For two quarters in a row National-Oilwell Varco, Inc. (NYSE:NOV) has reported a decline in earnings coupled with an increase in revenue. In the second quarter the company posted 18% year-over-year revenue growth and a record backlog of orders, but adjusted EPS declined to $1.33 from $1.46 one year ago. Is this a short-term problem, or should long-term investors be worried?
A flurry of acquisitions
National-Oilwell Varco, Inc. (NYSE:NOV) has grown over the years largely by acquisitions, acquiring companies that complement and extend the company’s vast line of products. Since the beginning of 2012 National Oilwell Varco has spent $5.3 billion on 20 separate acquisitions, although 60% of this amount was tied to three large acquisitions.
One reason for the decline in margins was a soft North American market, and since many of the new acquisitions rely on that market they’re currently not operating at their full potential. But management is confident that demand will eventually return, and that the investments made will pay off. CFO Jeremy Thigpen had this to say in the earnings call:
As a direct result of these integration efforts, the more favorable commercial terms that we’re pushing through in our offshore rig equipment business and the ongoing supply chain improvements that we’re implementing within our rig equipment business, we certainly expect to see margins expand over time. While it may take another quarter or 2 to begin to recognize the impact of today’s actions, we’re completely confident that we’re on the right path.
The energy business in general is a volatile one, and results are generally not going to be clean and consistent quarter-to-quarter and year-to-year. But as demand picks up and integration efforts are completed margins will almost certainly rise.
A period of adjustment
A second reason for the decline in margins is generally tighter delivery schedules. In the earnings call COO Clay Williams gives as an example drillships, which used to be delivered in 36 months or more, now being delivered in 26-30 months. Long-term this is likely a good thing, allowing for higher volume, but short-term it means higher costs as operations need to be ramped up quickly.
Williams also commented on an imbalance that the company is currently facing:
Within Rig Technology, we have plants for land and pressure pumping products onshore with low volumes and under-absorption and plants for offshore products that are overflowing with work. Nothing seems to be at the optimal volume at the moment.
It seems that the company is simply out of sync right now, which is not all that surprising given that it’s trying to integrate $5 billion worth of acquisitions. This should get better over time, but it likely won’t be fully resolved for at least a few quarters. Margins will likely remain weak for next quarter at least, but over the next year the company will hopefully find the right balance and recover from this period of transition.
Valuation
National-Oilwell Varco, Inc. (NYSE:NOV) took on some debt to fund recent acquisitions, but the levels are fairly reasonable at $4.1 billion, given the size of the company. There is also $2.3 billion of cash on the books, leaving a net debt position of $1.8 billion, or $4.20 per share.
In a previous article about National-Oilwell Varco, Inc. (NYSE:NOV) I calculated owner earnings for 2012 to be $6.07 per share, but 2013 will likely see a decline given the current issues. The current enterprise value is about 12.6 times last year’s owner earnings, and given that the margin issues seem to be temporary and that 2013 is a transitional year the company still looks attractive. Analysts are expecting, on average, a 9% drop in full year EPS in 2013 followed by a 17% rise in EPS in 2014, and the stock trades at 11.4 times 2014’s EPS.
National-Oilwell Varco, Inc. (NYSE:NOV) is the dominant company in the oil equipment business, and you shouldn’t let short-term issues cloud the long-term picture. The company has excelled at integrated acquisitions, and there’s little doubt that a year or two from today these short-term problems facing the company will be resolved.
Strong performance from oil service companies
Along with oil equipment companies like National-Oilwell Varco, Inc. (NYSE:NOV), another good choice is the oil service companies, namely Schlumberger Limited. (NYSE:SLB) and Halliburton Company (NYSE:HAL). Schlumberger reported earnings in July, beating analyst estimates on both earnings and revenue. The stock trades at 14.4 times 2014 expected earnings, so it’s not as attractive as National Oilwell Varco in terms of price. However, Schlumberger isn’t having short-term issues like National Oilwell Varco, and since most of its business comes from international markets the weak North American market is less of a concern.
