What's Behind Schlumberger's New $168 Price Target?

Some analysts believe that Schlumberger's shares can hit $168 -- is this a likely scenario?

Jul 7, 2014 at 11:49AM

Over the last year, Schlumberger (NYSE:SLB) has jumped 65% and outperformed the S&P 500 by a staggering 44%. The past year has been exceptional for its shareholders, but will this performance continue?

Further to go
Morgan Stanley believes that Schlumberger can push higher. Around 43% higher in fact, and this news caused the company's shares to surge. But is this more Wall Street hopeium, or can Schlumberger really double from current levels?

To arrive at the price target of $168 per share, analysts at Morgan Stanley have used Schlumberger's own forecasts. Schlumberger believes that through 2017, assuming that the oil and gas industry's capital spending grows by around 6% per annum, earnings per share should expand 15% per annum. On this basis, Schlumberger expects to earn $9-$10 per share by 2017.

On a forward P/E basis, these predictions mean that Schlumberger is currently trading at a 2017 P/E of 13.1 to 11.8, which is not overly demanding.

However, Morgan Stanley's analysts go a step further by factoring in Schlumberger's free cash flow yield to arrive at their price target.

So what free cash flow yields do Schlumberger and its peers offer? Well, according to Morgan Stanley, peers Cameron International, Dril-Quip, and FMC Technologies trade at free cash flow yields of around 3%, while Halliburton (NYSE:HAL) has a free cash flow yield of just over 1%.

Schlumberger has a free cash flow yield of about 3.5%. These metrics make Schlumberger look cheap compared to its peers while Halliburton, on the other hand, appears expensive.

What about that $168 target?
You may be asking how Morgan Stanley's analysts came up with a price target of $168 per share. They used Schlumberger's own forecasts which, as mentioned above, call for 2017 EPS of $9-$10 during 2017. Historically, the company has converted 75% of its earnings per share into free cash flow, which implies that by 2017 the company will be producing cash flow of $6.75-$7.50 per share.

Analysts then discounted this figure back at 10% for two years. Assuming that the company continues to trade at a free cash flow yield of 3.5% in 2017 gives you a price target of $168. At the high end of $7.50 in earnings per share Schlumberger's shares could trade at $200, assuming a free cash flow multiple of 3.5%.

A likely scenario
Working through the analysis above, it does seem as if Morgan Stanley's analysts have a point about Schlumberger's price target. What's more, it would appear that the company's peer Halliburton could actually be overvalued.

Halliburton, like Schlumberger, has put in a solid performance over the past few years, and this is set to continue. As shale oil projects become ever more prevalent around the world, Halliburton's services and products will be in demand. Additionally, Halliburton has the highest return on capital in its peer group and profit margins are widening.

However, with such a high valuation on free cash flow compared to that of peer Schlumberger, it does seem as if Schlumberger is the better pick, on a valuation basis anyway.

What's more, Halliburton has more exposure to the North American market, which makes the company more cyclical than Schlumberger. Unfortunately, companies with cyclical natures do not deserve higher valuations than their peers (in this case Schlumberger) that operate within more stable operating environments.

Foolish summary
Overall, based on Schlumberger's own forecasts, there is no reason to doubt the fact that the company's shares could hit the $168 price target set by Morgan Stanley's analysts.

On the other hand, there is evidence to suggest that at current levels Schlumberger's peer Halliburton could be overvalued. Schlumberger is set for rapid growth over the next few years and its shareholders are set to see the value of their holdings soar.

An energy tax "loophole"?
You already know record oil and natural gas production is changing the lives of millions of Americans. But what you probably haven’t heard is that the IRS is encouraging investors to support our growing energy renaissance, offering you a tax loophole to invest in some of America’s greatest energy companies. Take advantage of this profitable opportunity by grabbing your brand-new special report, “The IRS Is Daring You to Make This Investment Now!,” and you'll learn about the simple strategy to take advantage of a little-known IRS rule. Don't miss out on advice that could help you cut taxes for decades to come. Click here to learn more.

Rupert Hargreaves has no position in any stocks mentioned. The Motley Fool recommends FMC Technologies and Halliburton. 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.

Money to your ears - A great FREE investing resource for you

The best way to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as “binge-worthy finance.”

Feb 1, 2016 at 5:03PM

Whether we're in the midst of earnings season or riding out the market's lulls, you want to know the best strategies for your money.

And you'll want to go beyond the hype of screaming TV personalities, fear-mongering ads, and "analysis" from people who might have your email address ... but no track record of success.

In short, you want a voice of reason you can count on.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich," rated The Motley Fool as the #1 place online to get smarter about investing.

And one of the easiest, most enjoyable, most valuable ways to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as "binge-worthy finance."

Whether you make it part of your daily commute or you save up and listen to a handful of episodes for your 50-mile bike rides or long soaks in a bubble bath (or both!), the podcasts make sense of your money.

And unlike so many who want to make the subjects of personal finance and investing complicated and scary, our podcasts are clear, insightful, and (yes, it's true) fun.

Our free suite of podcasts

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. The show is also heard weekly on dozens of radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable. Rule Breaker Investing and Answers are timeless, so it's worth going back to and listening from the very start; the other three are focused more on today's events, so listen to the most recent first.

All are available for free at www.fool.com/podcasts.

If you're looking for a friendly voice ... with great advice on how to make the most of your money ... from a business with a lengthy track record of success ... in clear, compelling language ... I encourage you to give a listen to our free podcasts.

Head to www.fool.com/podcasts, give them a spin, and you can subscribe there (at iTunes, Stitcher, or our other partners) if you want to receive them regularly.

It's money to your ears.


Compare Brokers