Schlumberger's Margins Are Falling. Do I Worry?

Schlumberger's (NYSE: SLB  ) fourth-quarter earnings released back in January beat estimates. While profit margin showed improvement sequentially, the company's year-over-year margin is falling. Here is a quick check to see how this oilfield services behemoth is faring.

Strengths

  • Schlumberger has a global footprint. International operations accounted for about two-thirds of total revenues in 2011. The company's operations are spread over nearly 85 countries.
  • It has a strong research and development (R&D) wing and is a leader in technological innovations, with a presence in each of the oilfield services segments. The company spent more than $1 billion on R&D in 2011.
  • Since 2004, the company has posted double-digit sales growth, except for 2009. Last year, revenue grew a whopping 44%.
  • The company has a healthy balance sheet with over $4 billion in cash and a manageable debt-to-equity ratio of 32%. In 2011, the company generated $1.7 billion in free cash flow.

Weaknesses

  • Return on equity in 2011 was 15.3%, lowest in the last six years. While this figure is still healthy, the company will have to rein in its spending or start borrowing more.
  • Profit margins are falling. Gross and net margins in 2011 were the lowest in the past five years. The company seems to be struggling to keep expenses down. Additionally, rivals seem to be faring better. National Oilwell Varco (NYSE: NOV  ) has a gross margin of 30.7%, operating margin of 20% and net margin of 13.6% compared to Schlumberger's margins at 20.7%, 16.9% and 12.6%, respectively. Another competitor, Halliburton (NYSE: HAL  ) , is also breathing down its neck with margins at 20.2%, 19.1% and 11.4%, respectively. The emergence of these companies threatens Schlumberger's dominance of the industry.

Opportunities

  • Worldwide offshore drilling is picking up, with the Brazilian market leading the way, followed by the East and West African markets. Schlumberger has already opened a Research & Geoengineering Center in Rio de Janeiro.
  • Oil prices are above $100 again, and investments in the E&P space are on the rise. Opportunities thus provided for oilfield services are immense.
  • Hydraulic fracturing (one of Schlumberger's core services) should be picking up across the globe, with Argentina and China having vast reserves of shale gas.

Threats

  • Competition among oilfield services is intense. With companies such as Halliburton, Baker Hughes, and National Oilwell Varco offering stiff competition, Schlumberger cannot afford to slip up in terms of technological advances, which have always given the company a competitive edge.
  • With operations in nearly 85 countries, the company will always be prone to geopolitical risks that can significantly affect its business. The fourth quarter of 2011 included a pre-tax and after-tax charge of $60 million relating to non-recoverable assets as a result of political unrest in Libya -- a perfect case in context.

Foolish bottom line
This 500-pound gorilla of the oilfield services industry is doing well, but higher costs could well be the Achilles' heel for Schlumberger. Right now, the pros outweigh the cons. Investors must, however, dig deeper. To stay up to speed on the top news and analysis on Schlumberger, you can start here by adding it to your watchlist

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Fool contributor Isac Simon does not own shares of any of the companies mentioned in this article. The Motley Fool owns shares of National Oilwell Varco. Motley Fool newsletter services have recommended buying shares of National Oilwell Varco and Schlumberger. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 11, 2012, at 1:38 PM, TDRH wrote:

    Schlumberger just sold off the Wilson Supply division to NOV. Wilson's contribtution was very low margin, and this should improve the gross and net margin % relative to the peers outlined in your article.

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