Schlumberger: Best buy in oil services

From onshore to ultra-deepsea drilling, this is the top play in the sector.

By TheStockAdvisors Oct 26, 2012 12:21PM

Scott Gibson CorbisBy Elliott Gue, Energy and Income Advisor

With a market cap of $96 billion, Schlumberger (SLB) is the largest of the Big Four oil field services companies.

The company is known for its commitment technological innovation, strong presence in international markets relative to its peers and leadership in services related to exploration for new oil and gas fields. It generates more than 90% of its annual revenue and net income from three primary business lines: drilling, reservoir characterization and reservoir production.

In 2011, reservoir characterization accounted for a little more than one-quarter of Schlumberger's total sales and more than one-third of net income.

With a pretax operating margin of 28.2%, this division is by far the company's most profitable business segment. Drilling posted an 18.4% operating margin, while reservoir production's margins came in at 16.4%.

Within the reservoir characterization segment, Schlumberger's WesternGeco subsidiary has driven results in recent quarters.

Acquired in 2006, WesternGeco is the industry leader in marine geophysical services, a business line that's critical to oil and gas companies' exploratory efforts in the deep water.

By emitting sound and pressure waves and tracking their subsequent reflections, WesternGeco's fleet of specially designed vessels accumulates data about the positioning of subsurface rock formations to identify areas that are prospective for oil and natural gas.

Schlumberger's most recent innovations in this space enable the company to render highly detailed, three-dimensional models of geological formations.

This data is highly prized by exploration and production companies, which rely on seismic information to determine the best locations to drill exploratory wells.

With prevailing charter rates on ultra-deepwater drillships exceeding $600,000, high-quality geophysical data is critical to saving money and avoiding every oil company's nightmare: the dry hole.

Schlumberger's reservoir characterization division also offers a suite of wireline open-hole services, a product category that comes into play before a new well is completed.

By lowering advanced sensors into the well at various depths, the wireline operator can collect a wealth of environmental data and identify the most productive zones.

Fortunately for Schlumberger's reservoir characterization division, we're entering the sweet spot for spending on exploration-related services.

In addition to Schlumberger's exposure to deepwater exploration and development, we also like the company's geographic footprint. The company generates a little more than one-third of its revenue in North America.

With the permitting process finally returning to normal in the Gulf of Mexico, offshore drilling activity should continue to accelerate, bolstering Schlumberger's margins and offsetting pricing pressure in the onshore market.

Schlumberger's business mix and geographic diversification make it the best-placed of the Big Four oil-field services companies to profit from the cyclical upturn in exploration spending and the end of easy oil.

The stock also commands a premium valuation trading at 17 times Wall Street's consensus earnings estimate for 2012, compared to a multiple of 11 times to 12 times for its peers. Schlumberger rates a buy up to $85 in our Focus List.

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