I’ll do a simple discounted cash flow calculation to value a share of NOV under these three scenarios. I’ll use a discount rate of both 12% and 15% to define a fair value range. Here are the results:
| Scenario | Low-end | High-end |
|---|---|---|
| Slow growth | $59.38 | $81.93 |
| Fast growth | $72.70 | $101.86 |
| Faster growth | $89.11 | $126.64 |
The stock currently trades at about $70 per share, so it’s within the slow-growth range and below both the fast-growth and faster-growth ranges. The average analyst estimate for 5-year annual earnings growth is 14.33%, well above even my most optimistic scenario. If the analysts are currect then NOV is seriously undervalued. If NOV grows slowly instead the stock is at worst fairly valued.
The big question is: how fast will National-Oilwell Varco, Inc. (NYSE:NOV) be able to grow its earnings? There are two factors which will drive NOV’s earnings forward. First, the company will likely continue its policy of making acquisitions. With a strong cash flow the company could spend $2 billion per year on acquisitions without adding any more debt. Second, growth in drilling rigs will drive organic growth for the company. NOV’s equipment is used not just for drilling oil but for all types of drilling, meaning that the company will benefit from an increase in natural gas production.
The company’s backlog, which measures the value of orders which have been received but not yet filled, is at an all time high. The backlog sat at $11.9 billion at the end of 2012, up from $10.2 billion the year before. This could suggest that the company is poised for strong performance. First quarter earnings came in under analyst estimates but the backlog grew to $12.92 billion, reflecting strong demand for NOV’s products.
I think that the fast-growth scenario is reasonable, and under that scenario the stock is at the very bottom of my fair value range. There’s a real chance that this scenario proves too pessimistic and that the stock is worth a lot more, but it’s better to be overly pessimistic than overly optimistic when it comes to valuation. The stock could reasonably trade at $100 per share today.
Any cheaper options?
NOV appears to be the cheapest oil equipment stock available. Competitor Cameron International Corporation (NYSE:CAM) trades at 26.8 times owner earnings, adjusting for the net debt. Cameron International Corporation (NYSE:CAM) is a smaller company, with less than half the revenue of NOV and far lower margins. Cameron International Corporation (NYSE:CAM)’s operating margin in 2012 was 11% compared to National-Oilwell Varco, Inc. (NYSE:NOV)’s 17.7%. Schlumberger Limited. (NYSE:SLB), a large oil services company, also trades at about 26 times adjusted owner earnings. In both Cameron’s and Schlumberger Limited. (NYSE:SLB)’s cases owner earnings are significantly lower than the net income. NOV has a higher operating margin than Schlumberger Limited. (NYSE:SLB) as well, 17.7% compared to 17%.
The bottom line
National Oilwell Varco looks like a compelling investment opportunity. It’s on my list of stocks to consider buying, and it should be on yours too. It’s a play on oil and natural gas without betting directly on either one, and the stock is undervalued under all but the most pessimistic of scenarios. The stock traded as low as $64 per share earlier this year, which would have been a steal, but at $71 it still offers value.
The article One Cheap Energy Stock to Buy originally appeared on Fool.com and is written by Timothy Green.
Timothy Green has no position in any stocks mentioned, but may buy shares of National Oilwell Varco within the next month. The Motley Fool recommends National Oilwell Varco. The Motley Fool owns shares of National Oilwell Varco. Timothy is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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