Investors punish Schlumberger

The stock drops after a presentation from the CEO.

By Jim J. Jubak Mar 28, 2012 2:45PM
Image: Oil drums (© Kevin Phillips/Digital Vision/age fotostock)Schlumberger (SLB) CEO Paal Kibsgaard delivered a decidedly mixed message at the Howard Weill Energy Conference on March 26.

I'd score his presentation two big pluses for investors in Schlumberger and one big minus.

You might think that would wind up giving the big oilfield services provider a positive score, but in this case the market clearly thinks that two minus one is a negative number. The stock tumbled to $69.96 on March 27 from $79.85 on Feb. 24 -- a 12.4% decline in a period of a little more than a month during which the Standard & Poor's 500 Index ($INX) went up 3.4%.

Let me give you the plusses and minuses and then you can do your own addition.

Plus No. 1: The technology component of oil and gas services continues to increase and, thanks to its outsized R&D spending, Schlumberger has a sizable lead in many of the new technologies. In some, in fact, the company seems to be the only significant player.

Why is technology increasingly important to the oil and gas industry? Technology is the only reliable way to combat the rising costs for finding and producing oil. The oil industry is caught in a terrible cost squeeze. (I know that breaks your heart.) Over the last 10 years, Kibsgaard told the conference, the cost of exploration and production has gone up four times (in nominal terms) but oil production has increased by just 11%. 

Part of the reason for this is that the technical success rate for oil exploration has remained steady at 40% for that decade. But while the number of exploratory wells that find any oil has held steady, the percentage of those finding commercially viable amounts of oil has declined. That has pushed up the cost-per-discovered barrel and there's no indication that this trend is about to reverse.

For Schlumberger, that means any technology that can improve the odds of finding oil in commercial quantities and that lowers the cost of that search is the better mousetrap that will bring oil companies to your door. Kibsgaard offered this example of one of Schlumberger's better mousetraps, a seismic system called Q-technology. 

These days, 3-D seismic imaging is a technology minimum for finding oil. To produce a 3-D image, the oil service company tows a series of seismic streamers across the ground. Each streamer takes a picture of the geology underneath its path and then powerful computers piece together a picture of the whole area from the multiple streamer data collections. You can see the cost trade off: The more streamers, the better the seismic picture but the higher the costs to the oil company for the streaming equipment. 

In effect, because of cost and because of the limits to how closely together the streamers can be placed in the traditional technology, the resulting 3-D image is less than ideal. Kibsgaard disparages it by calling it "2.5-D." Schlumberger's new Q-technology uses streamers that capture the seismic data of 30 or 50 or 60 streamers using just 12 streamers. That lets Schlumberger cut costs by using fewer streamers and improve the image at the same time.

Plus No. 2: Deep-water, and especially deep-water international, will see the most growth over the next three or four years. Schlumberger is the most overseas-oriented of he major oil field service companies and its emphasis on technology gives it an edge as deepwater drilling gets more and more expensive and more and more complex. Kibsgaard noted that deepwater drilling was at an all-time high in 2011. New rigs representing 24 rig-years were added by the drilling industry in 2011, with another 34 rig-hears forecast for 2012. Kibsgaard projected that 200 new deepwater oil fields will come on line in the next four years.

Minus No. 1: Schlumberger may be the most internationally oriented of the oil service majors but that doesn't mean it doesn't have substantial exposure to the North American drilling market. In fact, in 2011, North America generated 33% of oilfield service revenue at Schlumberger. And that's a problem right now because drilling activity in North America is falling.

On March 21, Baker Hughes (BHI), the third-largest oilfield services provider, formally warned on its first-quarter earnings. Profit margins might fall to as low as 13.2% from 18.7% because of declining drilling activity in North American natural gas basins. With natural gas prices at a 10-year low companies are either down shutting drilling operations or moving their rigs to liquid-rich basins. Those moves take time -- during which oil producers don't spend on drilling services -- and cost money that won’t be spent on drilling services.

Kibsgaard echoed those concerns about North America in his presentation, and while he didn't put a precise figure on growth in the North American oilfield-services market, he did note that the current decline in rig count isn't likely to be a one or two quarter event.

So how does this math come out for you?

For me, in the short-run I get a negative result just like the stock market does. I think these pluses and minuses raise the solid possibility that Schlumberger will miss earnings estimates when it reports first-quarter earnings April 20. Analyst estimates for the quarter have moved lower in the last month, but not by enough to offset the Baker Hughes warning. The consensus now stands at $1.03 a share for the quarter. That's down from $1.04 a month ago and $1.09 three months ago -- hardly a big slide. (One of my partners, MSN Money, has a neat free tool that tracks changes in earnings consensus over the last 90 days. Here's the link  to the Schlumberger page.)

Some analysts have indeed cut their target prices -- Credit Suisse, for example, has gone from $99 a share to $92. But I think these expectations are still too high even with the recent 12% drop in the stock price. (The stock bottomed around $55 in August 2010 and at $59 in September 2011. I don't think absent a big macroeconomic shock that it will pull back to those levels.)

I'd like to see the shares down at around $64 or $65. That drop, another 8% or so, I think, would adequately discount the short-term risk in the stock and let me focus on the long-term math that is dominated by the pluses I've listed above. Schlumberger is a member of my long-term Jubak Picks 50 portfolio. For investors with a shorter-term time horizon, such as the 12-18 month holding period of my Jubak's Picks portfolio, I'd put this one on the watch list right now.

At the time of this writing, Jim Jubak didn't own shares of any companies mentioned in this post in personal portfolios. The mutual fund he manages, Jubak Global Equity Fund (JUBAX), may or may not own positions in any stock mentioned. The fund did own shares of Schlumberger as of the end of December. For a full list of the stocks in the fund as of the end of the most recent quarter, see the fund's portfolio here. 
Tags: BHIoilSLB
Mar 28, 2012 8:33PM
I don't even know what this article is saying. What the F. Angel
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