weatherford International WFT
July 19, 2010 - 1:00pm EST by
skca74
2010 2011
Price: 14.50 EPS $0.50 $1.25
Shares Out. (in M): 746 P/E 29.0x 13.0x
Market Cap (in $M): 10,817 P/FCF 37.0x 12.0x
Net Debt (in $M): 6,629 EBIT 800 1,550
TEV ($): 17,446 TEV/EBIT 4.6x 8.9x

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Description

Weatherford is the cheapest oil services company with the greatest earnings power and free cash flow generation ability over the next several years.  The company had made significant international infrastructure investments over the last several years and these investments should bode well as more and more E&P capex moves overseas.  The company seems to have gotten religion with a focus on profitability and returns on capital after putting up several disappointing quarters.  The operating leverage is significant in a recovery and earnings power should be close to $3/share.  The company should garner a 14-15x multiple and could be worth in the low to mid 40's over time or 3x from current prices.

Business Description

  • Result of 250 acquisitions - now a leading provider of equipment and services to the oil and nat gas exploration and production industry operating in over 100 countries
  • Provides a large portfolio of services and products including pressure pumping, directional drilling, and artificial lift
  • Demand driven by (Rig count is an indicator of the level of spending):
    • Maturity of world's oil/gas reservoirs
    • Accelerating production decline rates
    • E&P service intensity increasing outside the US (e.g. NA is 5.5% of E&P, Latin America is 5% of E&P spending, EUROPE/SSA/FSU is 3%, MENA/Asia Pac is 3.5%)
    • More recently (E&P spending shift to Land and overseas due to Gulf)
    • Continued drilling of unconventional gas, expansion of deepwater drilling and provision for bundled packages (means the larger players win)
  • Have a land orientation and a service concentration in well construction and products (only 1/3 is services)
  • Heavily invested in Middle East, Latin America and Russia
  • 40% USA, 16% Canada, 9% Latin America, 35% eastern hemisphere

 

Investment Highlights

  • Business Strategy changes: Change in old strategy to grow at any cost to grow profitably - should bode well in valuation multiple as ROIC's should improve; the company is targeting over 20% ROC
  • Leverage global infrastructure on investment made over the last several years
    • Volumes recover overseas and improve margins as pricing recovers (e.g. the company says they have $2bn of underabsorbed capital); CEO said they could accommodate another 50% (or $3bn in sales) with current infrastructure internationally
    • Segment SG&A increased 46% from $850MM in 2007 to $1.2bn in 2009
    • Company spent $7bn in capex from 2005-2009 and $4bn on acquisitions; have not seen the returns from these investments due to recession and possibly poor allocation of capital
    • 2009 international rev were up 18% (but growth was due to an acquisition in 09), while rig count was down 8%; operating income was 24% of revenues in 2008 down to 16% in 2009
      • The company made a conscious decision to maintain its international workforce and infrastructure and as a result is considerably underutilized; note that the company had significant startup and delay costs on project initiations; 2011 should be very strong
  • Huge operating leverage when rigs return: North American rig count declined 42% in 2009 and revenues were down 38% while op margins decreased 82%; op margins declined from 25% to 7%;
  • Significant pricing erosion in North America and the international markets in 2009 are behind them and should improve with improved volumes
    • NA should begin to show meaningful margin improvement (not only with improving rig count/volume but also as a result of restructuring - company had taken out $500MM in costs in 2009 in NA); Also note that HAL reported this morning and said that NA pricing and volumes have come back dramatically already
  • Consolidation: Service company consolidation should help industry pricing (e.g. Baker and BJ's and SLB and Smith)
  • Move towards Integrated project management (IPM) - favors companies with breadth, expansive geographic footprints, and integration capabilities; this has been a focus for the company on there international contracts
  • Operating at trough levels (6-8 cents/share per quarter) considering peak earnings were at $0.55 in Q3 2008 or $2.20 annualized; believe they can get back to $2/share by 2012
  • Major investment spending behind them (2010 capex expected at around $1bn versus previous highs to $2.5bn); should be in the $1-1.3bn range going forward
  • Significant potential to grow share internationally
    • 2008 - 4.5bn in rev on industry spend of $100bn in North America; and internationally had $5bn in rev on $280-$300bn industry spend - the opportunity is to increase mkt share with new product lines that were born out of NA (e.g. as the rest of the world matures to technology developed in NA - WFT should continue to grow share)
  • Valuation: $14.50, shares out: 746MM or $10.8bn mkt cap, $6.6bn net debt; $17.4 EV; 2012 earnings power over $2 or about $3.5bn ebitda so trades at under 7x p/e or 5x ev/ebitda
    • Assumes NA revenues returns to previous peak but margins remain well below peak at 18% versus 25%
    • Assumes International rev grow 50% from $6bn to $9.2bn with only 27% incremental margins; this seems very conservative given that the CEO told us he could add 50% more in rev internationally with his current infrastructure
    • PT: 15x 2012E $2/share is $30/share

Earnings Potential

 Historical Ebit Margins
  • Trough: North America: negative; International: 10%
  • Peak: North America: 29.8%; International: 25.2%
  • Company believes next peak will be higher than previous peak given historical precedence and that international could be higher than North America; I don't give them credit for this but if you believe them - earnings power is much higher than my $3/share
   
                  30%      
                  underutilized   20%  
                  Volume   Pricing  
Revenues                 Recovery   Recovery  
North America 1,670 2,401 3,673 3,937 4,460 2,766 3,562          
   % of Total 53% 55% 56% 50% 46% 31% 38%          
International 1,462 1,933 2,906 3,895 5,140 6,061 5,791          
  % of Total 47% 45% 44% 50% 54% 69% 62%          
Total Revenues 3,132 4,333 6,579 7,832 9,601 8,827 9,353   2,806   1,871 14,029
                         
Op Income 490 701 1,341 1,616 1,934 666 644         3,153
  % of Rev 16% 16% 20% 21% 20% 8% 7%         22%
EBITDA 746 1,035 1,824 2,222 2,665 1,573 1,641   842   1,871 4,353
  % of Rev 24% 24% 28% 28% 28% 18% 18%         31%
Capex 337 1,514 1,245 1,910 2,985 1,456 1,100         1,754
  % of Rev 11% 35% 19% 24% 31% 16% 12%         12.5%
EPS 0.46 0.74 1.27 1.67 2.00 0.50 0.32         2.95
FCF (assumes maint capex = depreciation)                       2.95
Risks
  • Execution and pace of market acceptance of new technologies
  • cap allocation - outspend op cash flows over the last few years to build out international capabilities
  • Cap structure - 3x levered at end of 2010
  • Political risk working in countries like Russia, Iraq, Algeria, China, etc.
  • Regulatory risks - spread of US regulation to other countries
  • Currency risk - translation risk to US dollars should dollar strengthen significantly

 Catalyst

  • - FCPA settlement
  • - Meet EPS targets after five consecutive quarter misses

 

Catalyst

- FCPA settlement
- Meet EPS targets after five consecutive quarter misses
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