Schlumberger (SLB +1.80%) has several tailwinds working in its favor. It's putting up solid growth across each of its core businesses, including reservoir characterization, drilling, and energy production. In addition, the company is experiencing strong performance across its key geographic areas of focus, including North American onshore development, offshore deepwater, and international markets.
Not surprisingly, the stock has followed suit by registering solid gains so far in 2014. This begs the question, whether Schlumberger's success has been priced in. Fortunately, the stock isn't over-priced at all. Given its strong growth prospects and a valuation that remains modest, there is enough reason to believe Schlumberger may have further room to run.
Valuation looks attractive
To be sure, Schlumberger isn't a screaming bargain. Value investors may be turned off by its trailing P/E ratio of 20, since the S&P 500 Index holds a trailing multiple of about 19. On this basis, the stock looks overvalued when compared to the broader market. However, it's equally important for investors to look ahead as it is to look in the rearview mirror. It's critical to understand the next direction a company is likely to take, and put its trailing valuation into better context.
Schlumberger isn't a lumbering giant clinging to an above-average valuation. It's growing, and is expected to continue putting up solid growth throughout the remainder of the year. Schlumberger reported 8% revenue growth and 15% growth in pre-tax operating profit last quarter, year over year. Year to date, revenue and pre-tax operating profits were up 7% and 18%, respectively. All areas and all groups of the company registered growth last quarter, which management credited to the company's execution and the penetration of its new technology. This gives management enough confidence to predict a good year in 2014 overall. In its last quarterly conference call with analysts, management maintained its forecast for modest growth this year.
Because of this, Schlumberger's forward-looking valuation looks much more comfortable. The stock trades for 15 times forward earnings estimates, which actually represents a discount to the S&P 500. That means Schlumberger is expected to grow earnings at a higher clip than the rest of the market. As a result, right now could be a good time to buy the stock.
Share repurchases and balance sheet strength will support valuation
In addition to its earnings growth potential, Schlumberger's forward valuation is likely to expand because the company aggressively buys back stock. Last quarter alone, Schlumberger bought back 11.53 million of its own shares for a total cost of $1.17 billion. These share repurchases will boost earnings per share even further. That's because with a lower share count, each remaining share becomes more valuable as it captures a higher portion of the company's income.
In addition, Schlumberger holds a very good financial position. A company that has a strong balance sheet offers investors an extra margin of safety because investors know the company can more easily endure a business downturn. To that end, Schlumberger holds $11.7 billion in long-term debt, compared to $40.7 billion in shareholder equity. This equates to a long-term debt to equity ratio of 29%, which is a very comfortable level. Schlumberger also has $6.7 billion in cash, so it's clear that current and long-term debt is not a huge concern.
Now looks like a great time to buy
Schlumberger is a highly profitable company operating a great business model. It caters to energy companies across several different types of industries, and it offers its services in countries around the world. The results speak for themselves, as Schlumberger is putting up very good growth numbers to start the year.
Even better, the stock does not appear overvalued by any means. Going forward, continued growth prospects result in a modest valuation that could represent a compelling entry point for investors.
