A Potential Bet on Oil

This week’s Hot Stock is a leading worldwide provider of equipment to the energy industry. Energy stocks as a whole have been hit hard with the decline in energy prices, and NOV is no exception with the stock down 25% over the past year. However, this price decline is unwarranted, as National Oilwell Varco possesses particular qualities that allow it to weather this price decline better than most energy companies. This company’s steady profit growth and diversified revenue streams, when coupled with its stock’s gross undervaluation, allow it to earn our Very Attractive rating. This week’s hot stock is National Oilwell Varco (NOV).

National Oilwell designs, manufactures, and sells equipment and components used in the building of oil and gas rigs. In addition, the company also provides aftermarket parts to rigs that it’s already built. This aftermarket business garners high operating margins (27% in 2014) due to its focus on existing systems already created by the company, and is a support to existing rigs. Furthermore, the company also designs, sells, and rents equipment used in various processes on completed oil rigs, including drilling equipment. When viewed as a whole, National Oilwell’s services and products serve the entire lifecycle of an oil rig: from construction to operation to maintenance. This complete business can be highly profitable, even in down times. When rigs start drilling again, National Oilwell will be able to supply the drilling equipment, provide maintenance to the aging rigs, and even begin building new rigs.

Overall, revenue in 2014 remained strong, increasing 12% year over year. While revenue growth may slower going forward, over the long term National Oilwell is in a good position to serve all aspects of an oil rebound. This revenue growth in 2014 allowed National Oilwell to grow its after-tax profit (NOPAT) by 5% in 2014 over the prior year. Over the last five years, profit growth has been even stronger, growing at 11% compounded annually.

The company’s return on invested capital (ROIC) was 10% in 2014, slightly higher than the year before. Possibly best of all, National Oilwell had over $4 billion in free cash flow and only $3.8 billion in total debt in 2014. A strong balance sheet allows this company flexibility in tough times. Another positive sign is that the decline in oil prices is something we have seen before, and something that the industry has bounced back from.

Oil Price Anomaly? 

In a nine-month stretch in 2008-2009, the price of oil dropped over 73%, only to rise 94% from the lows over the next five months. A similar situation occurred, even if of lesser magnitude over a six-month stretch in 2011. The price of oil dropped 26% in mid 2011, only to rise more than 29% from the lows over the next six months. The most recent price decline, down 54% over the past eight months, may be just a blip on the radar six months from now.

As mentioned above, National Oilwell’s stock price is down over 25% in the last year despite strength in the underlying business. Not being overexposed to one particular segment or location (NOV operates in 70 countries) of the oil industry gives the company even further strength. At its current price of ~$53/share, National Oilwell has a price to economic book value (PEBV) ratio of 0.7. This ratio implies that the market expects National Oilwell’s NOPAT permanently decline by 30%. While 2015 may be a trying year, National Oilwell is positioned well to benefit greatly as soon as oil begins its turnaround. In the meantime, a $14 billion backlog and large existing base of rigs provide National Oilwell ample ability to withstand a prolonged oil price decline.

If National Oilwell can grow NOPAT by just 3% compounded annually for the next six years, the stock is worth $80/share –– a 51% upside. With upside potential like this, it’s easy to like NOV.

Disclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, style, or theme.

Photo Credit: Matt Niemi (Flickr)

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