Image source: National Oilwell Varco.
In an interview with The Motley Fool, NOW Inc. (DNOW 4.27%) Chairman Pete Miller explained the reasoning behind spinning off NOW from National Oilwell Varco (NOV 1.45%) into a standalone business. The largest part of the deal was because NOW was big enough to be its on business now. As Miller described, though, an added benefit is that both companies are a little easier to understand:
We think it's going to give the analysts -- people like you -- a better opportunity to be able to look at the company and say, "OK, I understand this part of it, and I understand this part of it," and probably get a better valuation because of that.
It appears that even though the spinoff has been wildly successful for both companies -- shares of DNOW and NOV are up 14% and 12%, respectively, since the split in May -- analysts still don't quite understand this company because it's still undervalued compared with both its peers and the broader market. Let's look at what National Oilwell Varco looks like post-split and how much it's undervalued compared with the other stalwarts of the oil services industry: Schlumberger (SLB 0.08%) and Halliburton (HAL -0.34%).
Same name, new look
While NOW was once part of national Oilwell Varco, they are both very different businesses from a financial standpoint. National Oilwell Varco, as it exists today, is almost exclusively an equipment manufacturer for the oil and gas industry, whereas NOW is dedicated solely to the distribution and sale of equipment. As you can imagine, distribution and sale isn't exactly a high-margin business. In the last earnings report, where NOW was part of its former parent, operating margins in the distribution segment were a paltry 5.3% compared with its most profitable venture, rig technology, which earned a very healthy margin on 21% even thought the company saw a decline in business from weaker demand across the industry. The separation of NOW may cut into the total revenue generated, but it certainly helps to boost margins and helps increase its case as an investment compared with Halliburton and Schumberger.
| Company | Total Revenue (Q1 2014, in Millions) | Operating Income Margin (Q1 2014) |
|---|---|---|
| National Oilwell Varco, as reported (includes NOW) | $5,777 | 15.2% |
| National Oilwell Varco, pro forma | $4,889 | 16.7% |
| Schlumberger | $11,239 | 18.9% |
| Halliburton | $7,348 | 14.1% |
Source: Company earnings release.
National Oilwell Varco, with its strong margins, squeaky-clean balance sheet, and quite possibly the most dominant position in rig equipment manufacturing, makes for a pretty compelling investing case.
Considering that from a financial standpoint, NOV is pretty much on par with Schlumberger and Halliburton, you would expect that the all three companies would be valued relatively similar. This simply isn't the case. On just about every measure, National Oilwell Varco trades at a pretty significant discount to both Schlumberger and Halliburton as well as the S&P 500 average.
| Company/Index | Enterprise Value/EBITDA (TTM for Companies, Current for S&P) | Price/Earnings (TTM for Companies, Current for S&P) |
|---|---|---|
| National Oilwell Varco | 8.1 | 14.8 |
| Schlumberger | 12.4 | 21.3 |
| Halliburton | 10.4 | 22.4 |
| S&P 500 Index | 13.01 | 19.42 |
Sources: S&P Capital IQ and gurufocus.com.
What a Fool Believes
The oil services industry is a cyclical one. For National Oilwell Varco, it is likely in one of those down cycles in its largest revenue source, rig technology. With hundreds of new rigs set to hit the open waters this year and next, several rig companies are slowing their newbuild programs to let the market catch up. This will likely mean that the company won't be able to grow organically as much as it has in the past couple of years. However, National Oilwell Varco is in a fantastic position, finacnially and strategically, once that market picks up again. For the long-term investor, now could be a great time to add NOV to your portfolio or even pick up a few extra shares.
