When it comes to oil services companies like Weatherford International (NYSE: WFT), its hard to justify intangible aspects of a company like brand power. So when you are analyzing these kinds of companies, you really need to roll up your sleeves and look at the really important numbers such as financial ratios. After all, you can't get a great return on a company if you buy it for an exorbitant price. So let's get into Weatherford's financial ratios and compare it to other oil services companies in the space based on four themes: growth, margins, returns, and valuation.
To slightly adjust Gordon Gecko's famous phrase: Growth is good. The type of growth -- sales, EBITDA, net income -- might be more important than others, but if we can have all three the better, right? Oil services companies can see pretty large swings in revenue throughout the year -- have you ever tried to do anything in Northern Canada or on the Alaskan North Slope in the winter? -- so it's better to compare sales annually instead of quarterly. Here are the compound annual growth rates over the past three years for Weatherford and several of its peers.
|Company||Sales CAGR||EBITDA CAGR||EPS CAGR|
|Weatherford International||6.7%||7.1%||N/A (no earnings in last 12 months)|
|Baker Hughes Incorporated||9.9%||4.9%||(1.2%)|
|National Oilwell Varco||32.1%||13.1%||12.7%|
Well, at least Weatherford has been able to grow its sales and operational profits. Problem is, though, that these increases aren't flowing all the way to the bottom of the income statement. This has a lot to do with the fact that the company is making interest payments that are equivalent to 3.4% of revenue every quarter as well as large charges for things like impairment of goodwill and asset value writedowns. As long as it's making debt payments that big, it's going to be hard to grow the bottom line.
Oil services companies are at the disadvantage that they are pretty much beholden to the master that is capital expenditures from exploration and production companies. If producers want to spend less on new ventures and give more cash back to shareholders, revenue for oil services gets a little less robust and margins will decline. Oil services companies that have technology patents or have a corner on a particular market can stave off some of these issues, but oil is a commodity, and therefore anyone who deals with it is going to be subject to the swings in supply and demand.
|Company||EBITDA Margin||Change in EBITDA Margin (2011-2014)|
|Baker Hughes Incorporated||17.5%||(3.9%)|
|National Oilwell Varco||18.8%||(5%)|
Over the past few years Weatherford has struggled to maintain strong margins compared to its peers in large part because it has several business segments that have barely turned a profit. To be fair, though, almost all companies in this space have seen margins decline as certain services such as hydraulic fracturing become more common -- and therefore cheaper -- and the real big spenders like ExxonMobil and Chevron plan on scaling back their capital budgets over the next few years.
After all of the margin and growth numbers of a company, it's useless if the company doesn't generate a return for its shareholders. One simple way to evaluate this is the return on equity. There are two ways to do this. One is to simply divide net income by total equity, but this allows accountants to massage the numbers and hide the fact that a return is being held up with a high debt load. A more complete way is to use a return on equity model built by chemical manufacturer DuPont, which breaks up the components of return on equity into five components and multiplies them together. Here are those factors:
And this is how Weatherford looks compared to its peers.
Weatherford has two things really working against it here. The first is that its pretax, preinterest margins stink compared to its peers, which we already knew. The second is that it's overloaded with debt. When you see it broken down this way it's not surprising at all that Weatherford's management wants to completely overhaul the company by offloading some of its less profitable business segments, pay down debt, and return to positive cash flow. If it can do all of those things -- which sounds much easier on paper than it really is -- then the company could see a big boost in returns.
So now we know how Weatherford the company performs, but what kind of performance can we expect from Weatherford's stock? To check this, let's look at two things: total enterprise value to EBITDA, and price to earnings per share. Price to earnings per share is the quintiessential valuation metric. However, earnings per share can be affected by nonoperational things, such as asset impairments and one-time sales. To account for this we can also look at total enterprise value to EBITDA. This is a more apples-to-apples valuation of a company's operations. Also, since better performing companies normally have higher valuations, let's also look at today's valuation compared to the 10-year historical average.
|Company||TEV/EBITDA (current)||TEV/EBITDA (10-year avg.)||Price/EPS (current)||
Price/EPS (10-year avg.)
|Weatherford Inernational||11.86x||10.79x||N/A (no earnings)||37.4x*|
|Baker Hughes Incorporated||7.93x||11.71x||22.98x||30.42x|
|National Oilwell Varco||7.21x||11.16x||13.24x||19.49x|
By just about every measure, shares of Weatherford are expensive. For those who believe in the turnaround case that the company's management has planned, then perhaps it can grow into this valuation with higher earnings per share over time. Still, it has a long ways to go to be considered cheap when you look at everyone else in the space, though.
What a Fool believes
Somewhere out there, someone is making that case that Weatherford is a turnaround story, and it's working. So far this year shares of Weatherford are up 37%, and the stock has outperformed every other company mentioned so far.
The one thing that makes it difficult to make the case for Weatherford right now is that the company hasn't yet completed this turnaround, so the future of it is far less certain than some of the others. Also, and perhaps this is a personal preference, why invest in a more speculative stock -- the most expensive one in the group -- when you can buy companies that have more consistently performed well over the years and are selling at a discount? Using this logic, it may be in your best interest to look at one of these other companies instead of Weatherford.