Thursday, January 22, 2015

Why I Purchased National Oilwell Varco, Inc. (NOV)

Boy, I’m getting the month started off a little earlier than I anticipated. As previously aforementioned, my capital availability for stock purchases is going to be light this year, especially for the first few months. But there’s no challenge I’m not willing to take on!
Anyway, I wasn’t planning on purchasing any stocks for the first week or so. I had a couple of names in mind and I was doing some research when oil took another beating on Monday, dropping below $50 per barrel for the first time in five years. If being greedy when others are fearful is the name of the game, consider me a player.
That said, I’m not particularly enthusiastic about going crazy on energy stocks due to my allocation to that sector, which is already north of 15%. Furthermore, my cost basis in a number of really great stocks is already attractive. However, one stock in particular is trading well below my cost basis and the opportunity to average down became apparently too strong to ignore.
I purchased 20 shares of National Oilwell Varco, Inc. (NOV) on 1/5/15 for $61.91 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%). Moving forward, the new segments will be: Rig Systems, Rig Aftermarket, Wellbore Technologies, and Completion & Production Solutions.
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.


I initiated my position in NOV back in early November at $71.05 per share. I obviously regret the timing, but not the logic. The drop in oil has probably been a bit swifter and more substantial than some might have expected, but it really changes very little from my point of view.
The recent drop in oil and subsequently NOV’s stock has given me an opportunity to average down in a big way. I usually start to get interested in averaging down around the 5% level, and that’s because I always attempt to buy stocks with a large margin of safety at the outset. But give me a chance to buy in at a level 10% cheaper and it’s tough for me to pass it up.
I often write about conviction, which is basically being confident with your analysis. If a stock touts excellent fundamentals, great qualitative aspects, solid growth opportunities, and an attractive valuation, then a cheaper price should be welcome and appreciated. Now, that’s assuming the fundamentals are still in place, which is sometimes difficult to decipher because we’re oftentimes trying to anticipate events that have not yet come to pass. But price and value are not one and the same, so a substantial drop in price is often just a chance to buy a stock when the gap between the two is more advantageous to the long-term investor.
So what’s changed with NOV since I purchased it? Nothing, other than the fact that oil has dropped so significantly. This drop could very well have a material impact on National Oilwell’s business, however. So their earnings over the next fiscal year or two could be negatively impacted in a big way, but it’s really difficult to say. It really depends on how protracted this drop in oil is and how much some of the bigger players in this industry cut back on capital expenditures.
But there are some enduring tailwinds for NOV, regardless of the current climate in energy:
  • They have a massive backlog of $16.43 billion (as of Q3), which should keep them busy even if new order inflows are reduced.
  • A considerable portion of the company’s revenue (over 50%) is derived from wells that are already in operation.
  • The company recently announced a massive $3 billion share repurchase plan, which is more than 10% of the market cap. This buyback is even more effective with the shares so depressed right now, which is really wonderful for both the company and long-term investors.
  • They have an excellent balance sheet, with a long-term debt equity ratio of just 0.14 and an interest coverage ratio north of 30. Furthermore, they have more than $4 billion in cash and cash equivalents on the balance sheet, which covers about five years of dividend payments at the current level. I see the dividend as extremely well-covered here, especially in light of the low payout ratio of just 31.5%.


I went over some of the risks in the last article on NOV. I viewed the largest risk as a protracted downturn in oil prices, which is possibly materializing. In addition, there’s a black swan risk, like a failure of one or more of their components, which could lead to litigation and damage to their reputation. One other risk I didn’t go over last time is acquisition risk. National Oilwell Varco has grown substantially through acquisitions, and there’s not only the possibility that attractive acquisitions could dry up, but also the risk that future acquisitions might not be integrated as successfully. The company could also overpay for acquisitions, though they seem to have a pretty solid track record in this arena.


The stock is on the market for a P/E ratio of 10.68, which is substantially lower than the broader S&P 500. In addition, it’s at a sizable discount to NOV’s own five-year average P/E ratio of 13.7. This discount perhaps makes some sense in the short term due to lower oil prices, though I think the tailwinds buffer a lot of their potential setbacks over the long term. Furthermore, one should consider that this stock is down 25% over the last six months. So I guess I have to ask myself if the company was temporarily impaired to the point to where it’s permanently worth some $8 billion less? My answer is no.
I valued shares using a dividend discount model analysis with a 10% discount rate and an 8% long-term growth rate. This growth rate is less than 1/3 of National Oilwell’s earnings growth rate over the last decade. Meanwhile their dividend growth rate is 30.4% over the last five years. Factoring in continued growth, a low payout ratio, and a healthy balance sheet, and I think the projected long-term growth rate is appropriate, though at the higher end of what I usually use. The DDM analysis gives me a fair value on shares of $99.36.


National Oilwell Varco is a dominant player in the oilfield services space. With a diverse product lineup, a sizable backlog, a large buyback plan, and exposure to almost every element of drilling for oil and gas, I think the company is well-positioned to excel through almost any economic environment in energy. Even if they grow at a slower rate in the future, shares appear to be substantially discounted here.
The payout ratio is very low, to the point to where earnings could temporarily halve and the dividend could continue growing at a robust rate. Factor in plenty of cash on hand and what will surely be less shares outstanding, and I think the dividend will continue growing for the foreseeable future.
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 $84.00.
S&P Capital IQ rates NOV as a 3/5 star hold, with a fair value calculation of $82.10.
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 February to reflect this recent purchase.
Full Disclosure: Long NOV.
What do you think of NOV here? Have you ever taken a look? Think it’s attractively valued? 
Thanks for reading.

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1 comment:

  1. I had never heard of NOV but after reading your analysis and doing a little research, it looks very attractive. Another plus is that it's not one of the oil giants like cvx and xom that everyone seems to be looking at these days.



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