If you want to invest in the oil and gas industry, but you don't want your company's prospects be completely reliant on the whims of oil prices, National Oilwell Varco (NOV -1.62%) might be your kind of stock. As an equipment and services supplier to oil companies, it taps into an industry that spends hundreds of billions of dollars every year to keep the oil flowing. However, just because the company is less exposed to oil prices than actual production companies doesn't mean it is immune from falling share prices.
I can't say with any certainty what the company's shares will cost in the future. There are simply too many unknown variables that could send it off track. However, this article will look at three risks that investors should watch for.
1) Vulnerability to industry cycles
Some aspects of National Oilwell Varco's business are pretty much bulletproof. Equipment and components that regularly need replacing (for example, drill bits) will always be in demand. However, this is only one sector of the business, while the primary generators of revenue are big-ticket items such as rigs and floating production, storage, and offloading facilities.
These items are highly dependent upon the cycles of the oil and gas industry. When companies are flush with cash from high oil prices, orders for these types of equipment are in abundance; but when a few too many rigs are on the market and can't find work, new orders dry up rapidly. To give you a better idea of these trends, this chart shows orders for jackup and floating drill rigs since the 1980s: When oil prices are high, companies can't buy enough of this equipment, but that doesn't last when oil prices slump.
Source: Bloomberg.
While this might not necessarily lead to a structural decline in National Oilwell Varco's overall business, it can certainly impact share price. Someone who buys into the company at the peak of one of these cycles might have to wait some time before seeing a return on that investment.
2) Beholden to American tax laws and (more important) sanctions
Selling oil and gas equipment is a global business. National Oilwell Varco has operations in over 60 countries today, and more than 65% of the company's revenue is generated outside the United States. Having this much exposure to international markets is extremely attractive, but being an American company means that if Uncle Sam has a disagreement with a certain country, National Oilwell Varco might need to close up shop there.
The best example of this today is Russia. Certain tight oil and shale gas formations in the country contain trillions of barrels of oil, and Russia's share of Arctic resources is absolutely massive. To access these more complex oil and gas reservoirs, companies will need the equipment that National Oilwell Varco provides. However, many Western sanctions put in place against Russia as a result of the ongoing conflict in eastern Ukraine specifically relate to the sale and export of technology needed to access this oil. If National Oilwell Varco is banned from selling its goods in this high-demand market, it could lose significant market share to foreign companies that are not under the same strictures.
3) More than 10% of revenue comes from a single customer
There aren't many companies that manufacture drilling rig packages -- a term for any piece of equipment related to drilling on a floating vessel. National Oilwell Varco is estimated to have about 80% of the drilling package market, giving it a huge platform for both newbuild packages and aftermarket replacement equipment. The one catch, though, is that there are few companies building the ships that require this equipment, which means National Oilwell Varco makes lots of sales to a small handful of companies.
One company, Samsung Heavy Industries, is responsible for over 10% of National Oilwell Varco's nearly $23 billion in annual sales. After all, it is one of the world's largest ship builders. Losing a customer like Samsung would significantly cut into the company's prospects. One advantage that National Oilwell Varco has in this realm is that Samsung's customers -- rig owners, integrated oil and gas companies, etc. -- will likely ask for NOV products in the specifications of the rig. Nonetheless, maintaining strong partnerships with customers such as Samsung Heavy will go a long way in determining future revenue for National Oilwell Varco.
What a Fool believes
There are many reasons a company's stock could drop. Some of those reasons are sound, while others are overreactions from Mr. Market. Knowing the difference between the two can go a long way in making better investments. In the case of National Oilwell Varco, swings in oil prices and analyst calls could send prices in the wrong direction, but they are rarely indicative of the company's long-term prospects. Overall, there are several reasons to believe that National Oilwell Varco will be a strong business for many years to come. However, the three vulnerabilities listed above could have a significant impact on the share price and could mean that a poorly timed investment might not produce a good return.
Matters such as relationships with customers and political action are hard to predict. It's just one of the risks you will have to live with as an owner of this company. Watching market demand for new rigs, though, should give you a better idea of where the industry is in terms of business cycle and should help you determine the right time to invest.
