Image Source: National Oilwell Varco corporate website.
After National Oilwell Varco (NOV -0.16%) posted earnings last week that showed another leg of decline, investors are likely getting fixated on a recovery. When it will happen? To what level will oil prices rise? How quickly can National Oilwell Varco respond to an uptick in business?
Trying to time oil's recovery, or where prices will end up recovering to, is an exercise in futility; but knowing how NOV will react once prices rise again can help you make better investment decisions. The trouble is, National Oilwell Varco's diverse business model means it's not a simple answer. So let's take a look at the different business segments at National Oilwell Varco, how they will respond to a recovery, and how you should treat the company as a whole.
Different segments, different drivers
There's a little bit of a misconception when it comes to National Oilwell Varco. It's assumed that the company has a couple of business segments that are centered around the building and resupplying of drilling rigs. In reality, the company has a much more diverse set of businesses under it, and each has its own unique drivers. To be fair, though, two of those business segments are the manufacture of land and offshore rigs, and those businesses are a dominant profit center for the company.
Image Source: National Oilwell Varco earnings release, author's chart.
A great example of how these different segments react to the market is the wellbore technologies segment. This is the part of the business that supplies tools and parts that are specifically used in the well itself. Think rentals of equipment that manages drilling fluids and downhole instrumentation tools.
These pieces of equipment are affected more directly by spending levels of producers as they go out and spend on new wells. Conversely, building new rigs is slightly more separated from the direct spending of producers because most of its clients are the companies that own the rigs, and need to manage their fleets.
While it may not sound like a huge difference, those little nuances will mean that different business segments will react differently as the market declines, and when it does eventually recover. Some business segments could pick back up overnight, while others might not see a significant improvement for a couple of years.
The quick turnaround
As oil prices start to rise to more sustainable levels, there will be a chain reaction across the entire oil and gas industry. Before we see any significant changes to the status quo, producers will likely look to stash some cash and bolster balance sheets. After all, even the better-off producers have been bleeding cash for coming up on two years.
Once they have some semblance of cash flow generation, then we will likely start to see drilling activity pick back up again. For National Oilwell Varco, this will likely lead to immediate work for a few segments, such as equipment rentals, rig repairs and servicing, and downhole tool sales. Most of these businesses are lumped in with the company's wellbore technologies segment; and just as it has been one of the segments to decline rapidly as oil prices slide, it will be the first segment to see a robust recovery.
The slower recovery
For many of the other businesses at NOV, there is a second challenge to get over: excess equipment in the market. In a little more than a year, 1,350 rigs have gone from being active in the field to idle in a company lot somewhere. This poses two headwinds. First, so many extra rigs lying around means that it will take a while before anyone's ordering new rigs en masse; and second is that many of those idle rigs can be stripped for parts.
These are like having a huge inventory build, and National Oilwell Varco's spare-parts business will suffer until that inventory of parts and equipment is drawn down. This means that segments such as rig aftermarket and rig systems will recover at a much slower pace.
The slowest segment to recover will be the company's sales of offshore rigs. Offshore drilling and production take longer to implement than land and shale drilling in the first place, and then add the fact that the offshore rig market is absurdly oversupplied with rigs right now. This means that sales increases in this segment will not likely happen until producers clean up balance sheets and start to spend in the offshore environment; then rig owners need to clean up their balance sheets, get the rest of their fleets employed, and then see contract rates climb enough to justify bringing on new rigs. This long lag could mean that offshore rigs may be a couple of years away from a recovery.
What a Fool Believes
The one benefit for National Oilwell Varco is that all of these separate business segments that play a different role in that chain reaction are under one corporate roof. Therefore, the company is going to be able to capture the benefits at different stages of the cycle. It may take a while for new rig orders to come in, but the company should be able to make up for it with parts and servicing work along with sales and rentals of equipment that go directly to producers.
For investors, it will pay to be patient with National Oilwell Varco as the market recovers. It may not recover as quickly as a company that specializes on one aspect of the oil services segment, but gradual improvement could last for quite a while.
