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Why Schlumberger Is the Best Pick in Oilfield Services

By Arjun Sreekumar - Jul 29, 2014 at 2:07PM

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Schlumberger’s world-class products and services, strong financial position, and compelling valuation make it an attractive stock.

Oilfield services companies provide upstream operators with the necessary equipment and services to extract oil and natural gas from increasingly challenging operating environments. As such, their profits depend largely on the level of upstream spending. Luckily, oil prices are high and expected to remain high, which bolsters the case for continued growth in upstream spending.

Against this favorable macro backdrop, Schlumberger appears especially attractive, given its leading market share in most product and service lines, its solid financial footing and shareholder-friendly policies, and its compelling valuation. For these reasons and more, Schlumberger may be one of the best picks among large-cap oilfield services names.

Photo credit: Flickr/Nestor Galina 

A world-class operator
Schlumberger is the world's largest oilfield services company, with peer-leading technological solutions and dominant market share in a number of operating regions and product lines. It currently commands first or second market position in products and services including hydraulic fracturing, wireline logging, drilling and completion fluids, directional drilling, production testing, and seismic data acquisition.

The company maintains this dominant market share through heavy investment in research and development, which allows it to continuously introduce innovative solutions to the upstream industry's most challenging problems. For instance, it recently launched its Geosphere reservoir mapping-while-drilling service, which helps customers optimize production and reservoir management.

In addition to its industry-leading offerings, Schlumberger has another major advantage over peers: a highly diversified revenue stream. The company's $45.3 billion in revenue last year was spread quite evenly across its four major operating regions: North America contributed about 31% of revenues, Latin America about 17%, Europe/CIS/Africa roughly 27%, and the Middle East and Asia about 24%.

By comparison, peer Halliburton is much more heavily exposed to North America, which accounted for about half of its full-year 2013 revenues. This diversified geographic footprint means that Schlumberger is less vulnerable to weakness in a single operating region relative to peers like Halliburton.

Shareholder-friendliness and strong financial footing
Schlumberger is also a free cash flow monster. In the first half of this year, it generated $1.9 billion of free cash flow, up from $1.4 billion in the prior-year period. Coupled with continuous improvements in operational efficiency, this strong cash flow generation has helped the company build up a fortress-like balance sheet that held nearly $3.5 billion in cash and equivalents as of the end of the second quarter.

This robust financial footing allowed the company to comfortably increase its dividend by 28% earlier this year, while also reducing its net debt by around $700 million. It has also returned a ton of cash to shareholders through share repurchases, having bought back $2.6 billion worth of shares in 2013 alone. Schlumberger's large cash balances and exceptional free cash flow generation also improve its ability to withstand cyclical fluctuations in demand for its products and services relative to peers.

While its current dividend yield of 1.5% isn't all that appealing, the company expects to return 75% of its earnings to shareholders through dividends and share buybacks in coming years. You'd be hard pressed to find that kind of return of capital anywhere in the energy industry outside of master limited partnerships, which are required by law to pay out the lion's share of their earnings to shareholders.

Compelling valuation
Despite its remarkable earnings power, leading market share, robust balance sheet, and shareholder-friendly policies, Schlumberger currently trades at a slight discount to the market. Shares currently change hands at 16 times forward earnings, a premium to peer Halliburton's 14 P/E multiple, but nonetheless a slight discount to the S&P 500.

Considering the company's aforementioned advantages and the fact that it expects to grow its earnings per share at an average annual rate of 17% to 20% over the next few years, it may deserve a higher multiple. Assuming oil prices remain high and upstream spending stays strong, Schlumberger could climb a lot higher over the next few years.

Arjun Sreekumar has no position in any stocks mentioned. The Motley Fool recommends Halliburton. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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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