Image Source: National Oilwell Varco corporate website.
With oil prices down, drilling activity drying up, and an excess supply of drilling equipment on the market, there wasn't much that could keep National Oilwell Varco (NOV 0.64%) from posting another down quarter. But when it comes to investing in NOV, cyclical downturns are part of the game. It's all about riding through the downturns until the industry inevitably turns back up again.
When that will happen is anybody's guess, but National Oilwell Varco's management spelled out what it will take for the market to turn during its most-recent conference call. Here are five quotes from management that explain what the company is seeing in the oil and gas market, and what investors in NOV should and shouldn't be concerned about.
When the market turns, this is why it will happen
Oil and gas producers have to spend more money constantly to keep up with declining supply and increasing demand, but as CEO Clay Williams points out, companies all around the world are not doing that right now.
The industry has not seen 2 years of declining CapEx since the 1980s, signaling the severity of the downturn we find ourselves in. We believe many, if not most, North American producers in OPEC countries are producing existing fields close to maximum levels, trying to offset lower revenues due to oil price declines with higher volumes while sharply reducing drilling activity. OPEC and non-OPEC production are up year-over-year. This is not sustainable. Production will begin to decline naturally as it has begun to in the United States, and therein lies the seeds for a recovery. -- CEO Williams
Oil and gas reservoirs decline; it's simple high-school physics. When companies don't look to enact projects that manage this decline effectively to run at full speed, it makes those decline rates happen much more quickly. Without drilling activity to replace those declining production centers as Mr. Williams mentioned, then it could catch up to the industry. The path toward more oil and gas activity is known; it's all about how long it will be until we get there.
Attractive acquisitions are out there, but we're not rushing into it
National Oilwell Varco has largely built its company through a slew of mergers and acquisitions during the past couple of decades. Because of all this practice at buying companies, management has become pretty good at it. With the market where it is, there are lots of attractive acquisition options out there; but it doesn't look as though management is in any rush to make a deal.
As the downturn has lengthened, we believe values of potential target companies will become more and more compelling. Thus far, it has been challenging to bring the bid and the ask on potential acquisitions into alignment, but we remain patient and disciplined in these discussions. -- CEO Williams
With spending levels expected to be low in 2016, chances are the prices for some potential buy targets will come down. When that happens, NOV will likely pounce.
Companies preserving cash, but it can't last forever
Many producers out there have touted cost savings that have allowed them to lower per-barrel costs to levels that are close to current prices. While some of those cost-cutting efforts can be carried over into operations permanently, there are other methods that simply can't last. As Mr. Williams put it, some of these efforts can't continue indefinitely.
During such a cyclical pause, our biggest competitor becomes the overhang products and consumables and equipment that our customers cannibalize extremely effectively in their Darwinian quest to preserve cash. The idled rigs and pressure-pumping fleets and wireline units and a myriad of other items we sell are being systematically stripped of spare parts and components to keep the much smaller fleet of units that remain under contract, working. This remains a highly capital equipment-consumptive industry. The life expectancy of mechanical equipment is tied to the footage it drills or the volume of profit it pumps. The ability of the industry to increase borehole created per year or stages fracked per year means that the physical consumption of mechanical equipment per year has also risen sharply, probably linearly. -- CEO Williams
There's only a limited supply of extra parts lying around for producers and other oil services companies to pilfer from idle equipment. Once those parts are exhausted, chances are they'll be lining up to order new ones from NOV.
Still plenty of financial strength to lean on
Despite the decline in business, the company is still generating cash at a decent clip to cover its capital expenditures and its dividends. However, with shares as low as they are, the company is utilizing some of its balance-sheet strength to buy back shares.
For the quarter, the company generated $410 million in cash flow from operations. Offsetting this cash flow were share repurchases of $444 million, dividend payments of $174 million, investments in our business of $124 million and FX impact on our cash balances and other items totaling $44 million. The net impact of our cash flow for the quarter was a $376 million increase in net debt. However, total debt decreased $322 million as we successfully repatriated $1.1 billion to the U.S. We ended the quarter with a cash balance of $1.8 billion, $4 billion in debt, and our net-to-debt capitalization was 11.8%. -- CFO Jose Bayardo
With close to $2 billion in cash and a net debt-to-EBITDA ratio of 0.69x, there's very little fear that the company is in any sort of financial distress.
The one red flag to watch
If there's one aspect of the business that should concern investors, it's National Oilwell Varco's exposure to Brazil. With Petrobras (PBR 1.43%) mired in a sweeping corruption scandal, and its finances getting stretched thin, there's a chance that some of the rig orders for its deepwater fields may get cancelled. For NOV, there's a decent amount of exposure in its backlog:
Brazilian rigs totaled $3 billion of the $8 billion in our September 30 backlog and accounted for only $53 million of revenues during the third quarter. As we reported previously, we have suspended or delayed work on certain of these 22 rigs. Our shipyard customers are continuing to work with their customers at Sete to address overdue funding needs and future funding to move the projects forward. In the meantime, we are reducing costs in-country. -- CEO Williams
Chances are that National Oilwell Varco won't need to cut ties with all of these projects; but getting ahead of this, and proactively reducing its exposure to Brazil, is a good thing.
