This week we wanted to highlight a stock from our “Power Epicenter Trifecta” list. This list identifies the strongest stocks within our more extensive ‘Trifecta’ Epicenter list. We have added a ‘power rating’ to the stocks in the trifecta list to find stocks with the strongest price appreciation potential. Thus, the criteria for stocks within this list are positive views from a Global Portfolio Strategy perspective, a Technical perspective, and a Quantitative perspective. The trailing one-month return must be greater than the 12-month return, it must have outperformed the S&P 500 for the last six months, and its price must be above the 50 and 200 days moving average at the time of selection. We also wanted to make sure the first company we highlighted would be a good buy for at least the medium-term horizon. We landed on the largest oilfield services company in the world, Schlumberger (SLB0.08% ).

This company’s unique competitive advantages and position as one of the focal points for the digitization and modernization of the Energy Industry and its efforts to respond to climate concerns make us think this is a great pick. It has powerful economies of scale, the best capital efficiency in the industry, and a diversified geographic footprint and customer-base that expose it to many high-growth projects. In addition to this, Schlumberger has very impressive and noticeable earnings revision momentum.

Source: Seeking Alpha

Many Americans aren’t acquainted with the particular culture in the American Energy industry. Houston is the industry’s capital in the United States, and the wider community can regularly feel the flagship industry’s cyclical nature. Boom and bust is more so a part of Houston’s life than other places and has been for a while.

A big deal in the region is the pomp and circumstance of elaborate, very socially important holiday parties. Various executives of major energy firms all mix at these sometimes ornate, sometimes less so, galas. In bust years the menus are subdued, the champagne and liquor are a few notches down, and the holiday cheer isn’t quite as palpable. It might be beer and barbeque instead of caviar and cognac. In boom years, ornate displays of the energy-derived wealth like shellfish and caviar bars displayed on ten-foot mock-oil derricks are commonplace. Outsiders would have no trouble determining where the funds for the party came from. Due to its ubiquitous place in the industry if its’ a party associated with an oil company, then you’d be hard-pressed not to find dozens of Schlumberger’s employees around. For the company, which had to layoff thousands of employees and suffered from the worst down-business cycle in memory, it appears that the trough has been reached. It’s a great time to buy this stock in our estimation! We think you’ll certainly want to own this name for the coming recovery and beyond. This company, definitely an old dog, has learned some serious new tricks and has exposure to potential high-growth areas both in renewables and the older oil-centric segments.

Suffice to say, the Holiday parties this year were subdued, if they occurred at all. Our bet is by Christmas this year, the gaudy menus and luxury items will be back in full force along with a significantly higher share price for our pick this week. If you live in Houston, you know; the bad years have always been followed by good years, and usually the worse the year, the higher and sweeter the comeback. We think this once-in-a-generation low that was disproportionately felt by the Energy industry will give way to an epic upcycle.  While there is much debate and uncertainty to the provocative claim that a commodities supercycle may be beginning, there is definitely a super-cycle coming in CAPEX by the Energy industry. No company is better positioned to benefit than Schlumberger.

Schlumberger Has Best Competitive Position in Oilfield Services and Not Highly Correlated to Oil Price

We have covered the massive implied opportunity in Oilfield Services in our previous work on Energy. Schlumberger is the largest holding of this fund at nearly 20%. Many investors may not like oil majors because their profitability is closely correlated to the oil price, which is influenced by many uncontrollable and unpredictable factors. One of the benefits of owning Schlumberger is that their services are needed pretty much equally if the oil price goes up or down. The trough of this capital cycle is so severe that revenue is virtually assured to expand significantly. 

At its core, oilfield services companies have their revenue determined by the capital and operating expenditures at energy companies that conduct exploration and production. The capital cycles of upstream producers are, of course, influenced by the price of oil. Still, the recent-drop off in capital expenditures by those companies in the upstream segment has taken a massive hit as these companies tightened their belts to survive the worst down-cycle in the Energy business that has ever occurred. The company survived this down-period with significantly less revenue but managed to pull off $700 million in free-cash-flow in the 4^th quarter. The momentum is clearly to the upside.

We picked one of the Energy companies on our Power Epicenter list with many characteristics that distinguish it from some of the things many investors don’t like about Energy. We think the tired and inaccurate narrative that Energy is a broken, flawed industry with people running for the doors is shallow and not grounded in the reality that the Energy industry pulls off some of the most technologically impressive tasks the human race is capable of, much of it not possible without Schlumberger’s assets or employees.

Ford and GM’s experience shows that cutting-edge technology can be deployed by new and exciting Growth companies but also by established industries far later in their lifecycle. Schlumberger will profit from the inevitable rise in CAPEX and investment in modernization and efficiency of oil production, however, it also has an impressive renewable portfolio that is much more than PR. It’s at the forefront of clean hydrogen production and just launched a carbon capture project with Chevron and Microsoft. The company is also developing a lithium extraction plant in Nevada The New Energy section is not an American Petroleum Institute going through the motions type of deal; the company is making real breakthroughs and real money in renewables. These are encouraging prescient moves from management, but the company also has enormous growth opportunities in modernizing a lot of existing oil infrastructure to get more efficient production. The interruption in upstream capex means that there could be unexpectedly high demand for the business’s margin expanding digital services segment. 

Schlumberger is the largest Oil and Gas Equipment Services company with a market cap of  $39.59 billion. Like Exxon, this number significantly understates it’s true size and influence. It’s currently trading well below its enterprise value of 54.89 billion. It announced its 4^th quarter earnings and beat on EPS by $0.05 and on revenue by $288.33 M. They have had 15 upward revisions to EPS estimates by sell-side analysts in the last 90 days. All four revenue segments saw sequential growth this quarter for the first time since COVID-19 roiled markets.

We Still Think There Will Be Energy FOMO: SLB Will Benefit

Many institutional investors seem to have an overly pessimistic view of the Energy sector. Why shouldn’t they? Many got burned over the last years. It’s almost like the industry needed an epic do-or-die restructuring. Oh, wait! That is precisely what happened. However, Schlumberger is far less dependent on oil prices for profitability and performance than, say, an oil major. It had a unique industry position as the largest oilfield services company and the most geographically diversified. It operates in many high-growth markets that don’t want the participation of oil majors but still need the vital oilfield technology they usually bring. SLB’s most significant portions of revenues come from the Middle East and Africa, followed by Europe, followed by North America. Schlumberger is more dependent on business cycles within the Energy industry, particularly capex, which plummeted with demand over the last year.

Source: Bloomberg

As you can see the R squared for SLB is .112, for XOM it is .251 and for CVX it is .632. Coincidentally, this shows part of the reason why we prefer Exxon Mobil to Chevron.  We picked one of the Energy companies on our Power Epicenter list with many characteristics that distinguish it from some of the things many investors don’t like about Energy names. We also think SLB will be attractive to institutions when they eventually chase the outperformance occurring in the sector.  

SLB Compared to Peers

Source: Seeking Alpha

You can see from the comparison that maturity pays off despite the current investor obsession with the new-fangled. May we suggest that this pick is a little bit of both, leading in cutting-edge energy technologies but with the established footprint, scope and size to leverage massive economies of scale. Their astute financial management is of course also appealing. An upgrade of their debt could be forthcoming with the latest quarterly results and positive revision momentum. Schlumberger has kept a relatively steady and uninterrupted profit margin partially due to its decision to divest from shale and to focus on its plethora of high-growth international assets. Like Ford and GM, SLB is becoming less dependent on assets to derive to revenue (although this is, of course, still primary) and more reliant on software, big data, and digital solutions it provides. Its revolutionary project with the Egyptian government is a prime example.

Similarly, Schlumberger possesses several financial strengths and advantages over competitors that should begin to distinguish it in terms of returns as demand for its services picks up. If you include severance in free-cash-flow, it had an impressive annualized FCF yield of around 9% during the last quarter. If this is the yield in the nadir of a down-cycle, you can expect it to be significantly higher when the ‘true-up’ occurs with Energy industry capital expenditures. The relative financial stability of SLB compared to peers, as well as its geographic diversification should make it a prime pick for institutions when they eventually pile into the space!

Source: Seeking Alpha

Risks and Where We Could Be Wrong

Schlumberger (SLB) is an established Oilfield Services company with deep relationships and penetration throughout the industry. If prices skyrocket, it could lose out on some of the high, but also high-risk, margins that can come out of a shale boom, although it does still have exposure through stock it owns. Right now, its geographic diversification is a strength but it could potentially become a weakness in the event of political instability or continued escalation of the war in Yemen as it’s largest geographic segment is the Middle East and Africa. Recent unsuccessful Houthi attacks on Saudi oil facilities highlight this major risk. However, the company is mature and has the ability to pivot. There is a risk that it overspends on unproductive capital projects in renewables. However, we think this name makes a great compliment in a portfolio to one of our other main energy recommendations, Exxon Mobil that does not have this risk as acutely. Anything related to coronavirus and demand concerns will continue to push off the restart of the Energy industry capex cycle, which will postpone the company’s return to pre-COVID EPS and revenue levels. We think the price is headed toward the neighborhood of 2014 highs over the medium-term, rather than back to COVID-19 lows.