National Oilwell Varco (NYSE:NOV) has a reputation as one of the more reliable investments in the oil and gas industry. Over the past several commodity cycles, the company has been much more resilient during the down times and outpacing growth in the boom years.

NOV EBITDA (Quarterly) Chart

NOV EBITDA (Quarterly) data by YCharts

This past year, though, the company has see a very rapid decline in profitability that has sent investors to the exits rather quickly. In the past year alone shares have declined more than 55% as profits have dried up at almost the same rate. Is this just another one of those cyclical declines for National Oilwell Varco to endure? Or is there something else here that could make this one last? After all, Warren Buffett completely sold out of his position in National Oilwell Varco just recently, that has to mean something, right?

Let's take a look at both sides of the argument to see whether the decline in share prices is an overreaction to the decline in the entire energy sector or if there is something bigger at stake here.

The logic in the decline
If you want to look at the weakness in the past year, all you need to do is look at the company's Rig Systems segment. Over the past 5 years, this part of the business has generated 40-50% of the company's revenue and 50-75% of its operational income. You could even argue that it is also indirectly responsible for the success of the Rig Aftermarket segment since it sells replacement parts for NOV equipped rigs. 

The reason that this is of concern is that the demand for rigs-- and hence the rig segment -- is on the decline while many new rigs are hitting the market. This means the appetite for further new rigs is next to nothing. You only need to look at the company's backlog over the past several quarters to see it.

Nov Backlog

Source: National Oilwell Varco earnings release, author's chart

In the most recent quarter, the company had a book-to-bill ratio of only 18%, which means that for every dollar's worth of backlog that was completed, only 18 cents of new orders came in. Considering where oil prices are, the moves made by oil and gas producers to cut capital expenditures, and the excess amount of rigs currently on or about to enter both the onshore and offshore market; there isn't a lot of hope that new orders will be coming in soon and that revenue backlog will continue to dry up for at least a few more quarters.

On top of the decline in new business, margins have taken a pretty hard and fast dive in recent quarters. This is especially true for the company's Completion & Production services segment, where margins have declined from the mid-teens to the low single digits in less than a year.

Nov Margins

Source: National Oilwell Varco earnings release

Based on its results over the past several quarters and its balance sheet, the company will certainly be able to keep its lights on. However, declining margins and much lower demand could continue to take a toll on those profitability levels for quite some time. 

The case for overreaction
There are plenty of reasons to think that the next several quarters or even the next couple of years might not be some of National Oilwell Varco's banner years. The one thing that you always need to keep in mind when looking at oil and gas equipment manufacturers, though, is that oil and gas drilling chews up equipment and and spits it out, so new equipment is routinely needed.

In fact, National Oilwell Varco CEO Clay Williams even noted that rig companies and service providers were already starting to cannibalize their equipment, which is where you take spare parts off an out-of-work piece of equipment to keep operating equipment running. As these cannibalized parts get used up, companies will need to start buying replacement parts -- and buy replacements for those out-of-service rigs as well. 

Another aspect that brings the need for new equipment into focus is that the oil and gas industry is still in a rather nascent stage of a major technology turnover. For the past couple of years the US has seen a drastic turnover in its fleet of land rigs to AC-powered rigs, mobile rigs that have the horsepower for long lateral wells needed for shale. If we look internationally, though, these rigs have not been put to use even though there are plenty of places around the world where today's horizontal drilling and hydraulic fracturing could be implemented.

Nov Intl Rig Markets

Source: National Oilwell Varco Investor presentation

According to the company, by 2040, the world will need the following additions to its drilling fleet to meet the anticipated demand:

  • 6,650 land rigs
  • 589 jackup offshore rigs
  • 470 floating offshore rigs
  • 303 Floating Production, Storage, and Offloading facilities (FPSOs)

These numbers are pretty specific, and coming from a company that directly sells these pieces of equipment, so we should probably take these with a grain of salt. However, looking beyond the rough times ahead, there is definitely ample opportunity on the horizon for National Oilwell Varco to continue its industry leading profit growth.

What a Fool believes
Being invested in National Oilwell Varco over the past year or so has been a frustrating experience for anyone, and looking at what to expect over the next several quarters won't wow anyone. So yeah, it's understandable why some investors might see the company's prospects and decide that the opportunity costs are too high right now. However, chances are the ones willing to hang on and wait out this industry weakness will be rewarded much further down the road.

Tyler Crowe owns shares of National Oilwell Varco. You can follow him at Fool.com or on Twitter @TylerCroweFool.

The Motley Fool owns and recommends Halliburton and National Oilwell Varco. The Motley Fool recommends Oceaneering International. 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.