Momentum Building In National Oilwell Varco's Business

By Stephen D. Simpson, CFA | August 03, 2011 AAA

Energy services stocks will give some investors motion sickness, as producers rush to build equipment and start drilling in fat times and pull back sharply (or go out of business altogether) when oversupply drives down prices. That makes it very hard to recommend a stock like National Oilwell Varco (NYSE:NOV) as a long-term hold, as this stock can drop 20% or more in a single month. Still, with an aging production fleet out there and big plans for further production expansion from the major oil and gas companies, now may not be a bad time to hold these shares.

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Orders Flowing in the Second Quarter
NOV's reported performance for the second quarter was not the big story. Sure, 12% sequential revenue growth is not bad, and the company saw 18% sales growth in its rig technology business. Likewise, 16% sequential growth in operating income is a solid performance and those improving margins are encouraging against a backdrop of higher input costs.

But the real story here is in the future business trends. Orders came in at $3 billion for the quarter, and the company saw its backlog improve 26% from the first quarter (to over $7.7 billion). Perhaps that long-awaited jump in capital spending has arrived.

Old Equipment and New Fields
National Oilwell Varco is one of the largest energy service companies out there, and the company is heavily focused on capital equipment - actual drilling rigs, tubing equipment, pressure pumping units, mooring systems, subsea equipment, and so on. With the global jack-up fleet really starting to show its age, at last it seems service providers and producers are willing to shell out cash for new equipment.

Some of this spending is clearly motivated by a desire to exploit new fields - whether to simply boost production or hold leases. The company's pipe and expendables business (Petroleum Services and Supplies), for instance, saw 7% sequential growth this quarter and has been benefiting by increasing its presence in areas like the Bakken and Eagle Ford shales.

Longer term, though, some of the biggest opportunities are offshore. NOV has established facilities in Brazil in part to better service Petrobras (NYSE:PBR) and get orders from companies looking to drill into those huge offshore reserves. All in all, NOV traditionally has rather large exposure to both international and offshore and while that hasn't been a strong area lately, NOV's order flow suggests a brighter future and investors may also want to consider ideas like Transocean (NYSE:RIG) and Weatherford (NYSE:WFT) accordingly.

Let the Free-For-All Begin
Certainly NOV isn't the only company shooting for this business. FMC Technologies (NYSE:FTI) has announced several large orders from producers like Statoil (NYSE:STO), Petrobras, and Royal Dutch Shell (NYSE:RDS.A). Future orders are expected from the likes of Chevron (NYSE:CVX), BP (NYSE:BP), and Exxon Mobil (NYSE:XOM).

Keep in mind that these majors tend to have preferred providers - BP and Exxon have historically favored Cameron (NYSE:CAM), while Chevron often works with General Electric (NYSE:GE). Still, it is not always (or even often) a winner-takes-all market; Cameron, for instance, has a sizable share in blowout preventers, but NOV can still win other parts of the total equipment order.

The Bottom Line
Multi-year cash flow modeling on oil service companies seem fatuous as orders appear and disappear with little warning - analysts spend quarters waiting for upticks in order activity and are then surprised when they disappear. For better or worse, forward EBITDA multiples are probably the best way to value companies in this sector and NOV currently trades at a discount to its normal forward multiple. It's not an especially cheap stock, but order momentum seems to be building and growth investors could start moving this one up strongly even though it has already more than doubled in the past year. Remember, though, this is a stock that is bought to be sold; holding on too long is an invitation to pain that will almost certainly be answered. (For addional stock analysis, see ConocoPhillips Is A Strong Buy.)

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