I first noticed National Oilwell Varco, Inc. ( NOV ) when Warren
Buffet’s Berkshire Hathaway reported a stake in the company in
August 2012. I was also intrigued to learn that National Oilwell
Varco’s CEO since 2001, Merrill (Pete) Miller was selected
“Morningstar’s 2012 CEO of the Year.” Given that NOV stock is down
to the $65 level, I decided to take a closer look at the company.
National Oilwell Varco operates in the cyclical business of oil and
gas equipment and services, but due to the astute strategy of its
management, with continuous innovation and improvements that
benefit its clients and intelligent capital allocation, the company
has built up a strong economic moat.
I)The Record
National Oilwell Varco ( NOV ) under Pete Miller
has grown book value per share from $8.50 to $50 from 2003 to 2013.
EPS has increased from $0.45 in 2003 to $5.83 in 2012. Cash flow
per share has increased from $0.75 in 2003 to $7.25 in 2012. Share
price has increased from $10 in 2003 to $65 in 2013. In spite of
numerous acquisitions over the last decade (some with shares) the
shares outstanding has increased only from 330 million to 427
million. What has been most impressive is the widening of the
economic moat of the company due to the diligent strategy by Pete
Miller and recently elevated Chief Operating Officer Clay Williams.
National Oilwell Varco initiated a modest dividend in 2009 which
currently stands at $0.52 per year, and I expect this to grow
substantially over the next five years if the company does not find
opportunities for value creation. A dollar invested with Pete
Miller in 2003 would now be worth $7 in 2013.
NOV 10-Year Chart from Google Finance:
II)Business and History
National Oilwell Varco is a worldwide leader in the
design, manufacture and sale of equipment and components used in
oil and gas drilling and production, the provision of oilfield
inspection and other services, and supply chain integration
services to the upstream oil and gas industry.
Since 1841, National Oilwell Varco has been dedicated to ensuring
that customers receive the highest quality oilfield products and
services. Leveraging over 800 worldwide manufacturing, sales and
service centers, National Oilwell Varco supplies customer-focused
solutions that best meet the quality, productivity, and
environmental requirements of the energy industry. National Oilwell
Varco is a worldwide leader in providing major mechanical
components for land and offshore drilling rigs, complete land
drilling and well servicing rigs, tubular inspection and internal
tubular coatings, drill string equipment, extensive lifting and
handling equipment, and a broad offering of downhole drilling
motors, bits and tools. National Oilwell Varco also provides supply
chain services through its network of distribution service centers
located near major drilling and production activity
worldwide.
III)Operations and Competitive
Advantages
Morningstar Analysis Stephen Ellis puts it well
when he writes “National Oilwell Varco remains at the center of
several major industry trends, collecting large and growing
economic rents. For offshore drillers, the firm represents the best
and only source of rig equipment and the deep-water technology
needed for new rigs to economically drill far more and deeper
wells. For onshore drillers, National Oilwell Varco plays a similar
role in providing the needed technology to properly exploit more
demanding tight oil and gas reservoirs. The firm supplies nearly
all of the equipment needed for a land rig and much of the downhole
equipment and consumables. National Oilwell Varco’s latest foray
into subsea equipment positions the firm to lay claim to an
increasing share of the economic rents as floating production
storage and offloading and subsea development efforts accelerate
over the next decade.”
NOV Products and Services:
National Oilwell Varco organizes its operations in three business
segments:
1. Rig Technology: The Rig Technology segment (accounted for 57%
of the company’s 2012 operating profit) designs and manufactures
integrated drilling systems and components for land and offshore
drilling rigs.
2. Petroleum Services & Supplies: The Petroleum Services &
Supplies segment (37%) consists of a number of the company’s
services and consumables, including inspection and quality
assurance services for tubular goods, solids controls and rig
instrumentation.
3. Distribution & Transmission: The Distribution &
Transmission segment (6%) sells and rents technical equipment used
in the drilling process.
NOV 2012 Operating Profit by Segment:
These are some of the competitive advantages:
1. National Oilwell Varco dominates in rig equipment particularly
in deep-water rigs, which is a wide-moat business. Its equipment is
on 90% of the world’s rigs. The large market share gives economies
of scale advantages.
2. National Oilwell Varco has built out a large product portfolio
through acquisitions over the years leading to a shift toward a
more standard rig design. This allows improvements in rig up-time,
as well as lower training, maintenance, and installation costs
which are major competitive advantages and a strong barrier to
entry for competitors. Customers would rather choose a one-stop
shop than deal with multiple suppliers. It saves on labor and
increases efficiency.
3. National Oilwell Varco also provides a wide range of services
and extensive support which are an advantage over other smaller
competitors.
4. National Oilwell Varco is an innovative force in the industry,
constantly inventing and manufacturing products that improve the
safety and productivity of drilling and well-servicing
processes.
5. National Oilwell Varco offers rig operating companies
innovative and time-saving products make their rigs safer and more
comfortable places to work – a big plus in recruiting and retaining
valuable employees.
6. National Oilwell Varco offers education and training for its
more complex products, increasing switching costs for customers.
Once a company has invested time and money training for and
implementing a system, it becomes a burden to move to competing
products.
7. National Oilwell Varco has operations in the United States,
Canada, Norway, Denmark, the United Kingdom, Brazil, China,
Belarus, India, Russia, the Netherlands, Singapore, South Korea,
South Africa and Angola. This global presence is a major
competitive advantage.
8. National Oilwell Varco has numerous patents which can
serve as a barrier to entry.
9. National Oilwell Varco has a service backlog of $12.9 billion
as of April 2013. Maintenance and replacements services for
existing deliveries assure a stream of revenue for years to
come.
IV) Balance Sheet and Profitability
National Oilwell Varco, Inc. has one of the best balance
sheets in the energy sector and also compares favorably when
compared with businesses in the manufacturing and industrial
sector.
At December 31, 2012, the company had cash and cash equivalents of
$3,319 million, and total debt of $3,149 million. At December 31,
2011, cash and cash equivalents were $3,535 million and total debt
was $510 million. The $2,855 million reduction in the net cash
(cash less debt) balance in 2012 was due primarily to $2,880
million in cash paid for 2012 acquisitions. A significant portion
of the consolidated cash balances are maintained in accounts in
various foreign subsidiaries and, if such amounts were transferred
among countries or repatriated to the U.S., such amounts may be
subject to additional tax obligations. Of the $3,319 million of
cash and cash equivalents at December 31, 2012, approximately
$1,994 million is held outside the U.S. Of this amount,
approximately $1,785 million is considered permanently reinvested
and is available to fund operations and other growth of foreign
subsidiaries including, but not limited to, capital expenditures,
acquisitions and working capital needs. If opportunities to invest
in the U.S. are greater than available cash balances, rather than
repatriating this cash, the company may choose to borrow against
its revolving credit facility.
On February 20, 2013, the company completed its previously
announced acquisition of Robbins & Myers, Inc. for
approximately $2.5 billion in cash. The company borrowed
approximately $1.4 billion under the $3.5 billion revolving credit
facility and used approximately $1.1 billion of cash on hand to
fund the acquisition.
Balance Sheet Information:
Statement of Operations:
2012 Result of Operations by Segment:
V) Management
CEO Merrill (Pete) Miller, Jr. has led
National Oilwell Varco since 2001 and is Morningstar’s 2012 CEO of
the Year. In late 2012, Miller stepped back from the day-to-day
operations of NOV in preparation for his eventual retirement, after
orchestrating numerous acquisitions that have largely consolidated
the equipment market to the firm’s benefit. The company also
consistently offers some of the best industry commentary on its
quarterly calls. Miller and recently elevated Chief Operating
Officer Clay Williams, who now manages more of the day-to-day
operations, are shrewd judges of value and very good capital
allocators. Overall National Oilwell Varco is a very well-run
company with a thoughtful management team that is focused on
creating shareholder value.
Management Holdings:
Here are some excerpts from the first quarter 2013 conference call
that give insight on how management thinks about capital
allocation:
Clay C. Williams – President, Chief Operating
Officer
“Since the beginning of 2009, we had generated $6.9
billion in cash from operations, and raised $3.4 billion in debt
financing totaling $10.3 billion in capital generated were raised.
We have paid $1.1 billion or 11% to our shareholders in dividends,
invested $1.7 billion or 17% internally in capital expenditures and
invested $7.4 billion or 72% in acquisitions.”
“The largest of our acquisitions since 2009 is Robbins & Myers
which finally closed in the first quarter; it’s strengthened our
position in a number of key technologies – progressing cavity
pumps, flow line, artificial lift and downhole drilling motors,
just to name of few. This acquisition makes NOV the largest
provider worldwide of enabling required for the drilling and
completion of horizontal wells and has a very busy four year period
as far as closed 51 acquisitions. We are excited about this
aggregate addition of new businesses to NOV including the talented
teams that have joined our own.”
The verdict on the performance of Clay Williams after he takes
over as CEO will be out in next three to five years, but I am
optimistic about the prospects of National Oilwell Varco under his
management since he has played an integral part of strategy and
execution over the last four years and has been groomed for this
role by Pete Miller.
VI) Value and Price
National Oilwell Varco ( NOV ) is currently
trading in the $63 to $72 range. Value Line projects an earnings
growth rate of 15%, book value growth rate of 11% and dividend
growth rate of 25% over the next five years. Due to the cyclical
nature of the business and assuming a conservative YOY growth rate
of 9% over the next five years gives us a 2017 EPS of $9.00.
Assuming a normalized terminal PE of 13 gives us a 2017 price
target of $117. This equates to a 16.75% annualized return,
assuming a 1% dividend.
Diligent capital allocation of cash flow over the next few years
offers further upside potential. Below is also an example of the
capital allocation record of the company’s 2012 cash flow. The
dividend is very low at less than 1% currently but payout is likely
to grow in the future, assuming better avenues for value creation
are not available for management.
NOV 2017 Mritik Capital Projection:
2012 Acquisitions and Investments:
National Oilwell Varco paid an aggregate purchase price of $2,880
million, net of cash acquired for acquisitions in 2012. On February
20, 2013 the company completed its previously announced acquisition
of Robbins & Myers, Inc. for approximately $2.5 billion in
cash. The company borrowed approximately $1.4 billion under the
$3.5 billion revolving credit facility and used approximately $1.1
billion of cash on hand to fund the acquisition.
VII) Catalysts
The market is focused on the short term which allows us
to own this wonderful business which will be successful and growing
decades from now. Shares of National Oilwell Varco will be volatile
in the next five years but as Warren Buffet says, it is better to
have a bumpy 15% return than a smooth 8%. Although there may not be
any immediate catalysts in next few months, I can think of the
following catalysts over the next three years.
1. Increased delivery of deep water rigs in the coming years could
boost earnings and surprise to the upside.
2. The synergies from $2.8 billion worth of acquisitions in 2012
and $2.5 billion Robin & Myers in 2013 could increase earnings
above initial expectations.
3. Increase in growth in international sales, especially to Brazil
and Asia, may be a positive. Onshore drilling activity in North
America which has been in a downturn for the last year may pick up
in late 2013.
4. Continued innovation could lead to new products and services,
and boost earnings.
5. Diligent capital allocation and annual dividend increases and
prudent deployment of cash flow ($3 billion to $4 billion per year)
over the next three years will increase the intrinsic value of the
company. If share price drops further, the company could execute
opportune share buybacks.
VIII)Specific Risk
As in any investment there are some risks associated with an
investment in National Oilwell Varco:
1. National Oilwell Varco results are heavily levered to changes
in the overall energy price environment, which are inherently
volatile and subject to complex market forces. A prolonged downturn
may affect the company revenues, earnings and cash flows.
2. The recent weakness in the North American onshore drilling has
been a negative for National Oilwell Varco, which derives a
substantial portion of its revenues/earnings from the region.
3.The One-Subsea joint venture combining Cameron’s equipment
design, manufacturing and installation expertise with
Schlumberger’s reservoir knowledge and well completion expertise
could affect prospects of NOV’s subsea ambitions.
4. There are certain environmental and regulatory risks. Terrorism
and security-related risk factors exist.
5. Depreciation of foreign currencies against USD may reduce
reported earnings.
6. There is execution risk with acquisitions not turning out to be
accretive to earnings.
IX)Why Is This Cheap?
These are some reasons why we think the shares are
cheap:
1. The market is overly pessimistic and as always focused on the
near-term factors while ignoring the high- quality nature of the
underlying business.
2. The market is under-appreciating the growth potential of
business while focusing on the near-term weakness in the North
America onshore drilling activity.
3. The market is taking a wait and watch approach due to global
macro uncertainty.
4. The market is waiting to see if the acquisitions over the last
year will be accretive to earnings.
5. When the price of oil drops, the share price of National
Oilwell Varco also drops.
Disclosure
I own shares of National Oilwell Varco. I have also sold January
2015 puts on National Oilwell Varco at $ $65.
Comments and questions welcome.
Read more:
NOV 2012 Annual Report
Read More:
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