Expanding Margins Will Lead Weatherford International Higher

Expanding margins and more cash to pay down high debt levels will help Weatherford International reward shareholders with higher stock prices.

Jul 23, 2014 at 3:23PM

Recently, Weatherford International (NYSE:WFT) sold drilling assets in Russia and Venezuela to further transition away from unprofitable businesses that never achieved the expected margins. Investors can quickly compare the numbers to the solid international margins of Schlumberger Limited (NYSE:SLB) and Halliburton (NYSE:HAL) to quickly grasp how far off course Weatherford had steered in the process of expanding internationally.

The oilfield services laggard has turned to improving operations after a few years of working out accounting and tax issues. Weatherford has taken several previous steps to improve operations with the hopes of growing margins. Even after the recent gains in the stock, Weatherford continues to trade at low revenue multiples, showing how much of an impact the low-margin drag has had on the stock.

Rosneft deal
About a week ago, Weatherford unloaded the company's land drilling and workover operations in Russia and Venezuela for $500 million in cash. The deal includes 61 land drilling crews and a fleet of workover rigs with approximately 8,200 employees transitioning to Rosneft, mostly in Russia. The deal involves roughly half of the revenue Weatherford produced in Russia, but in the process the company will possibly strengthen a business relationship with Rosneft for the core product lines going forward.

The deal follows a previous $250 million asset divestiture of the pipeline and specialty business and a restructuring of the workforce with expected pre-tax annualized savings of $263 million. In addition, it precedes a plan to IPO the remaining international land drilling rigs focused on the Middle East. Weatherford currently operates 115 international drilling rigs and plans to reach the public markets in early 2015.

Will higher margins lead to higher multiples?
During the first quarter, Weatherford had already made substantial progress in improving margins. At the time, the company provided margins of 15.1% in the core product lines and a negative 5.8% in the non-core product lines, including the recently sold land drilling units.

As an example of the weak international margins and the need to unload these weak product lines, Weatherford only produced operating margins of 6.9% for the Middle East/North Africa/Asia region and 8.1% for the Europe/Africa/Russia region. Total international margins actually increased 278 basis points sequentially despite a weak revenue showing due to weather.

One quick look at the massive margins from industry giant Schlumberger and it's very obvious why Weatherford needed to cut operations that weren't producing solid profits. For the just announced second quarter, Schlumberger produced a substantial 24% operating margin from the international operations. The North American division only generated 18% margins for the quarter, but it was still substantially above the margins produced by Weatherford.

Even Halliburton, which is more focused on North American drilling, forecasted international margins from the Eastern Hemisphere to reach an average in the upper teens for 2014 after hitting 16.1% in the second quarter.  

Bottom line
Weatherford continues selling segments and raising cash to better focus on its most profitable divisions. Not to mention, the cash obtained from these asset sales will help reduce the substantial debt load, which is still expected to sit at $7 billion at year end.

The margins obtained by Schlumberger and Halliburton are prime examples of why Weatherford needed to sell off weak operations and focus on the profitable divisions. With the company no longer chasing bad businesses with good money, the stock could have more upside, selling at only 1.1x revenue estimates while the larger players trade at 2x and 3x revenue expectations. Investors will want to key on the margin improvements in the upcoming second quarter report where solid gains will send the stock higher.

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Mark Holder and Stone Fox Capital clients own shares of Weatherford International Ltd.. The Motley Fool recommends 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.

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