Typically, an investor would not be happy to see a company lose 8% of its value over the course of a year while the S&P 500 gains more than 12%. However, when you consider that shares of oil equipment and services specialist National Oilwell Varco (NYSE:NOV) lost that amount of value in 2014 while the energy sector as a whole dropped by 11.8%, an 8% drop doesn't seem that bad.
When the industry in which you operate relies completely on the price of one product, and that product loses close to half of its value in a year, then any investor should expect rough times. And so it is for National Oilwell Varco and its peers. Despite one of National Oilwell Varco's biggest business segments -- rig systems -- headed for what appears to be an extended cyclical downturn, there are some reasons investors shouldn't fret too much after this less than stellar year.
National Oilwell Varco's connection with oil prices
Even though National Oilwell Varco's business never touches a drop of oil, all of its money comes from companies that do drill for oil. So while the price of oil remained a producer-friendly $100 a barrel in the first half of the year, things at National Oilwell Varco looked pretty good. It completed the spinoff of its distribution business segment into NOW (NYSE:DNOW), which left the company to focus on its higher-margin equipment manufacturing and services business. At the same time, it appeared the transition from longtime CEO Pete Miller to Clay Williams would go off without a hitch.
Then things started to look a little hairy. First, it became clear there was a rather large (over)supply of offshore drilling rigs even as the Big Oil companies that normally contract those rigs were winding down capital spending as some major projects came online and were focusing on free cash flow generation. With a glut of rigs already on the market, orders for the rigs for which National Oilwell Varco supplies equipment started to dry up, increasing fears of the order backlog declining, as CFO Jeremy Thigpen noted during the company's latest conference call:
Looking into the fourth quarter of 2014, we believe that orders for new floaters will once again be limited and that opportunities for jack-ups could be halved. Still, demand for complete land rigs, land equipment packages, and individual land components should remain strong in the U.S., Latin America and the Middle East.
This was in November, and the price of oil has since slipped even further to about $50. With oil that low, many of National OIlwell Varco's largest clients have announced major cuts to their 2015 capital budgets. This will likely mean that the many disposables that National Oilwell Varco manufactures, such as drill bits, will be in much lower demand, which could impact sales slightly.
This is keeping Varco afloat in a sinking market
One thing that has protected the company from a major drop in sales and business has been its large backlog of projects. In its most recent conference call, management said the $16.3 billion backlog should keep the company working steady until demand for new equipment picks up again. The largest fear, of course, is that clients will cancel some of those orders, but the number of aging rigs that need to be replaced means that is unlikely to occur in great numbers.
What a Fool believes
National Oilwell Varco is built to handle the big swings of industry cycles. With a near-monopoly on certain segments of the oil equipment and manufacturing business, and a standardization program that essentially locks in customers for the life of a rig, there are plenty of aftermarket sales opportunities to keep existing equipment running and keep the business going in a weaker oil market. The price of oil might not have been kind to Varco in 2014, but the company should be able to weather the storm longer than many of its peers and potentially look to make acquisitions in this down market to further solidify its market share.
The Motley Fool recommends National Oilwell Varco and NOW. The Motley Fool owns shares of National Oilwell Varco and NOW. 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.