Description

I like SLB, and am currently long it along with other oil services names like VAL and HAL. As with most oil related ideas, if you aren’t modestly constructive on oil prices over the mid-term, this idea is likely going to be a pass.

SLB provides the usual checklist of qualities that I am looking for in an oil services company - 1. Geographic diversification; 2. Customer diversification; 3. Product diversification across oilfield lifecycle; and 4. Scale. As the oil cycle has continued to develop, it has become clear that private shale companies and state-owned players continue to be the most aggressive in ramping drilling activity. Supermajors are starting to increase development activity as well, primarily with offshore drilling. US shale production continues to disappoint (shale volumes are currently declining sequentially), and public shale companies remain hesitant to greenlight new projects. As a result of these dynamics, I continue to prefer oil services names that have customer exposure to state owned producers, with a large portion of the business outside of US shale, and ideally with significant offshore exposure – SLB aligns with these themes (for those ok with a less liquid name, VAL is my biggest oil related position).

Let’s briefly chat about oil setup before more on SLB. The recent 2mm headline (1mm effective) OPEC production cut was a key signal on supply fundamentals. Some folks have framed this as a political move, or around OPEC fears of impending demand destruction. There is obviously some merit to both of these points, but I think the far larger motivation was the inability for Saudi to continue producing above 10.5mm barrels per day for an extended period. This level basically leaves no real spare capacity, and puts future production stability at risk. The reality is there is limited (if any) spare capacity in OPEC, Russian production is starting to decline as sanctions take their toll, and US shale production continues to miss expectations. Now comes: 1) China demand improvement post re-opening (probably worth 1mm+ per day of demand, date TBD obviously), 2) SPR drain ending (1mm per day of supply), 3) EU Russia oil ban comes into effect start of Dec, and 4) EU winter demand from gas to oil switching. Couple that with the strong US demand highlighted by recent EIA reports, and super low inventories in the US (see chart below) – TLDR I think oil is headed higher. You would need 2008 style demand destruction to offset all the positive factors described above (the GS commodities team has some good notes on this topic).

SLB’s business peaked at $48.6B of revenue and $9.5B of EBIT in 2014 at the top of the last oil cycle, as WTI averaged in the $90s per barrel for several years. Even in 2010, with WTI in the $70s per barrel, the business did $4.5B of EBIT on $26.7B of revenue. Consensus is undemanding at 2022/23/24 revenues of $27.3B/$31.2B/$34.2B, EBIT of $4B/$5.4B/$6.3B, and EPS of $2.02/$2.81/$3.39 – FCF per share should be about in line with EPS. That’s 13.3x/11.4x 2023/24 EBIT and 15.3x/12.7x 2023/24 EPS. Given current oil prices and the dynamics I pointed out above, I think 1) oil prices are going higher, 2) SLB consensus estimates need to go up just to account for higher drilling activity at current strip vs. activity levels in folks’ models (which assumed oil prices below strip), and 3) numbers are too low when looking at how the business historically performed in a similar oil price environment. Consensus for 2024 would basically have SLB performing in line with 2011, which is still down ~25% or so on revenue and EBIT from the average of 2012-2014, despite similar oil prices and a more efficient cost structure (which was dramatically reset during the 7 year downturn). I think a 6.5% FCF yield on 2023 numbers (7.7% on 2024) is very attractive given the upside to consensus and the durability of this multi year energy up-cycle. Management is disciplined and you should expect this FCF to be returned without excessive spending on Capex or M&A. Additionally, I like the significant offshore and non-shale onshore exposure that SLB has vs. other oil services names, and continue to think those areas will see the most drilling activity resumption during this cycle.

I think SLB can do $4 of EPS in 2024 (would be ~9% yield on current stock price), and believe 15-16x is a reasonable multiple for a best in class asset like SLB. That gets me to a $60-65 price target. SLB earnings should prove defensible even in a weak growth macro environment, unless we see 2008 style oil demand destruction.

Catalyst

Oil prices and earnings expectations continue moving higher; EPS grows despite weak macro, showing durability of this up-cycle