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Thursday, July 12, 2012 12:17:36 PM
But after two years of lackluster spending, and with oil flirting with $100 a barrel, I expect oil companies to aggressively begin spending on exploration.
Which is where my energy stock, Schlumberger [NYSE: SLB], comes in. It provides the picks and shovels these oil and gas companies need.
But I keep coming back to Schlumberger, despite the run it's been on, as a stock to buy before the next wave of exploration spending begins.
Why Schlumberger?
Schlumberger is the clear leader in oilfield services in terms of size, scope, and technology, and it's in a superior position to benefit from a ramp up in oil exploration spending.
The company's size -- which dwarfs its nearest competitors Halliburton, Baker Hughes, and Weatherford -- makes it a key partner for the largest oil companies in the world. And it helps produce the most attractive profit margins when business is booming.
National and major public integrated oil companies will likely be aggressive investors in the next spending cycle, which I expect to occur in international oilfields and deepwater drilling.
This scenario puts Schlumberger in the sweet spot, since it's a one-stop shop with close ties to national oil companies. Schlumberger is one of the few companies with the ability to integrate technology, from seismic all the way to well completion, in one integrated package, which attracts large oil companies.
What's more, the company's focus on international operations is a hidden catalyst as customers ramp up spending. After all, international rig counts recently reached an all-time high.
Schlumberger's geographical reach, which put it at a disadvantage to competitor Halliburton over the past year as spending heated up in North America, should reverse as the exploration focus shifts overseas. With more than 40% of sales coming from exploration and 75% from international markets, Schlumberger is poised to grow its share of oil services revenue.
Schlumberger's size has also differentiated it from its peers thanks to its clear technological lead -- plus a research and development budget that's larger than that of its three closest competitors combined.
The bulk of service and equipment spending over the past year came from gas shale plays in North America, where independent exploration and production companies spent primarily based on equipment price versus quality.
This should reverse as Schlumberger's major customers beef up spending in harder to reach places like the deep waters off the coasts of West Africa and Brazil.
Oil is not getting any easier to find, and Schlumberger's strong technological lead will be key in the next spending cycle.
3 critical elements to the thesis
The price of oil does not need to reach $140 a barrel again for this investment to work out. All we need is stability above $75 a barrel for oil companies to bring exploration spending back online.
Schlumberger brings in three-fourths of its revenue from international markets, which are at an all-time high in terms of rig counts. International exploration spending typically lags that in North America at the beginning of a cycle. Brazil, the Middle East, and Africa are key regions where activity is expected to be robust and growing.
Margin expansion. Schlumberger's strongest margins come from its international business, which should expand over the next few years. As an added kicker, margins in North America should rebound after the company has reorganized its fragmented operations domestically, and the recent wave of mergers and acquisitions will bring larger players to North America -- Schlumberger's primary customer base.
What could go wrong?
Schlumberger should gain market share and expand its profit margins as exploration spending heats up.
Economic growth from emerging markets like China and India should support oil demand, but a major economic meltdown would curb the spending cycle -- or at least shorten the duration. The broader economy is a huge factor here.
Political and operational risk is always high. Iraq is a key region in the Middle East, as it boosts production and is expected to absorb a good deal of capacity. This will be a key component of margin expansion internationally.
Growth overseas may also stall as projects that were put on hold in 2008 take longer than expected to restart.
But at the end of the day...
I expect earnings per share to surpass its prior peak in 2008 and could break above $5 a share in 2012, which makes it a solid pick for the next few years.
This post is for DD purposes only and not a recommendation to buy or sell.
"My well came in big, so big, Bick and there's more down there and there's bigger wells. I'm rich, Bick. I'm a rich 'un. I'm a rich boy." - Jett Rink
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