Given how volatile the energy sector can be, as investors have seen lately with major service providers such as Baker Hughes (NYSE:BHI) and Halliburton (NYSE:HAL), as well as smaller names such as Basic Energy (NYSE:BAS), it's no surprise that Schlumberger (NYSE:SLB) gets the premium that it does. Although it is not immune to the ups and downs of the cycle, this is a company that executes on a consistent basis. While Schlumberger's leading position in energy services offers good leverage, it is worth asking if the stock's premium mitigates the potential returns.

Credit Card Comparison: Find the credit card that is just right for you.

Relatively Strong Results in a Tough Quarter
This is not going to go down as a banner quarter for energy services, but Schlumberger's results speak to its leadership position.

Revenue rose about 2% from the second quarter, with North American revenue down about 2% and international revenue up nearly 3%. That North American performance puts it in the middle of the Big Three (Halliburton saw a nearly 5% decline, while Baker Hughes was up almost 3%), while the international numbers were the best of the group.

Schlumberger also did quite well on cost controls. Overall operating income rose 2% sequentially and the company eked out a small improvement in operating margin. North American operating profits were down sharply (12%), but Schlumberger delivered better North American margins than Halliburton for the first time in a while. On the international side, profits were up about 7%, margins expanded and the company is widening its margin lead over Halliburton and Baker Hughes.

SEE: Analyzing Operating Margins

Schlumberger's Strengths Serving It Well
Schlumberger is unusual in the extent to which it has built a revenue base outside of North America - about two-thirds of the company's revenue comes from overseas. That diversification is helping the company avoid some of the downside to the weakness in North American pressure pumping - an over-supplied market that is hitting companies like Baker Hughes and Basic Energy pretty hard.

It's also true that Schlumberger benefits from leadership in several different service categories. Schlumberger pretty much owns seismic, and that market is fairly strong right now (Schlumberger's Reservoir Characterization segment, which includes seismic, saw almost 5% sequential revenue growth). Likewise, strength in markets such as wireline, tools and well testing are all helping.

See: The Importance of Diversification

Plenty Left to Do
Schlumberger already has leading margins and technology, but the company is not resting on its laurels. The company is pushing hard into subsea (where it recently got a large contract from Total (NYSE:TOT) for work off the coast of Algeria) and positioning itself to be a leader in Chinese shale exploration/exploitation.

At the same time, there's still risk in the market. Price competition is still a risk, and sooner or later Schlumberger is going to run up against the efforts of various energy-producing nations trying to promote/build their own domestic energy service sectors. What's more, energy companies are stuck in a Catch-22, where Wall Street badly wants ongoing production growth, but punishes companies for raising their exploration budgets.

The Bottom Line
If you want just one sign of Schlumberger's quality, take a look around the sector and note how many other energy service companies employ former Schlumberger employees in senior management positions. Likewise, the company spends a considerable sum of money on R&D and has a definite edge in regards to the capital it can devote to developing new products and techniques.

All of these advantages are certainly worth some sort of premium, but figuring out just how much is a very inexact process. If Schlumberger ought to get a forward EBITDA multiple on par with its historical average, the stock looks about 20% undervalued today. Keep in mind, however, that most of the sector is trading at a discount of about 30% to its historical average and by that standard Schlumberger would actually look a little overpriced.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

Related Articles
  1. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  2. Fundamental Analysis

    4 Predictions for Oil in 2016

    Learn four predictions for oil markets in 2016 including where prices are heading and the key fundamental factors driving the market.
  3. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  4. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  5. Investing News

    Is Buffett's Bet on Oil Right for You? (XOM, PSX)

    Oil stocks are getting trounced, but Warren Buffett still likes one of them. Should you follow the leader?
  6. Economics

    Will Silver Recover in 2016? (SLV, GLD, JJC)

    The end of the silver downtrend is likely to coincide with similar recoveries in gold, iron and copper.
  7. Stock Analysis

    The Top 5 Silver Penny Stocks for 2016 (LODE,AG)

    Learn about five of the top silver penny stocks and why investors may want to consider adding them to their investment portfolios in 2016.
  8. Investing News

    Chipotle Served with Criminal Probe

    Chipotle's beat muted expectations and got a clear bill from the CDC, but it now appears that an investigation into its E.coli breakout has expanded.
  9. Stock Analysis

    Analyzing Sprint Corp's Return on Equity (ROE) (S)

    Learn about Sprint's return on equity. Find out why its ROE is negative and how asset turnover and financial leverage impact ROE relative to Sprint's peers.
  10. Stock Analysis

    Why Alphabet is the Best of the 'FANGs' for 2016

    Alphabet just impressed the street, but is it the best FANG stock?
RELATED FAQS
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
COMPANIES IN THIS ARTICLE
Trading Center