Second-quarter results from the oil services heavyweights were surprisingly strong, defying analysts' expectations. Despite lower oil prices, global demand for drilling services proved robust. Schlumberger (NYSE: SLB ) is arguably the highest-quality name in this space and a company worth serious consideration for any energy investor.
The outlook for oil services companies
It's no secret that a shale energy revolution is under way in the U.S. Besides oil and gas exploration and production companies, oil services firms also stand to benefit in a major way from this renaissance in domestic energy. These companies play a crucial role, as they supply the necessary technology and services for oil and gas drilling, particularly for highly sought-after hydraulic fracturing.
But a combination of macroeconomic uncertainties, pricing weakness in North America's pressure-pumping market, and sky-high prices for guar -- a key component in the fracking process -- had given investors reason to pause on the big oil-service companies. However, market sentiment appears to be improving, as the three big names in the space -- Schlumberger, Halliburton (NYSE: HAL ) , and Baker Hughes (NYSE: BHI ) -- are all up 10% or more over the past month.
Schlumberger's solid quarter
Schlumberger, the largest oil field services company in the world, reported solid second-quarter earnings driven by its international operations. Net income rose to $1.4 billion, or $1.03 a share, from $1.1 billion, or $0.81 a share, a year earlier. Sales jumped 16% to $10.4 billion.
Total operating income rose 8% on the quarter and 19.9% year over year to $2.09 billion. Margins improved in most geographic regions, with the company posting overall operating margins of 20.1%, up 50 basis points on the quarter and 62 basis points year over year. The improvement in overall margins was strengthened by international and deepwater ventures, which yielded better margins than onshore activities.
Increased global demand for oil drilling was a major catalyst for the solid performance. Despite the decline in oil prices, the number of rigs actively drilling for oil across the world rose 6.6% during the quarter. Going forward, the company expects solid growth from international markets to continue.
While international operations were key drivers for competitors Baker Hughes and Halliburton as well, Schlumberger outdid the other two, receiving a whopping 67% of its sales from outside North America.
With the exception of North America, all geographical areas posted sequential growth. A pickup of activity in Russia and the North Sea, as well as in China, drove the company's international operations. In addition, the company's seismic, wireline, and drilling-related offerings saw improvements in pricing, which helped increase international margins.
North American growth was hampered by the seasonal breakup in Western Canada, sustained cost inflation, and weaker pricing in the U.S. pressure-pumping market. However, excluding the impact of Canada, revenue in the U.S. actually grew slightly, boosted by strong performance in the Gulf of Mexico.
Another reason to like Schlumberger is its technological leadership position in the space -- a crucial advantage. The company consistently invests more money each year into research and development than all its competitors and boasts 25 R&D facilities in various corners of the globe.
The company's WesternGeco unit recently announced the launch of a new marine isometric seismic technology called IsoMetrix, which captures wave-field data in three dimensions. This breakthrough technology greatly enhances the resolution of wave-field data and renders the most accurate subsurface images ever recorded. WesternGeco president Carel Hooykaas said, "The step change in imaging is as profound as was the move from X-rays to full 3-D scans in the world of medicine."
In collaboration with Chevron and Total (NYSE: TOT ) , Schlumberger is working on further developing INTERSECT, a next-generation reservoir simulator. The project is an industry first and uses advanced mathematical techniques to simulate large, complex reservoirs using high-resolution models. End users of the technology benefit from increased efficiency of development plans, with the ultimate goal being to maximize recoverable reserves.
Schlumberger's international focus has been something of a disadvantage in recent years. As spending on unconventional plays in North America has soared, competitor Halliburton has gained a dominant market share on the continent.
But in the years ahead, Schlumberger's global reach should be a major advantage as drillers increasingly focus their attention overseas, especially in deepwater regions off the coasts of West Africa and Brazil. By 2020, offshore oil production is projected to account for 34% of global output, up from 25% in 1990. Not surprisingly, companies like Seadrill (NYSE: SDRL ) are making a huge bet on growth in offshore deepwater drilling.
While macro uncertainties and geopolitical risk no doubt remain, I think Schlumberger should continue to see decent to strong earnings growth so long as oil prices don't dip too much further. The company's international segment is on track to grow around 10% this year, and this should continue into 2013, barring a collapse in oil prices.
Overall, Schlumberger maintains an excellent global footprint, and its deepwater exploration offerings in particular should continue to shine, given the company's impressive seismic and reservoir characterization capabilities. The company remains, in my view, the highest-quality oil field services company out there today, though Halliburton and Baker Hughes are not far behind.
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