Oil and gas services provider Schlumberger (NYSE:SLB) is having a very good run. The company is posting higher revenue and pre-tax operating profit so far this year, as it's benefiting from its industry-leading solutions and increased demand in its key markets. As a result, the stock is having a good run as well, and has registered solid gains this year.
However, the possible downside case should be considered for any stock. After all, stocks always carry a certain set of risks, even when times are good. With that in mind, here are three specific reasons why Schlumberger stock could fall.
Falling oil prices
Recently, the price of oil has declined rather significantly in a relatively short amount of time. Crude oil is all the way down to $91 per barrel in the United States. This is down from $102 per barrel just a few weeks ago. This is meaningful for Schlumberger because Schlumberger relies on its customers' recurring usage of Schlumberger's technology and services. If oil prices continue to decline, oil and gas companies could curtail new projects, in light of the prospect of lower returns. New drilling activity is partially dependent on oil prices, so if oil keeps declining, Schlumberger could see lower demand for its services.
Strong activity was the primary reason why Schlumberger's second-quarter revenue in North America rose 6% just since the previous quarter. Onshore land revenue increased by double-digits last quarter thanks to a 5% increase in rig counts. Investors should keep an eye on oil prices going forward, because if crude continues to fall it could incentivize less new rig placements.
Exposure to Russia
Energy companies doing business in Russia are at risk, because of the heightened level of geopolitical risk due to the ongoing conflicts in eastern Europe. Schlumberger is also exposed, and the continued pressure for companies operating in Russia could adversely affect the company.
In Schlumberger's most recent earnings report, Russia was highlighted as a source of strength. Management specifically cited increased activity in Russia as a major reason why Schlumberger produced a 13% revenue growth in Europe and Africa. This segment led the way for Schlumberger's international operations last quarter. If the situation in Russia deteriorates, management probably won't have such great things to say in the next quarterly report.
If things go south in Russia, this will have an impact on Schlumberger's European segment. This matters a great deal to the overall business, because the combined Europe and Africa segment comprises approximately 27% of total revenue.
Valuation with room to contract
Schlumberger stock has provided good returns this year, and as a result it holds a valuation that is slightly higher than the overall market. Schlumberger trades for about 20 times trailing earnings per share. Looking in the rearview mirror, it's clear that Schlumberger has put up solid growth to support its expanding valuation. But given the potential headwinds mentioned above, Schlumberger could be at risk of a decline if its growth disappoints going forward. In order for Schlumberger to keep its above-average multiple, it needs to produce above-average growth, which may not occur if oil prices and Russian operations don't remain supportive.
The Foolish takeaway
Schlumberger has had a good year. Revenue and pre-tax profit is up at satisfactory rates so far in 2014, but this may not always be the case. Schlumberger needs a number of things, including oil prices and European operations, to work in its favor for its success to continue. Management expects a good year, but things have changed quickly, even since its last quarterly report. This is especially true when it comes to the ongoing geopolitical tensions in Russia. This could impact the company's ability to grow, and with a valuation that is far from cheap, a bearish thesis is far from impossible.
Bob Ciura has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.