The UN predicts that global population will increase by 2.6 billion by 2050. Royal Dutch Shell estimates that this population increase, coupled with strong economic growth in developing nations, will double the demand for oil (from its already record high of 91 million barrels/day).
A recent study by Morgan Stanley and Rystad Energy estimates that by 2035 the price of oil will most likely average between $125/barrel-$150/barrel (current price is $109/barrel).
With long-term oil prices likely to remain at historic highs the stage is set for the world's energy companies to invest hundreds of billions of dollars into new production infrastructure. In fact, a recent study by the Interstate National Gas Association of America predicts that $272 billion will be spent to build out America's oil infrastructure by 2035. Total energy infrastructure spending (including natural gas and natural gas liquids) is projected to be $641 billion. This represents only domestic investment. Worldwide the amount is certain to be much higher.
A great way for patient, long-term investors to profit from this coming bonanza is by investing in quality oil services companies (the "pick and shovel" providers of the black gold rush).
This article outlines three companies that are set to profit strongly from this oil production megatrend: National Oilwell Varco (NOV 0.16%), Halliburton Company (HAL 1.60%) and Schlumberger Limited (SLB 0.26%).
Enormous market potential
Source: Schlumberger
As seen above, investment by oil companies has been growing by about 15% CAGR over the last 11 years. As the world's existing oil fields become depleted, keeping production at current levels becomes harder and more expensive. Growing production requires even more investment. Thus, despite short-term oil company decreases in their capital expenditure (capex) budgets in 2014-2017,the long-term outlook for oil services companies remains bright. Any short-term weakness should be viewed as a chance to add more shares (which are already historically undervalued).
| Company | Yield | 20 yr div growth (CAGR) | 5 yr div growth (CAGR) | Payout Ratio |
| HAL | 1% | 3.83% | 8.04% | 22% |
| NOV | 1.30% | na | 22.06% | 17% |
| SLB | 1.60% | 6.42% | 8.27% | 25% |
| IND AVG | 1% |
Data from Fastgraphs
| Company | PE | 3 yr rev growth | 3 yr earnings growth | ROA | ROE | Operating Margin | Net Margin | Debt Interest Coverage |
| HAL | 17.8 | 17.8 | 5 | 7.5 | 14.5 | 10.7 | 7.2 | 8.91 |
| NOV | 15.2 | 23.5 | 11.8 | 7 | 11 | 15 | 10.2 | 34.24 |
| SLB | 19.6 | 17.4 | 16.4 | 10.5 | 18.1 | 19.6 | 14.5 | 28.05 |
| IND AVG | 25.7 | 15.8 | 14.6 | 5.7 | 10.6 | 12.1 | 7.4 |
Data from Morningstar
The investment thesis for these companies consists of three parts.
First, all three are undervalued -- both on an industry average and historical basis. For example, the 21-year average P/E multiples for Halliburton, Schlumberger, and National Oilwell Varco are 25.4, 31.1, and 18.8, respectively. Therefore, the current valuation represents a historic discount of 30%, 37%, and 19% respectively.
The undervaluation is caused by concerns over short-term profit weakness due to oil majors such as ExxonMobil, Total, and Royal Dutch Shell announcing cost-cutting measures.
The second reason to invest in these companies is the potential for strong dividend increases (backed by the growth thesis). As seen from the above tables, the five-year dividend growth has been strong and the payout ratios are low. In addition, all three companies can easily service their debt with available cash flows. However, there is one note of caution that investors should consider when it comes to oil service company dividends -- the growth is cyclical.
Schlumberger for example, between 1997 and 2004, didn't raise its dividend at all (the same for 2009 and 2010). Halliburton was even stingier, with a static dividend 1995-2005 and 2009-2012. Meanwhile, National Oilwell Varco only initiated its dividend in 2009 but has raised it every year and by very healthy amounts. Dividend growth investors might want to stick with National Oilwell Varco (since annual dividend growth is the primary goal).
The final pillar of the investment thesis for these companies is the immense growth opportunity presented by the oil production megatrend. Primarily this will be fueled by new technology, and each company is investing heavily to stay on the cutting edge (one of reasons dividend growth has been so sporadic).
For example, Schlumberger has greatly increased its patent filings over the last six years. This has been fueled by large scale acquisitions (such as Smith International) as well as smaller companies (Nova Drill). The benefit to the company has been the acquisition of new technology such as the Stinger drill bit (a revolutionary new diamond cutter drill bit that can increase oil well penetration by 15%-30%).
Further Schlumberger innovations include the Microscope (allows advanced imaging of geological formation while drilling) and PowerDrive ( improved steering of rotary drills benefiting horizontal drilling capabilities).
All three companies have their own patented technologies to help energy companies image, stabilize, and maximize productive life out of oil and gas wells.
Foolish takaway
Global oil production is likely to be one of the strongest economic megatrends of the next few decades. The three companies above represent excellent long-term investments to take advantage of the coming infrastructure boom. They each have the expertise, financial resources, and innovative technology to remain leaders in their industry. Investors can expect solid (if sporadic) dividend growth and robust capital gains in the decades to come.
