The supply/demand driven adjustment in oil prices has without a doubt taken the wind out of the sails of many oil service and equipment companies from an earnings perspective. Manufacturers of rig equipment, consumables and aftermarket parts have taken the opportunity in recent months to fine-tune assets, inventory and forecasts to better reflect the new resource price environment.
So here we look at National Oilwell Varco (NOV). The stock is down 35% over the last 12 months and since it reached an all-time high of around $90 in early 2014 it hasn't been the best performer in this sideways market. Backlog for oil rig orders has all but disappeared as of the fourth quarter of 2015, including a large $2 billion order from recently bankrupt company Sete in Brazil. The cyclical elements of NOV's earnings model have been reset to effectively zero at present.
Therefore NOV, with no more oil rig building business, is now comprised of well consumables and aftermarket equipment for existing rigs, comprising about two thirds of the business. Frac equipment, land rigs and subsea projects are the remainder. These parts of the business possess smoother cyclical elements and create a basis for consistency in revenue and earnings, from here forward, until (and if) new rig construction comes back.
When a cyclical craters, as is the case with NOV, we look for earnings power and franchise value. Assuming this steadier aftermarket and consumable business, we can expect NOV to earn upward of $2.25 per share into next year, as inventories replenish and demand and supply for NOV's products becomes more in balance.
The stock, currently trading around $30, is trading at 13x. And this is low-to-mid cycle earnings. The company can earn $4.00 in a couple of years. A premium valuation multiple should be awarded on these low-to-mid cycle earnings to value the franchise properly. Look, there is no other company like National Oilwell Varco. There is also no other Schlumberger (SLB) or Exxon Mobil (XOM), down 14% and up 6% respectively, over the last 12 months. Both companies are customers of NOV.
Cyclical investing requires the patience and gravitas to buy when the stocks look "expensive" on forward earnings; but it is important to realize that, when executed properly, the "buy low, sell high" mantra for cyclical quality companies, like NOV, can be extremely profitable in time.
NOV can go into the $40s based on normal valuation applied to the company's earnings capability.