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Schlumberger Earnings May Surprise You

Schlumberger Ltd. (NYSE: SLB) reported an impressive first quarter, and the world’s largest oilfield services provider is poised to follow that performance up when it announces second-quarter earnings this Friday.

Analysts polled by Thomson Reuters expect Schlumberger to report a second-quarter profit of $1 per share on revenue of $10.41 billion. But that could be selling the company short.

Here are a few reasons why:

  • After slumping in May and June, oil prices have shown tremendous resiliency, and are once again trading near $90 a barrel. That will encourage further exploration and development.
  • Natural gas prices are up 46% since mid-April – the start of a major rebound.
  • And global drilling activity continues to expand at a rapid pace.

Indeed, Schlumberger’s first-quarter net income clocked in at $1.3 billion, or $0.97 a share. That was up from $944 million, or $0.69 a share, a year earlier. Sales climbed 22% to $10.6 billion, topping the consensus of the 19 analysts covering the company.

The main driver of growth in that quarter was the company’s international offshore drilling operations. About two-thirds of Schlumberger’s revenue came from outside the United States and Canada.

So the key barometer for the company going forward is the number of drilling rigs operating worldwide. And as it stands now, rig demand is actually outpacing supply.

Schlumberger said in April that it expects a 10% increase in its rig count this year, amid robust exploration and deepwater activity.

In fact, the global oil drilling rig count is at its highest level in 25 years. Baker Hughes Inc. (NYSE: BHI) said in its monthly rig count that the total number of drilling rigs operating worldwide rose to 3,484 in June. That’s 149 more than in May and 227 more than in June 2011.

It’s also important to note that oil prices tumbled 18% in May. So oil producers have clearly not been scared off by falling prices or sluggish demand. And as long as explorers and producers are keeping busy, there will be a high demand for Schlumberger’s services.

The Natural Gas Rebound

Part of the reason there are so many more oilrigs is that producers are switching from natural gas production to focus on more profitable liquids. In fact, while the number of oilrigs operating is at a 25-year high, the number of rigs drilling for natural gas in the United States is now at its lowest level in 13 years.

However, there’s a growing body of evidence that suggests natural gas drilling will rebound faster than analysts anticipate.

For instance, the amount of natural gas in storage is still growing, but at a much slower pace. Natural gas stockpiles rose by 33 billion cubic feet (bcf) for the week ended July 6, far less than both last year’s build of 87 bcf and the five-year average 90 bcf.

The reason is that power companies have increased natural gas use by about one-third to take advantage of cheaper prices. Meanwhile, the summer heat wave that’s swept across the country is increasing power consumption.

Yet U.S. gas production in 2012 will slide 2.6% from 2011 levels. So while demand is increasing, production is declining.

As a result, natural gas prices are now at $2.78 per million British thermal units (Btu) – a 46% surge from the 10-year intraday low of $1.902 reached on April 19. And when the United States finally starts exporting some of its vast surplus, there will be even greater demand – and prices will shoot even higher.

Once that happens, more gas rigs will return to work in the United States, and Schlumberger will benefit.

And that’s not all. Schlumberger also has gotten a foothold in China, which could see a fracking boom that eclipses the one we’ll see in United States.

A Huge Opportunity

You see, China – which is rapidly urbanizing – wants desperately to replicate the United States’ success in fracking. With reserves 50% bigger than the United States, China is actually home to the world’s largest deposits of unconventional natural gas.

Ultimately, China aims to produce 6.5 billion cubic meters of shale gas by 2015 – and 60 billion to 100 billion cubic meters by 2020. The trouble is, so far its energy companies don’t have the technology or expertise to master hydraulic fracturing.

They need the West’s help. And Schlumberger aims to provide it.

To gain entry into China’s game-changing shale gas industry, the company recently took a 20.1% stake in the Hong Kong-listed Anton Oilfield Services. With Schlumberger’s help, Anton is already using multi-stage horizontal fracking in China.

So look for Schlumberger’s international operations to provide an even greater boost to the company’s bottom line going forward.

Indeed, given the aggression producers are showing while pursuing more oil supplies – and the rebound in natural gas development – Schlumberger’s stock is looking like a strong buy.

Better still, it’s trading at a significant discount. At about $67 a share, the stock’s current P/E is just 16.7, compared to a five-year average of 20.3. And it’s yielding 1.7%.

Currently, Sterne Agee has a price target of $89 on Schlumberger shares. Trefis has a $93 target, which represents a 38% premium to the stock’s current price.

So keep an eye on Schlumberger this Friday. It just may surprise you.

Cheers,

Jason Simpkins

 

Jason Simpkins

, Energy Editor

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