Is It Time to Buy National Oilwell Varco's Stock?

Breaking down National Oilwell Varco by its competition and stock value.

Sep 4, 2014 at 10:02AM
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Investing is simple. All you need to do is: 1) Identify great companies that generate superior returns, and 2) buy them at a decent price. As easy as it sounds on paper, it's extremely more difficult to do in practice. By just about all accounts, National Oilwell Varco easily passes the first test. Its leading position as an oil and gas equipment & services provider gives it a massive competitive advantage over many of its competitors. The more important factor with NOV is the second part: when to buy shares.

To help you better understand when to buy shares, let's take a quick look at why National Oilwell Varco is one of the best investments--if not the best investment--in the world of oil and gas services, as well as whether shares are worth buying today. 

National Oilwell Varco's case that it's the best investment

It's actually not that easy to find a comparable company to NOV. It has the size and scale of major diversified oil field services companies such as Halliburton and Schlumberger, but National Oilwell Varco is more about the sale of equipment than contract services like these companies are. At the same time, its most direct competitors in the sale of oilfield equipment--Cameron International and FMC Technologies--don't have the size or scale to match National Oilwell Varco. Today, more than 80% of floating offshore rigs have a National Oilwell Varco drilling package on them--a package refers to all of the oil drilling related equipment on the vessel. 

These two factors--dominant market share and a more specialized market compared to general oilfield services--all add up to superior free cash flow generation. When compared to its peers on a levered free cash flow margin, it's not even close

Company Levered Free Cash Flow Margin
National Oilwell Varco 18.93%
Halliburton 6.09%
Schlumberger 11.69%
Cameron International 3.36%
FMC Technologies 6.63%

Source: S&P Capital IQ

The ability to generate so much free cash is an extremely valuable trait, because it gives management a little extra wiggle room to make strategic acquisitions or to throw off cash to shareholders. With its free cash flow, it has been able to make over 300 strategic acquisitions in a 12-year span while remaining essentially debt free when you account for cash. At the same time, the company still easily supports a 2.1% dividend yield. 

It's awfully hard to argue against those numbers. Add to that National Oilwell Varco's sizable competitive advantages in the oil and gas equipment industry, and it's a pretty convincing case that National Oilwell Varco should be on the top of your list for stocks to buy.

Scouring through the numbers

Investors who are new to the energy space can get fooled that they are buying a company for a great value because it is cheap when compared to the S&P 500 average. Here's the problem with that theory; the energy sector habitually trades at a discount to the broader market because oil, gas, or any other type of energy is a commodity and is therefore likely to suffer cyclical booms and busts. Just to give you an idea of this deep discount, the Robert Shiller adjusted price-to-earnings ratio for the entire energy sector sits at only 15.9x while the broader S&P 500 has a Shiller adjusted P/E of 26.3x.

Now that we have calibrated our expectations for energy companies in relation to the broader market, here's a look at the numbers for National Oilwell Varco. By just about every metric out there, NOV trades at a pretty decent discount to its oil services and equipment manufacturing peers. This may seem a bit absurd, but the most likely reason is that a large amount of National Oilwell Varco's revenue comes from big ticket items like drilling rigs and drilling packages for floating vessels. I'm not saying that it's a good reason to be selling at a discount, but it's a possibility.

Company Price/Earnings Enterprise Value/EBITDA Enterprise Value/Total Revenue Price/Tangible book value
National Oilwell Varco 16.02x 7.85x 1.46x 4.12x
Halliburton 20.3x 9.8x 2.1x 4.7x
Schlumberger 21.1x 11.4x 3.1x 7.1x
Cameron International  22.4x 11.4x 1.7x 10.1x
FMC Technologies 22.0x 13.0x 2.0x 8.1x

Source: S&P Capital IQ

So NOV is cheap compared to its peers, but what about compared to itself? Let's take a look at the mean historical valuation metrics for National Oilwell Varco:

National Oilwell Varco valuation Historical mean value (last 10 years)
Price/Earnings (TTM) 21.95x
Enterprise Value/EBITDA 11.3x
Enterprise Value/Total Revenue 1.83x
Price/Tangible book 5.23x

Source: S&P Cap IQ

So even from a historical perspective, National Oilwell Varco looks pretty cheap. One thing to keep in mind, though, is that shares of NOV traded at wildly egregious premiums between 2004 and 2007 because, at the time, there was a large surge in orders for offshore rigs.

Bloomberg Rig Order History

Source: Bloomberg Industries

So while historical valuation may give you a better idea of what the company looks like today, just take NOV's numbers with a grain of salt because of its overpriced days.

The Buffett barrier

Since National Oilwell Varco's historical numbers may be a little artificially inflated because of years past, let's take another approach by comparing it to when Berkshire Hathaway started to buy shares. While it has been slowly adding to its position, its first acquisition was in the second quarter of 2012. At the time, shares of NOV looked a little something like this:

National Oilwell Varco valuation Period during Berkshire Hathaway's initial acquisition (Q2 2012
Price/Earnings (TTM) 18.73x
Enterprise Value/EBITDA 8.83x
Enterprise Value/Total Revenue

2.14x

Price/Tangible book 4.58x

Source: S&P Capital IQ

Although the numbers are a little bit more modest than the historical valuation for the company, it still is higher than what shares trade for today. It's no wonder, then, that Berkshire has added to that position considerably since the original purchase. 

What a Fool believes

There are an awful lot of things going for National Oilwell Varco's stock. Not only is the company behind those shares a rock-solid investment, but based on its valuation compared to its peers and its historical valuation it looks like a good value. NOV is a company in a cyclical industry, so don't be surprised if shares wax and wane over a long-term investment. Don't let that dissuade you from this stock, though. Personally it is a company I own and based on prices today I will likely be adding to that position soon.

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Tyler Crowe owns shares of Berkshire Hathaway and National Oilwell Varco. You can follow him at Fool.com under the handle TMFDirtyBird, on Google+, or on Twitter @TylerCroweFool.

The Motley Fool recommends Berkshire Hathaway, FMC Technologies, Halliburton, and National Oilwell Varco. The Motley Fool owns shares of Berkshire Hathaway and National Oilwell Varco. 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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