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NOV AT A GLANCE

P/E ► 11.1 LOW EV/EBITDA ► 7.73 AVG ROA ► 7.8% AVG ROE ► 12.5% AVG Debt to Equity ► 0.578 LOW Current Ratio ► 2.09 AVG Interest Coverage Ratio ► 47.0 HIGH

 

 

 

 

 

 

As the world's leading supplier of equipment to the oil and gas industry, National Oilwell Varco's (NYSE: NOV) name can be found on 90% of the offshore drilling rigs (and a similar proportion of land rigs) across the globe. NOV is a provider of equipment and components used in oil and natural gas drilling and production operations, oilfield services, and supply chain integration services to the upstream oil and gas industry.^[1] NOV's product portfolio is so extensive that it has been called a "one stop shop" for drilling contractors, and it conducts operations in over 800 locations across six continents.^[1]

NOV has pursued an aggressive expansion strategy, with three acquisitions in 2008 and four acquisitions in 2009.^[1] However, NOV's expansion has come amid a sharp downturn in oil drilling activity globally, which has had an adverse effect on NOV's performance. Due to the precipitous drop in oil prices in the fourth quarter of 2008 and into 2009, there has been lower demand for oil rig equipment as offshore drilling companies reduce investment in new drilling projects. However, NOV is partially shielded from the downturn in drilling activity due to its $9.6 billion backlog.^[2] Overall, NOV's performance is dependent on the demand for oil and gas drilling, the amount of well remediation activity, the price of crude oil and natural gas, capital spending by drilling contractors, and the inventory levels of oil and natural gas. The 2008 financial crisis and the downturn in the global economy has caused a decline in NOV's sales by sharply reducing drilling activity internationally.

Though NOV may benefit from the demand for fossil fuel energy in emerging markets like China and India, renewable energy has become a potentially serious threat to NOV's long term business model as a supplier for oil drilling rigs. Climate change fears, political instability in oil-rich regions, and peak oil concerns all have the potential to shift energy demand from fossil fuels like oil and natural gas to renewable energy such as solar power, geothermal energy, and wind energy. Governments throughout the world are trying to make renewable forms of energy more economically viable through subsidies, grants, and carbon trading schemes.

NOV competes indirectly with larger oilfield services players like Schlumberger, Transocean, and Halliburton, but it is the smaller companies that have large rig part segments, like Smith International, Cameron Corporation, and FMC Technologies that are NOV's main competition.

Company Overview

National Oilwell Varco is an international oilfield services company specializing in the hardware needed for oil and gas exploration and production. The company generates revenue by selling hardware components to drill rig manufacturers and leasing drilling rigs to oil and gas companies. NOV supplies and services cash-rich customers such as Exxon Mobil (XOM) and CONOCOPHILLIPS (COP) as well as large drilling companies such as Transocean (RIG).^[3]

NOV’s offerings include highly engineered products, consumable replacement parts, and value-added maintenance and aftermarket services.^[3] Offering replacement parts and maintenance-related services position NOV to capture high margins, receive repeat business, and secure recurring cash flow. The company has a global presence, and has adopted a one-stop-shop business model that features diversity and breadth of product and service offerings as well as the convenience of a consolidated vendor relationship for its clients.^[3]

Business and Financial Metrics

NOV Net Income and Revenue from 2005 to 2008 in millions of USD^[4]

Fourth Quarter 2009 Summary
NOV's fourth quarter 2009 earnings release will happen on February 3, 2010. Analysts revised their estimates for NOV's earnings upward due to improvements in North American oil and gas prices and stabilization of sales and distribution services. NOV also benefitted from increased demand for pumping and coil tubing equipment in North Africa, India, and China.^[5] Sales of bits and downhole tools improved in North America.

Third Quarter 2009 Summary
NOV's net income increased by 75% from the second quarter of 2009 to $385 million.^[6] Revenues for the third quarter were $3,087 million, an increase of 3% from the second quarter of 2009 and a decrease of 15 percent from the third quarter of 2008.^[6] Operating profit for the third quarter of 2009 was $618 million or 20% of sales.^[6]

During the third quarter of 2009, NOV added $333 million of orders to its capital equipment backlog, and removed $72 million of canceled projects.^[6] Backlog for capital equipment orders for the Company’s Rig Technology segment was $7.3 billion at September 30, 2009 compared to $8.7 billion at June 30, 2009.^[6]

NOV's performance is dependent on the demand for oil and gas drilling, the amount of well remediation activity, the price of crude oil and natural gas, capital spending by drilling contractors, and the inventory levels of oil and natural gas. The average price per barrel of West Texas Intermediate Crude reached historic heights in 2008, peaking at $147 per barrel in July 2008.^[7] Average natural gas prices were $8.86 per mmbtu.^[7] However, during the second half of 2008, prices of crude oil and natural gas plummeted to an average of $58.18 per barrel and $6.40 per mmbtu, respectively.^[7] Due to the sharp decline in energy prices, the falling demand for crude oil and natural gas, and limited liquidity in credit markets, drilling activity was rapidly curtailed.^[7] By January 30, 2009, there were 1,472 rigs actively drilling in the U.S., compared to 1,721 rigs at December 26, 2008, a decline of 14.5%.^[7] NOV's Petroleum Services & Supplies segment and its Distribution Services segment are most affected by the drilling downturn, while NOV’s Rig Technology segment is partially shielded from declining activity in the short term due to its high backlog.^[7]

Business Segments

• Rig Technology (63% of total revenue^[2], 84% of operating profit^[2]): NOV's Rig Technology segment designs, manufactures, sells, and services systems for the drilling, completion, and servicing of oil and gas wells.^[10] The segment manufactures highly-engineered equipment that automates complex well construction and management operations.^[10] First quarter revenues for the Rig Technology segment were $2,199 million, an increase of 5 percent over the fourth quarter of 2008 and an increase of 37 percent from the first quarter of 2008.^[2] Revenue from backlog orders increased 15 percent and rose 49 percent year-over-year, to $1,688 million for the first quarter of 2009.^[2] Non-backlog revenue declined 18 percent.^[2]
• Petroleum Services & Supplies (29% of total revenue^[2], 23% of operating profit^[2]): NOV's Petroleum Services & Supplies segment manufactures, rents, and sells products and equipment used to perform drilling operations, including drill pipe, transfer pumps, drilling motors, and drill bits.^[10] Revenues for the first quarter of 2009 for the Petroleum Services & Supplies segment were $1,014 million, down 27 percent compared to fourth quarter 2008 results and down 23 percent from the first quarter of 2008.^[2]
• Distribution Services (12% of total revenue^[2], 3% of operating profit^[2]): NOV's Distribution Services segment provides maintenance, repair and operating supplies and spare parts to drill site and production locations worldwide.^[10] The Distribution Services segment generated first quarter revenues of $408 million, which were down 16 percent from the fourth quarter of 2008 and represented an 11 percent increase from the first quarter of 2008.^[2]

Acquisitions

In December 2009, NOV acquired Hochang Machinery Industries, a Korea-based manufacturing and fabrication business, and South Seas Inspection, a Singapore-based inspection, repair, and maintenance provider for $160 million.^[11] In April 2008, NOV acquired Grant Prideco, Inc.^[1] In February 2008, NOV acquired Welch Power Source, L.L.C.^[1] In December 2008, it acquired Sakhalin Outfitters LLC and Mid-South Machine, Inc.^[1] In April 2009, NOV acquired ASEP Group Holding B.V. and Anson Limited.^[1]

The Hochang acquisition is expected to strengthen NOV’s fabrication capabilities within its rig technology segment.^[11] The South Seas Inspection acquisition complements NOV’s petroleum services and supplies segment by expanding regional coverage.^[11] The purchase of Grant Prideco, a drill bit and pipe manufacturer, has allowed NOV to become a player in the once lucrative drill pipe market, as Grant Prideco derives over half its revenue from that key piece of hardware. ASEP, based in the Netherlands, develops and manufactures well service equipment, including wireline units, cranes, coiled tubing equipment, pressure control products, and automation products.^[12] ASEP's extensive international presence and sophisticated technologies will strengthen NOV's Well Intervention and Stimulation Equipment product offering. Anson, based in the U.K., manufactures equipment that will complement NOV's pump and fluid expendables products.^[12] Anson also extends NOV's international reach.

Key Trends and Forces

A recovery in drilling activity increases NOV's sales

As the world's leading supplier of equipment to the oil and gas industry, NOV's sales increase when the demand for drilling rigs and equipment rises. Due to the precipitous drop in oil prices in the fourth quarter of 2008 and into 2009, demand for oil rig equipment declined as offshore drilling companies reduced investment in new drilling projects. By January 2009, the number of drilling rigs drilling actively in the U.S. fell 14.5% from December 2008.^[2] However, U.S. drilling activity climbed in September 2009, with 10 more rotary rigs active in the first week of September for a total of 1,009 units, slightly more than half of the 2,013 units drilling in the same period a year ago.^[13]

Despite the sharp decline in active drilling rigs in early 2009, NOV was partially shielded from the downturn in drilling activity due to its $9.6 billion backlog.^[2] Overall, NOV's performance is dependent on the demand for oil and gas drilling, the amount of well remediation activity, the price of crude oil and natural gas, capital spending by drilling contractors, and the inventory levels of oil and natural gas.

Falling oil prices have reduced demand for oil rig equipment

Since the fourth quarter of 2008, oil prices have fallen from a record high of about $150 a barrel to about $68 a barrel in mid-July 2009.^[14] Though National Oilwell Varco controls a 60% share of the rig equipment industry,^[15] falling oil prices have reduced investment in capital projects by oil companies. Since oil prices have fallen nearly 70% from their 2008 highs, oil companies are beginning to pay lower day rates for oil rigs and have curtailed investment in new rigs and upgrades to existing rigs.

In early April 2009, the U.S. government, OPEC, and the International Energy Agency revised their oil demand forecasts, all predicting that world consumption of oil would be lower in 2009 than previously expected.^[16] Oil Movements predicted that exports from OPEC countries would fall by 560,000 barrels a day before May 2, and Baker Hughes Inc. reported that drilling had declined by half from the second quarter of 2008.^[16] Moreover, the number of rigs actively exploring for oil and natural gas in the United States fell by 30 to 975 in the second week of April 2009.^[16] Lower demand for oil and drilling services restricts NOV's growth as it is the world's leading supplier of equipment to the oil and gas industry.

The key determinants of the price of oil include supply and demand considerations, generally rising equity markets, and a weakening dollar, which encourages the purchase of commodities.^[17] The weak demand for crude oil has and will continue to have an adverse effect on NOV's sales.

The long-term outlook for oil prices and demand, however, is promising. Goldman Sachs is projecting oil at $90 a barrel by the first quarter of 2010.^[3] If oil prices return to mid-2008 levels, NOV's customers will generate more revenue and pay its vendors more to supply drilling equipment and services. Meanwhile, heavy demand for oil from China and India should continue to place upward pressure on the price of oil.

A Weakening Domestic Land Market Can Hurt NOV Despite International Growth

The North American land drilling market has weakened over the past year, as maturing reserves and big deepwater discoveries have moved exploration offshore and/or to other countries. Despite strong international growth, however, a weakened North American land market has affected the company's bottom line. Because the company is so large, and its product lines extend into so many markets, National Oilwell Varco cannot avoid feeling the effects of a downturn in any market. The North American land market is a powerful example of this, as lower rig demand led to fewer expenditures from drilling contractors on upgrades and equipment, causing operating income for NOV's entire Petroleum Services and Supplies segment to decrease $4.4 million from the third to the fourth quarter^[18]. On the flip side, though NOV cannot avoid the sting of any one market's fall, its diversity allows it to make up for losses in one place with gains elsewhere - in this example, the international land rig market.

The Acquisition of Grant Prideco Greatly Increases NOV's Exposure to the Volatile Drill Pipe Market

With declining capital expenditures from land drill contractors, the market for drill pipes - the part of the drill that connects the bit to the rig - is likely to fall. Grant Prideco is the leading drill pipe manufacturer in the world, and takes over half its revenue from supplying that single piece of hardware. National Oilwell Varco's acquisition of the company greatly increases NOV's exposure to the drill pipe market; a decline in this market means fewer purchases, lower prices, smaller revenues and lower margins - all problems that seem to make a $7.37 billion acquisition much less valuable. A future downturn in rig demand will damage the market for drill pipes, leading to an overall devaluation of the Grant Prideco purchase. On the flip side, the drill pipe is the second most important part of a rig, after the rig itself. Because it is actively involved in the drilling process, it is also more damage-prone than many other rig parts. Both of these traits make this piece of hardware very profitable in a strong drilling market, as higher rig demand means more drill pipes will need to be installed and higher drilling activity means more drill pipes will need to be replaced.

Renewable Energy Could Prove Troublesome for NOV in the Long-Term

Whether it’s because of climate change fears, the rising price of oil, or the desire to separate energy needs from terrorist regimes, people are slowly becoming disillusioned by the world's dependence on oil and gas. Many developed, politically-progressive regions like Europe are beginning to transition away from these sources of energy, and towards renewable energy. In emerging markets like China and India, however, the drive for economic growth supersedes environmental concerns, and oil is still less expensive than most renewables. Since emerging markets are where many of the future opportunities in the global economy lay, the oil and gas industry, including oilfield services companies like National Oilwell Varco, who are intimately tied to the overall success of the oil and gas industry, could continue to grow in conjunction with a growing renewables industry.

The fall in oil prices after July 2008 has put the economics of renewable energy into question. With energy once again cheap and plentiful, the imperative to develop renewable energy has weakened. On the other hand, concern over global climate change has continued to rise, increasing government support for renewable energy grants and subsidies.

While oil and gas dominate the world's supply of energy, alternative energies such as wind energy, solar energy, and geothermal energy pose a long-term threat to the oil industry. On the other hand, some research institutes forecast that fossil fuels will account for 70% to 80% of global energy supply in 2100.^[19] The importance of oil to international commerce suggests the intermediate-term viability of NOV's business model, but the prospect of a transition to alternative energy threatens it in the long-run.

Competition

The oilfield services sector includes such companies as Halliburton, Schlumberger, Baker Hughes, Smith International, and Transocean. Schlumberger is the industry leader by market cap, though Transocean has the largest drilling fleet in the world - 146 drilling rigs, including 48 deepwater drills^[20]. Transocean, however, only drills, while the others offer more complex services like intervention and evaluation.

Baker Hughes, along with its standard services, produces drill bits and drill fluids that many oilfield services companies use in their equipment; Smith International is another company that has a strong drill bit and fluids segment. Because both companies sell hardware parts for rigs alongside their standard drilling services, they pose a greater threat to National Oilwell Varco than a company like Transocean, who only deals in drilling services. NOV also competes with subsea equipment companies like Cameron Corporation and FMC Technologies. These companies sell sub-sea products that are used, among other things, to control the flow of oil out of underwater wells.

While companies like Baker Hughes, Smith International, FMC Technologies, and Cameron Corporation may be market leaders in specific hardware areas, like drill bits or subsea "trees", none of these companies match NOV in ubiquity, as the company's prominence in the market is clearly illustrated by the fact that 90% of all offshore drilling rigs have some National Oilwell Varco hardware. Furthermore, acquisitions like the recent Grant Prideco merger only strengthen NOV's specific market positions (in this case, in the drill pipe industry).

References

1. ↑ ^{1.0 1.1 1.2 1.3 1.4 1.5 1.6} Reuters: National Oilwell Varco
2. ↑ ^{2.00 2.01 2.02 2.03 2.04 2.05 2.06 2.07 2.08 2.09 2.10 2.11 2.12 2.13} National Oilwell Varco Announces First Quarter 2009 Earnings and Backlog
3. ↑ ^{3.0 3.1 3.2 3.3} Examiner: "National Oilwell Varco positioned as value stock"
4. ↑ Google Finance: NOV Income Statement
5. ↑ iStockAnalyst: "Earnings Preview: National-Oilwell Varco, Inc. (NYSE: NOV)"
6. ↑ ^{6.0 6.1 6.2 6.3 6.4} NOV Investor Relations: "National Oilwell Varco Announces Third Quarter 2009 Results"
7. ↑ ^{7.0 7.1 7.2 7.3 7.4 7.5} NOV 10-k 2009, Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations, p. 33
8. ↑ NOV 10-k 2009 Item 7: Results of Operations
9. ↑ MarketWatch: 10-Q National Oilwell Varco Inc.
10. ↑ ^{10.0 10.1 10.2 10.3} NOV 10-k 2009, Item 1: Business, p. 2
11. ↑ ^{11.0 11.1 11.2} Offshore Magazine: "NOV makes double acquisition"
12. ↑ ^{12.0 12.1} "National Oilwell Varco Announces Two Acquisitions"
13. ↑ Oil & Gas Journal: "US drilling rig count climbs above 1,000 units"
14. ↑ Xinhuanet: "Oil prices retreat on record high inventory"
15. ↑ Morningstar Analysis, National Oilwell Varco, January 10th, 2008
16. ↑ ^{16.0 16.1 16.2} MSNBC: "Investors see safety in oil, prices above $50"
17. ↑
18. ↑ "National Oilwell Varco Q4 2007 Earnings Call Transcript", Page 3, February 6th, 2008
19. ↑ Peak oil, peak coal, peak gas and projected fossil fuel use
20. ↑ "Top Oil Drilling Companies to Merge", The New York Times, July 24th, 2007
21. ↑ "National Oilwell Varco Announces Fourth Quarter and 2007 Earnings"
22. ↑ "FMC Technologies Reports Fourth Quarter Diluted Earnings per Share from Continuing Operations of $0.70, up 49 Percent"
23. ↑ Cameron: News Releases, "CAMERON FOURTH QUARTER EARNINGS TOTAL $0.54 PER SHARE; REVENUES UP 25 PERCENT, ORDERS AND BACKLOG REACH NEW HIGHS"
24. ↑ Google Finance: BHI Income Statement
25. ↑ Google Finance: Smith International Income Statement

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