Thursday, December 11, 2014

Recent Purchase - National Oilwell Varco

It looks like I’m still keeping some of my old pace up. I wasn’t sure how much capital I’d be able to routinely deploy after leaving my full-time job back in May, but I’ve been incredibly happy with and grateful for the pace of stock purchases thus far. This is now my second stock purchase this month, coming not long after adding to my burgeoning position in Unilever PLC (UL).
I had enough capital for one more purchase this month, and I actually anticipated staying pretty true to my watch list, as I did with my UL transaction. However, Visa Inc. (V)rocketed beyond the price I was wiling to pay, and I’m also staying cautious around the idea of averaging up on what’s a rather small company, Armanino Foods of Distinction Inc. (AMNF).
I still see some value out there, and I’m committed to growing my Unilever position. In addition, continued weakness in BHP Billiton PLC (BBL) means I may add more there in December, after most recently adding to my equity in the company just last month.
However, the purchase I’m discussing today initially became an idea after I wrote about the stock for Daily Trade Alert. I knew of the company already and what they did, but I wasn’t quite familiar with their dominant position, excellent fundamentals, huge dividend growth potential, and attractive valuation. So an idea was born, and I decided to initiate a position in the company.
I purchased 20 shares of National Oilwell Varco, Inc. (NOV) on 11/13/14 for $71.05 per share.


With corporate history dating back to 1862, National Oilwell Varco is a leading worldwide provider of equipment and components used in oil and gas drilling and production, oilfield services, and supply chain integration services to the upstream industry.
The company conducts operations in over 1,200 locations across six continents. Approximately 65% of their fiscal year 2013 revenue was derived from operations outside the US.
They have recently operated in three segments, although these segments will be renamed for fiscal year 2014 and beyond after the spin-off of NOW Inc. (DNOW) was completed earlier this year. The segments up until FY 2013 were as such: Rig Technology (51% of FY 2013 revenue); Petroleum Services & Supplies (31%); and Distribution & Transmission (22%).
NOV provides all the heavy equipment necessary for oil and gas drilling, including rigs, derricks, rotarys, blowout preventers, mud pumps, wireline winches, cranes, drill pipes, drilling motors, drill bits, and transfer pumps, among many other products. They are apparently a one-stop shop for their clients.


What most impressed me when first investigating National Oilwell Varco was the rate at which the company has grown over the last 10 years. Now, oil has been priced rather high, especially since 2009. However, it appears to me that NOV has been particularly able to capitalize on this trend, with some of the better fundamentals I’ve seen in this space.
So let’s take a look. Their fiscal year ends December 31.
Revenue grew from $2.318 billion in FY 2004 to $22.869 billion by the end of FY 2013. That’s a compound annual growth rate of 28.96% over the last decade. Mighty impressive, in my view.
Meanwhile, earnings per share increased from $0.64 to $5.44 during this period, which is a CAGR of26.84%. Again, spectacular. The results were a little erratic, which is to be expected from a company that’s heavily exposed to oil and gas. And they also experienced a downturn during the financial crisis, like quite a few other companies. Not only did the Great Recession take hold, but oil dropped rather substantially during this period as well. However, the long-term trend is clearly upward.
S&P Capital IQ predicts EPS will grow at a compound annual rate of 14% over the next three years, citing a lack of notable upside potential to order flows. Still, a 14% growth rate is pretty fantastic.
NOV’s dividend growth isn’t as lengthy or mighty as some of the oil supermajors out there, but it appears that management is committed to paying and growing its dividend. The CEO, Clay Williams, stated during the most recent quarterly earnings call:
NOV is a special and unique enterprise, with market-leading positions across almost everything we do. We’re pleased to be in a financial position to be able to return capital to our shareholders through share buybacks, as well as paying an attractive dividend, while still being able to invest in growth opportunities.
But they do have a growing record. The company has increased its dividend for the past six consecutive years. And over the last five, they’ve increased it at an annual rate of 30.4%. Those are the kind of annual pay raises I can get behind!
The stock yields 2.59% based on my purchase price, which isn’t quite as high as I typically target. But it’s certainly healthy enough for me to invest here, especially considering the dividend growth rate. And the payout ratio, at just 31.5%, is quite low. So there’s not only plenty of room for future dividend increases, but also room to cushion any downturns in the industry.
So the CEO’s quote above mentioned buybacks. The company announced a $3 billion share buyback program at the end of September, which amounts to nearly 10% of the market cap of the company. This buyback comes not long after Williams took over the company, and he obviously seems some value in the company’s own shares. The company actually increased its share count over the last decade during an acquisition spree.
NOV maintains an excellent balance sheet. The long-term debt/equity ratio stood at 0.14 at the end of last fiscal year, while the interest coverage ratio finished at 31.1.
The company’s profitability metrics appear sound. Net margin has averaged 12.30% over the last five years, while return on equity averaged 11.29%.

Qualitative Aspects

When performing some research on the company, I noticed that their dominant position in their space comes up over and over again. Just an anecdote perhaps, but I’ve read that the company is nicknamed “No Other Vendor” as a play on their stock ticker, which refers to their all-world dominance and product availability for all aspects of their clients’ needs. They have the products necessary for both oil and gas; onshore and offshore; domestic and international. It’s this diversification across energy exploration and geography that really interested me.
It’s estimated that they enjoy the #1 market share in almost every product line in which they compete. Furthermore, the company estimates that nearly 90% of the world’s mobile offshore rig fleet and the majority of the larger onshore rigs manufactured over the last 20 years use products manufactured by them.
This strong market share and diverse product lineup gives them competitive advantages. You can’t viably avoid NOV’s products when building rigs, which gives them a strong base of recurring revenue. In addition, they manufacture most of the products necessary for the drilling process itself. And since they’re the most dominant company in their space, they can comfortably price their products to avoid competition. Competition, by the way, is fairly limited for NOV as they’ve been busy acquiring smaller companies over the last decade to round out their business and expand their offerings and services.
The company maintains a rather healthy backlog, at $14.3 billion as of the end of Q3. That’s a bit lower than where they finished FY 2013, but still solid.


I view the largest risk for NOV as a potential protracted downturn in oil prices. Oil prices have declined rather significantly and swiftly since the summer highs, and you see some of that play out in NOV’s stock; it’s down some 15% just since late August. Lower oil prices reduce demand for NOV’s products. In addition, there is always the threat of a black swan event in the energy space, and a failure of one or more components that National Oilwell Varco manufactures could lead to potential litigation and the loss of future orders.


The stock trades hands for a P/E ratio of 12.15, which isn’t only well below the broader market, but also below NOV’s own five-year average P/E ratio of 14. It appears to me that this discount is present due to concerns over oil prices.
I valued shares using a dividend discount model analysis with a 10% discount rate and an 8% long-term growth rate. That growth rate appears to build in a margin of safety by itself, as it’s less than 1/3 NOV’s earnings growth rate over the last decade. Factor in a low payout ratio and I see no reason why NOV can’t offer that type of dividend growth rate for the long term. The DDM analysis gives me a fair value of $99.36.


National Oilwell Varco absolutely dominates the oilfield services space. They manufacture just about every component that goes into a rig, as well as everything necessary for the drilling process. They have corporate history dating back well before the turn of the century, and I believe they’ll still be around at the turn of the next one. Their growth over the last decade has been absolutely stunning, and even if their growth rate were to permanently halve for some reason, this is still a great investment here. Oil prices could remain low for an extended period of time, but I believe their dominant position, strong backlog, diverse products, and exposure to all aspects of energy exploration across the world means they should be able to weather any short-term issues with oil prices. Of course, if you believe oil will go lower and stay there for a long period of time, this would not be the best time to invest in NOV or any other energy company.
The valuation seems to build in a sizable margin of safety. I used a growth rate that’s lower than their historical EPS growth rate over the last decade, considerably lower. Furthermore, the actual value on shares using that lower growth rate indicates potentially severe undervaluation. I’m comfortable with that type of margin of safety, even factoring in the drop in oil prices.
I’m going to include a couple of other valuation opinions below, as I use these to concentrate my reasonable valuation estimate:
Morningstar rates NOV as a 4/5 star value, with a fair value estimate of $89.00.
S&P Capital IQ rates NOV as a 3/5 star hold, with a fair value calculation of $86.30.
This purchase adds $36.80 to my annual dividend income, based on the current quarterly $0.46 dividend.
I’ll update my Freedom Fund in early December to reflect this recent purchase.
Full Disclosure: Long UL, V, AMNF, BBL, and NOV.
What do you think about NOV? Ever take a look at it? Impressive fundamentals?
Thanks for reading.

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