A month ago, I looked at the prospects for Schlumberger (SLB) in an article called “Slump, slump, slump” as the company was battling a near-perfect storm and in fact the situation was and remains highly uncertain. I was not happy as I hold a position at an average in their $40s.
I got sucked into believing the story of a premium operator having the potential to bounce back, yet the company of course has been facing a steep uphill battle, one with still a very uncertain outcome.
In March, I concluded that Schlumberger was seeing its shares in free fall amidst the plunge in the economy and oil prices. Too high dividends and too aggressive share repurchases and M&A in recent years has unnecessarily caused a lot of pressure on the business and the shares. While I recognize that shares look cheap, I essentially called shares a call option on a recovery in the economy and oil prices.
While markets have seen a rebound, oil prices have not rebounded despite a historical deal to cut production. I noted that all focus should be on cash flow management, as the continuation of the dividend was unacceptable in my book.
The company after all remains a quite impressive business which generated sales just shy of $33 billion in 2019, quite stable on an annual basis although they were down in the final quarter. The company reported a more than $3 billion operating profit number, excluding a multi-billion impairment charge, with adjusted earnings coming in around $1.50 per share.
The issue is that holding $2.2 billion in cash, Schlumberger operates with a $13 billion net debt number, a sizable number by all means. This was all fine when oil prices traded in their $50s, as the dividend already surpassed the adjusted earnings metric, with dividend payments to investors amounting to $2.8 billion a year.
In March, I recognized that a third of sales were generated in North America as I would not be surprised to see revenue declines to the tune of 50% in that area of the business given the current circumstances, as I believed that international sales would fall a great deal as well, but probably not to the same extent. While international production is typically of lower cost, these nations undoubtedly require volumes and market share to help their economies with stimulus plans.
With all of this I concluded that revenues might easily fall by about $10 billion, not necessarily for 2020 already, yet more in terms of the run rate. Such a fall in sales and associated margin compression would probably kill all the adjusted earnings, and perhaps cause losses. The only bright news is that capital spending will lag depreciation, yet far from sufficient cash flows to support a $13 billion net debt load.
The first quarter results, as released halfway April provided some sort of comfort to investors. First quarter sales of $7.5 billion are down 5% year-over -year with margins down more than a point, although the declines are more severe on a sequential basis. This results in adjusted diluted earnings of just $0.25 per share, five cents below last year and down from $0.39 in the fourth quarter of 2019. While these results look somewhat reasonable, note that the real impact of the COVID-19 crisis and decline in oil prices was really only seen in the last month of the quarter. This news triggered a massive impairment charge of $8.5 billion on a pre-tax basis, yet that is not of most interest for now as these are non-cash charges and the focus now is on cash.
With the unprecedented events, the company believes there is a supply/demand imbalance to the tune of 20-30 million barrels per day which means the outlook for the services of Schlumberger is outright disastrous.
Following a halt on spending plans and a near $300 million asset divestment, the company has bolstered its cash balance to more than $3.3 billion, offset by $16.6 billion in debt, for a still a +$13 billion net debt load. Furthermore, the company has a few billion in pension liability, dividends payable and environmental liabilities as well.
Nonetheless, the company is taking measures to address the situation. For starters is a 75% cut in the dividend to $0.125 per quarter which actually still creates a compelling yield at these levels, but that is not the point or goal at this stage. The company is furthermore cutting capital spending by 30% vs. 2019 to $1.2 billion, compared to an annualized depreciation expense of about $1.8 billion, providing some much-needed cash flows.
The company did provide somewhat of a reasonable outlook with regard to capital spending of its clients, expecting a 40% fall in North American capital spending, with international spending down just 15% according to expectations and talks with clients. Besides dramatically cutting the dividend and reducing capital spending, the company is cutting costs, furloughing employees and taking other measures. The strong international presence now really is beneficial for the company as it generates about two-thirds of sales abroad, and these sales actually rose 2% year-over-year in the first quarter.
In March, I noted that the first order of business by management should be a complete elimination of the dividend in an effort to save about $700 million a quarter. With the company still paying out $0.125 per share a quarter, that payout equals about $175 million a quarter, or $700 million a year.
The first quarter numbers are comforting although this is not reflected in net debt coming down, despite a small divestment as well. While I am/was impressed with the operating performance of the business, notably its solid margins and diversified operations, its capital allocation strategies can be questioned at best, and that is an understatement.
Conservatism in its finances might have avoided the great current stress and provide opportunities, as Schlumberger is not really entering this storm from a position of strength. This makes that investors might see pain in the form of dilution, or simply lack of management being able to take advantage of opportunities which arise here.
In March, I concluded to not bail on the shares with shares trading in the low teens at the time, and since have traded in the $12-$18 range, now at the middle of the range. I am still left in a state of puzzlement as I am not bailing on the shares, and while first quarter results were relatively resilient, the net cash position has not improved, and with oil around the $20 mark, I am still not adding or cutting my position here.
While a historic oil deal has temporarily ignited some optimism into the oil market, the situation remains very dire with demand destruction seen at 20-30 million barrels. Some kind of assistance or bailout might help the industry and certainly Schlumberger will remain one of the last standing, that is no guarantee that a solution cannot become very expensive for investors.
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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.