Prepared by Stephanie, Analyst BAD BEAT Investing
Schlumberger (SLB) is a name we have traded many times at our firm, and with our membership. We have been in and out of the name. We recently saw it going to $20, but as soon as it got there, energy reversed course. It has been a very tough 8-week period, we have to tell you. But enough is enough here. We think you have to take the contrarian view and start to do some buying here for the long term. Essentially, we encourage you to accumulate a position in anticipation of the full reopening of the economy and commerce stepping up globally. It is not going to happen tomorrow, but we feel it’s on the order of quarters, not years. We have always maintained a core position, which is underwater in our teams’ holdings. As you recall, we dumped a massive position in energy (and other sectors) in February, as we have previously stated. We believe we will see a ramp-up in the stock similar to what we saw coming out of the huge 2016 decline as we head into late 2020 and 2021. The recent massive pullback seems like an opportunity even if Q3 earnings will be rough. When the company reported Q2 earnings, the key metrics we follow were pressured. We expect Q3 sees even deeper pressure when it is reported, but it is always darkest before dawn. We think you can start buying again. If you have been holding through this recent disaster, consider adding here at $15.
Revenues so impacted by oil
We saw revenues declining sizably in Q2 (and expect pain in Q3). Expectations from opinion makers and analysts are all still all over the map. We see revenues coming in lower on the devastating decline in pricing that stems from a huge supply and generally weak demand. Revenues came in down significantly in Q2:
Source: SEC filings, graphics by BAD BEAT Investing
Make no mistake, Q3 will be tough, and we think the Q3 chart of sales will look similar with a huge drop. We do not see it as being as poor as Q2. We think operational performance has bottomed here in Q2 and Q3. Pricing is still weak. With the cut in revenues, we are pleased to see management cutting expenses too.
Revenues were nearly 100 million below what we thought we would see at the midpoint, though they only slightly missed consensus by $20 million. Right now, Q3 revenues look like they will be short too with the recent drop in oil. Revenues were down 35.2% as a result versus last year. Expect Q3 to be down in the low double digits as well. This is a pretty sharp decline, but with oil prices at decade lows and then into historic negative territory, no one can be surprised here.
The thing is that demand and pricing data has been horrific, though it is getting a bit better from two months ago, at least on the demand side. Supply is still just flooding the market, which is why prices are not getting a boost. Despite the spending cuts, we need demand to perk up. We think demand will pick up this winter as economic activity picks up. It has started to increase, but every day, it seems there are new COVID-19 scares, or flare-ups which are met by political reactions of states threatening shutdowns. It is just the reality, and it is bad for oil. As we wait for real demand to return, the company is back to cutting expenses to the bone like we saw five years ago.
Cutting expenses heavily
It seems so long ago, but back when oil prices declined from 2014 to 2016, Schlumberger worked to cut expenses significantly to maintain profits.
We are now seeing these big cuts again and are now seeing expenses having gone from cutting the fat, to management getting surgical to protect profit margins. That said, with the fall in revenues from last year, we were pleased to see that expenses were slashed compared to last year for Q2. Aside from the impairment charge, expenses were reined in. If revenues fall, we usually expect a decline in costs. When they rise, we hope to see a small rise in costs.
In Q2, with the revenue falling 35%, we expected to see a drop in expenses. The draconian cuts will likely be with us for the remainder of the year and will move commensurate with revenues/business volumes. Q2 total cost of revenues was $4.92 billion, which fell from $7.25 billion last year. Solid declines were noted across the board. Of course, we note another massive impairment charge.
As Q3 appears to be seeing pain in pricing and demand, we expect a revenue hit once again, in addition to seeing ongoing draconian cuts to protect the balance sheet.
Earnings getting hammered
As you can imagine in Q2 we saw margins that were quite obviously pressured from last year, coming in at 7.4% versus 11.7% last year. Earnings per share were $0.05, down from $0.35 a year ago:
Source: SEC filings, graphics by BAD BEAT Investing
This was a solid adjusted earnings result. This was a beat of $0.05 versus our estimates, though were helped by lower costs than expected. We think that, despite the difficulties, you should be buying for improvements to end 2020 into 2021, at lows not seen in recent history. The Q3 earnings chart will look similar in our opinion, though we are expecting $0.11-$0.15 in EPS.
We do note that cash flow from operations was $803 million, and they generated $465 million of free cash flow despite significant severance payments during the quarter. This was far above expectations. Keep an eye on this for when earnings are reported later this week.
The company continues to do what it can to preserve capital. Great cost-cutting work has been done. Some of the savings include furloughing personnel, cutting salaries, lowering headcount and closing facilities. Management is also taking a hit. The Board of Directors and executive officers have voluntarily agreed to reductions in their cash compensation. On top of that, management has reduced its capital investment program by more than 30%. But they can only cut so much.
We need a rebound in pricing. We will see what kind of news we get from the company when it reports, but we do want to be buying starting here at $15.
We certainly need another $10-$15 per barrel increase in oil prices to see real big gains in the stock and underlying performance of companies in the sector.
When we can reopen and resume more normalized travel, even if it is a fraction of what it was before, we will see a bounce.
Overall, we like the actions being taken and think that you can start buying here again.
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Disclosure: I am/we are long SLB. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.