Entering The Digital Era Of The Industry With Schlumberger (NYSE:SLB)
Schlumberger (SLB) is the leading global supplier for the oil and gas industry. Its know-how and relationships in the industry are two competitive advantages. However, SLB similar to its main competitors is heavily dependent on the capex spending of its clients – all indicators are pointing towards an increase in spending in the coming years. Besides that, SLB is planning to grab more of that capex by helping clients to increase the return on the capex deployed.
However, the current risk-reward profile is not attractive as I see a potential 15%-23% upside to $45-$48 per share but a 28% downside to $28 per share. I would start accumulating the stock below $33.50 as the risk-reward would be more attractive (-16% vs. 34%).
The SaaS company of the E&P industry
SLB is redesigning itself for the next era of the industry. The industry has already drilled the most profitable basins. Now the marginal wells are costlier and have lower quality or fewer reserves. So SLB is helping its clients to shorten the exploration and development phases by using artificial intelligence. This will help SLB to increase its revenues by offering more value-add services to its clients and the clients benefit by getting a higher return on the capex deployed, a win-win scenario.
SLB is implementing a strategy used in other industries where it shares the risk with clients for a potentially higher reward. It is offering performance-linked services, that is if SLB lowers the cost per barrel of development, it receives part of the cost savings. I strongly believe that SLB will excel in this thanks to its decades of know-how and its use of DELFI.
In 2017, SLB launched its digital solution called DELFI. DELFI is a SaaS for the E&P industry. In this platform, clients have access at scale to past data such as historical outputs per basin and the platform allows them to extract a higher value from that information. Clients could collaborate internally on this platform and leverage SLB’s experience and data as well.
So far DELFI has helped clients reduce cost and carbon while increasing capital efficiency. SLB had the vision that drilling and production operations are ripe for digital disruption, so they took a page from the Netflix playbook and disrupted themselves. While digital revenue grew 7.3% in the year, subscribers to DELFI grew by 160% and the margin improved from 21% to 35%.
The explosive growth in subscribers hasn’t followed with similar growth in revenues…yet. The reason is that operators have been slow to adopt new technologies, 77% of respondents in the annual wordoil.com survey are planning to keep the same process in testing and adopting new technologies. However, it is expected that the relevance and adoption of AI and advanced analytics will increase in the coming years.
Global E&P capex spending to increase in 2022 and onwards
Oil prices and cash flow are the two drivers of capex spending in the sector, and I think both are to increase in 2022 onwards for at least the medium term.
Global E&Ps assumed an oil price of $70 per barrel in their 2022 capex spending. The plans reset higher if oil prices go above $75 per barrel, as of March 2nd, WTI is $107 per barrel due to the war in Ukraine. Even if the war is de-escalated and we all become friends again, the west wants to lower its dependency on Russia by increasing exploration and production activities.
The current situation in Ukraine is only helping China as they will be grabbing Russian oil on the cheap, a similar strategy as when sanctions were imposed on Iran and Venezuela. Coming out of this, the Russian-Chinese ties will be even stronger and Russia’s needs to sell oil to the west will decrease even more.
I valued SLB using a DCF. The main assumptions were regarding the digital segment. This segment will grow revenues at a high pace and I expect it to be the largest revenue contributor for SLB by 2028. At the same time, I expect margins for this segment to converge to SaaS margins.
As per the other segments, while I expect more activity and we are entering the upcycle of capex spending in the industry, I foresee that clients will demand cost efficiencies so the higher activity is partially offset by the lower price.
Below are my estimates per segment:
Based on an unlevered beta of 1.18 for Oil & Gas service providers, I estimate the cost of capital at 7.9% and the fair value per share at $45.
If I am more optimistic about the revenue growth of the non-digital segments increasing it from 2% to 5%, the fair value would increase to $48 per share. And each 100bps increase in EBITDA margin increases the fair value by $2.50 per share.
While I could entertain a higher revenue growth of the non-digital segments, I think my EBITDA margin estimate, converging to 30% in the medium term, is very optimistic.
Despite liking the company and its strategy, I am not a buyer at the current stock price. I would wait for the stock price to dip below $33.50 per share to start a position.