Is National Oilwell Varco Inc. About to Become an Income Investor’s Dream Stock?

National Oilwell Varco’s cash flow is growing, creating the dilemma of what to do with that cash.

May 15, 2014 at 10:45AM

West Vencedor Web

Photo credit: Seadrill 

National Oilwell Varco (NYSE:NOV) has a big problem that only seems to grow over time. While the oil-field services specialist's business might not be firing on all cylinders, that's not stopping its cash flow from growing, nor is it doing any damage to the company's solid balance sheet. At some point the company will have to use that cash.

A wealth of options
While this is a problem most of us would love to have, it's an issue that not all companies can properly manage. Some companies use excess cash to repurchase cheap stock, but poorly timed buybacks have been known to incinerate shareholder capital. That said, companies such as Baker Hughes (NYSE:BHI) are actually using buybacks to increase earnings per share and create value for investors.

Meanwhile, others will go on an acquisition spree, which few are able to pull off to create value. National Oilwell Varco has had a lot of success with this strategy in the past. However, it's actually been too successful, which is why the company is now swimming in cash. 

The third option is to just return that cash to investors in the form of a bigger dividend. Companies such as Seadrill (NYSE:SDRL) have made their living in paying shareholders a massive dividend, which has unsurprisingly been well received by investors

Stock Market

Photo credit: Flickr/Francisco Diez 

If history is our guide
One reason National Oilwell Varco can create value through acquisitions is its strong discipline. While the company has acquired more than 300 companies over the past dozen years, according to former CEO Pete Miller, each buy had a specific purpose. That makes its acquisitions lumpy, so cash might build up before the company finds the right target at the right prices.

That lumpiness has the company actually considering a stock buyback for the first time. That's a surprise to many -- so much so that one analyst on the company's last conference call, Michael Kirk Lamotte of Guggenheim Securities, asked (and I quote), "Did I hear the words share repurchases come from your -- come forth from those lips?" New CEO Clay Williams noted that the company had always considered buybacks and even had one at Varco before the 2005 merger with National Oilwell. He also pointed out that the company was aware of the math on a buyback, which as Baker Hughes showed this past quarter can add to earnings per share. However, acquisitions and, more recently, dividends had become the priority uses for its excess cash flow.

All that being said, and despite Baker Hughes' buyback success, we're likely to see National Oilwell Varco actually go the Seadrill route and boost its dividend before it starts buying back stock. Since initiating the dividend in 2009, the company has steadily grown its payout, including doubling it last year. However, at 1.29% it's not exactly a dividend investor's dream stock; for comparison, Seadrill currently yields 11.42%.

On the conference call, Williams said the company was "looking hard at a meaningful increase to its dividend again." The question is by how much the company will boost its payout.The company's dividend payout ratio has averaged about 18% over the past 12 months. Meanwhile, its industry peers are paying out roughly 29% of earnings in the form of a dividend. This suggests we might actually see another significant dividend boost again this year, with the company having the capacity to double the payout again. While that won't put the yield anywhere near Seadrill's level, it could push it up over 2.5%, which is a pretty decent payout these days.

Investor takeaway
Bottom line here is that National Oilwell Varco appears poised to give investors a big dividend boost this year. While that won't make the stock a dividend investor's dream, it is certainly heading in the right direction.

 Dividends

Photo credit: Flickr/LendingMemo.com].

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Matt DiLallo owns shares of Seadrill. The Motley Fool recommends National Oilwell Varco and Seadrill. The Motley Fool owns shares of National Oilwell Varco and Seadrill. 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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