably above the $100 mark, as it was notably production numbers of E&P business that rose and profits for all the suppliers, but certainly not the shale producers themselves.

Shares have been trading stagnant and fell to just around the $40 mark pre-pandemic due to headwinds in the E&P sector, poor acquisitions, and too aggressive capital allocation decisions (mostly in the form of too high dividends, and too many share buybacks).

After revenues nearly peaked at $50 billion in 2014, sales were down to $33 billion in 2019, as the decline in sales came alongside substantial margin pressure, although the business still earned $1.50 per share on the back of operating profits of around $3 billion.

Net debt came in at $13 billion, a substantial amount, as the company furthermore paid out steep dividends, which limited the potential to deleverage. This set the business up for a tough 2020 as oil prices even briefly traded negative. This was seen in the results as well, as SLB saw sales fall to less than $24 billion in 2020 while posting multi-billion losses (including some one-time expenses as well).

The company regained profitability in 2021, even as sales fell 3% to less than $23 billion. This modest pace of recovery meant that shares ended the year around the $30 mark, trading well below pre-pandemic levels, while many other parts of the market were trading at fresh highs.

Recovering

By October of last year, shares had recovered to the $50 mark as the company enjoyed some real momentum. After first quarter sales rose by 14%, revenue growth accelerated in the second quarter, with revenues up some 28% in the third quarter.

This made a $27 billion sales number for the year look conservative, with earnings power seen around $2.25 per share, all while net debt was down to $10 billion and EBITDA improved to a run rate of around $7 billion.

This situation looked a lot more upbeat, as the company focused more on climate change, including carbon offset, climate technologies and decarbonization of oil & gas production. Those were the long-term drivers, but in the fall of 2022, energy prices were spiking, yet capital spending in the sector was lagging compared to the past. This might be due to more focus on ESG, which withheld E&P players from making large capital investments (as they did in the past).

Having held a small position for a long period of time, I have decided to hold onto that position. Since last year, shares have largely traded in a $45-$60 trading range, now settling at $52 per share.

Steady Progress

Earlier this year, SLB posted a 23% increase in full year sales to $28.1 billion, with growth reported across all four divisions of the business: digital & integration, reservoir performance, well construction, and production systems. Earnings for the year came in at $2.39 per share, more than a dollar improvement from the year before, as improved earning power made that net debt was down to $9.3 billion. Moreover, the run rate of the business was exceeding the annual results of course.

First quarter sales of $7.7 billion advanced some 30% year-over-year but were down 2% on a sequential basis. GAAP earnings of $0.65 per share however mark a dramatic year-over-year improvement, but were down 9 cents from the fourth quarter of 2022, which felt a bit soft.

Second quarter sales rose 20% to $8.1 billion, although earnings rose by just five cents to $0.72 per share. By October, third quarter sales were reported up 11% to $8.3 billion, which makes a $32-$33 billion run rate likely for the year. More important is that earnings of $2.14 per share have already come in half a dollar ahead of last year, and trend close to $3 per share here. Net debt has actually trended flattish at $9.4 billion, although improved earnings power means that leverage ratios just come in at over 1 time.

Fair, With Upside

With shares and net debt coming in flat versus this time last year, we have seen modest growth in SLB's revenues this year. Moreover, earnings power, which trended around $2.50 per share last year, now comes in closer to $3 per share here, reducing the multiple to a market multiple of about 17 times.

The issue is that year-over-year growth is rapidly slowing down as current oil prices do not induce massive capital spending in the near term, while the long-term headwind from an ESG point of view makes it hard to see this a GDP growth business, or even higher. On the other hand, CO2 emission reduction projects might actually create a new business line, which might actually induce growth, but we are still starting from scratch here.

Furthermore, underinvestments into the E&P sector itself might create room for upward surprises in energy prices, creating a potential boom in prices and thus future demand for SLB's services.

Hence, it makes sense that shares are trading range bound at these levels, as quite frankly shares look to trade around fair value, with potential upside, as I lack conviction to hold a greater position here.

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