SLB - Schlumberger Stock: A Buy Going Into Q2 Earnings

2023-07-17 09:00:00 ET

Summary

• Schlumberger, the largest provider of oil and gas exploration and production services, is set to report its Q2 earnings on July 21, with the stock having risen more than 30% since May.
• The plateauing of production growth in major basins could lead to a new era of potentially higher oil prices, benefiting Schlumberger.
• Wall Street expects strong earnings performance from Schlumberger, with the potential for SLB stock to reach the $80 to $90 range within the next 24 months if oil prices rise as predicted.

Introduction

It's time to talk about Schlumberger ( SLB ) . This energy services giant is scheduled to report its Q2 earnings on July 21, before the opening of the market.

In May, I wrote an article titled Schlumberger Is A Buy As Net Zero May Be Failing . Since that article, SLB has gained significant momentum, rising more than 30%.

In this article, we'll discuss why that is the case and what we can expect going into earnings.

So, let's dive in!

Why Energy Is Looking Attractive

It feels like 2021 again. Everyone is betting big on tech. Year-to-date, technology stocks are up almost 4 0%. Related sectors like consumer cyclicals, which includes Amazon ( AMZN ), and communications services are also doing very well.

Energy isn't doing so well. Over the past three months, it was the worst-performing sector. Only utilities had a poorer performance over the past six months.

I believe this offers opportunities, which is why I have been adding again to my energy investments. In fact, I opened a full position in a new investment: Canadian Natural Resources ( CNQ ).

Unlike tech stocks, energy stocks have priced in a (manufacturing) recession. In addition to the related underperformance, this has caused a significant shift in the risk/reward.

As reported by the Bear Traps Report, the energy sector valuation compared to the S&P 500 is at a significant discount.

The report makes the case that the Nasdaq (and tech stocks in general) is massively overloaded, which could trigger a significant rotation.

Essentially, that has been my thesis for a while now - the problem is that we didn't have a catalyst so far.

That may change.

One major reason is peaking production growth (not peaking production). As I discussed in a recent article (and many more before that), the growth engine of global supply growth (US shale) is running out of steam.

Most major basins peaked prior to the pandemic, which includes both Eagle Ford and Bakken.

Now, even the growth engine called the Permian Basin is now running out of steam. Estimates are that this basin could see peak production in 4Q24.

I believe that in a situation where global oil demand is not expected to peak before the 2050s, we will enter a new era for oil with a return to triple-digit dollar oil prices, as we witnessed prior to the oil price crash of 2014.

Furthermore, Brent crude oil is still close to $80 despite a steep deterioration in economic growth. A rebound in mid-term demand growth will likely boost commodities and put a floor under inflation, forcing a rotation from growth to value stocks similar to 2021.

Also, looking at the positioning of money managers, we see that net positions of futures and options haven't been this low since the pandemic bottom and the bottom of the 2014-2016 oil price crash.

This is obviously no guarantee that oil cannot fall further, but it shows that the value/commodity trade may be the least crowded one at the moment.

Even without higher oil prices, we're now at a point where energy and inflation comparisons become tougher, which is likely to cause upward momentum for inflation numbers.

The Bank of America ( BAC ) chart below displays this quite well. In addition to that, I've heard from multiple asset managers that this could pave the way for the rotation I cannot stop talking about. I expect that smart money will soon switch teams and move into value stocks.

That's where SLB comes in.

Buying Schlumberger Shares Going Into Earnings

Schlumberger doesn't produce oil. However, it's the largest provider of oil and gas exploration and production services and engineering.

The company generates its revenue in four major segments, with Well Construction being the largest segment.

With this in mind, service sector companies are always late to the party, as drilling activity is lagging behind oil prices.

The Bear Traps Report compared SLB to drill rates, which show an upswing.

This makes sense, as drilled but uncompleted wells ("DUC") are at the lowest level since measuring started, which means service companies will be needed as soon as energy prices pick up.

Having said that, we see that SLB shares are outperforming the shares of oil drillers. The ratio (including dividends) has hit a multi-year high this year. This confirms the thesis that higher prices down the road will almost immediately increase the need for higher CapEx - especially because DUCs are so low.

During the first quarter earnings call , Schlumberger CEO Le Peuch discussed the macro outlook, emphasizing a constructive multi-year growth perspective.

• Despite short-term economic and demand uncertainties, the underlying demand, investments, and activity in the energy sector remained resilient.
• Energy security, long-cycle projects, and OPEC's policy contributed to a positive outlook.
• Investments in the Middle East, international offshore basins, and gas projects were expected to drive long-term growth.
• The North American market, although exposed to short-cycle activity, was also anticipated to benefit from positive demand and commodity pricing.
• The Middle East and offshore markets were highlighted as key segments with significant growth potential, supported by visible investments and a diverse range of opportunities.

These comments were good, and I expect the company to give us more intel during its upcoming earnings call.

Furthermore, these developments are highly positive for SLB, as Well Construction, Reservoir Performance, and Production Systems were identified as areas with growth opportunities by the company.

The result of these comments was a strong outlook.

• For the second quarter, revenue growth of mid-to-high single digits and operating margin expansion of 50 to 100 basis points were projected, driven by a seasonal rebound in international markets.
• Growth is expected to be led by the Middle East & Asia Area and continued momentum in offshore markets. SLB anticipated reaching new highs in adjusted EBITDA for the second quarter, further advancing its earnings growth journey and bringing it closer to achieving its full-year ambitions.

With that in mind, Wall Street expects SLB to generate $0.71 in EPS in the second quarter. The company has beaten these estimates every single time since it met expectations in 3Q21.

This is based on ten analysts. One of them upgraded his/her EPS estimate over the past four weeks. Two analysts downgraded their target.

With regard to revenue estimates, we see that 21% year-on-year growth is expected, which would mark one of the strongest quarters since the post-pandemic uptrend started.

So, what about the valuation?

SLB Stock Valuation

SLB has a 1.1x leverage ratio using 2023E net debt and EBITDA. In 2024, that number is expected to fall to 0.6x EBITDA, which is based on both an expected decline in net debt and a 16% higher EBITDA.

Please note that the company enjoys an A credit rating.

The company is currently trading at 11.4x NTM EBITDA, which is fair, mainly because we'll likely see a steep acceleration in EBITDA after 2023.

The current consensus price target is $65, which is 14% above the current price.

I believe that's very conservative, as I expect the stock to move to the $80 to $90 range within the next 24 months if my oil thesis is correct.

That being said, going into earnings, I believe that bullish comments and good guidance could cause this stock to break out above $60.

Takeaway

As investors anticipate Schlumberger's earnings report, there are several key factors to consider.

The energy sector has faced recent underperformance, making it an attractive opportunity for value investors.

With production growth in major basins reaching a plateau, the global oil market may enter a new era with potentially higher oil prices. The positioning of money managers also indicates that the value/commodity trade is currently less crowded.

SLB, being the largest provider of oil and gas exploration and production services, stands to benefit from the anticipated rebound in drilling activity.

The positive outlook, strong projected revenue growth, and margin expansion further support SLB's prospects.

With Wall Street expecting strong earnings performance, bullish comments and guidance during the earnings call could potentially drive the stock price above $60, with the potential for SLB's stock to reach the $80 to $90 range within the next 24 months if my oil thesis holds true.

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