Did One Of Schlumberger’s Cylinders Misfire?

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Schlumberger CEO Paal Kibsgaard

The oil market never ceases to surprise. When oil was gushing into 2014 and then prices suddenly turned to the downside after the Fed ended its quantitative easing program. When oil services firms seemed like they were on the ropes in 2016, suddenly prices spiked to give them new life. OPEC followed through on promised supply cuts in the second half of 2016, which buoyed markets further. Oil services giant Schlumberger (SLB) was firing on all cylinders for most of the year.

However, one of its cylinders – Latin America – appears to have misfired. The company’s Q3 revenue was up 8% sequentially, but Latin America was off 8%. That’s a sea change compared to Halliburton who experienced 4% growth from Latin America last quarter.

Part of the decline was due to the completion of reservoir characterization and drilling activities in the Geomarket in Mexico and Central America. In the first half of 2016 Schlumberger curtailed operations in Venezuela due to slow payments from PDVSA, the state-owned oil company. The company helped PDVSA finance some of its oilfield services needs. At Q3 2017 it had a receivables balance of $0.5 billion and a promissory note of $0.2 billion with whom the company calls its “primary customer in Venezuela.”

According to Schlumberger’s recent 10-Q, it entered into a financing arrangement that involved the exchange of $700 million in outstanding accounts receivable for a three-year promissory note. Schlumberger recently recorded a $460 million loss on the note. In addition, the company reached an agreement to settled about $1 billion in past due receivables from Ecuador. Until certain Latin America customers improve their credit quality the company might reduce even more exposure to the region.

North America Land Drilling Might Have Peaked

North America land drilling has been white hot, and firms like Halliburton and Baker Hughes (BHI) with major exposure to the sector have benefited the most. Schlumberger receives about 33% of its revenue from North America. This quarter Schlumberger’s revenue from North America was up 18% sequentially as the company nearly employed its complete shale fracturing capacity for land drilling. Shale plays have taken advantage of rising oil prices driven by OPEC’s supply cut.

For the week ending October 27th the rig count was up by 352 Y/Y, but fell by 4 versus the previous week. It was the second consecutive weekly decline in the rig count. Some believe the the rig count has plateaued and shale oil plays are making a trade off between preserving capital and more expansion. This could mean Schlumberger’s one catalyst – North America land drilling – could be coming to an end. Its pending joint venture with Weatherford (WFT) to engage in shale fracturing will give the company even more exposure to the region just as the sector might have plateaued.

Takeaway

With cash on hand of $6.4 billion and debt/run-rate EBITDA of 2.4x Schlumberger has the best balance sheet in the oil services space. It has the capital and scale to thrive in an up or down market. However, 45% of its revenue is related to North America and Latin America where it could face face more headwinds. SLB is down 16% Y/Y and could fall further. I rate the stock a sell.

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