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Sold Schlumberger, with a return of 77% [ClearOnMoney]
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Sold Schlumberger, with a return of 77%

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Investment

Sold Schlumberger, with a return of 77%

18 Jan 2011 by Jim Fickett.

Schlumberger is an excellent company in a sector with great prospects. I was glad to get the opportunity to buy shares rather cheaply in the second quarter of 2009. Now the shares are probably overpriced and, in the interests of risk reduction, I've sold. Including fees, commissions, and dividends, my total return was 77%.

I think we are pretty close to the peak in world oil production. But, even if not, it is abundantly clear that deposits being discovered currently are smaller and harder to reach than the discoveries of the past. Hence oil exploration and production, the business of Schlumberger, is a great place to be.

In addition Schlumberger seems to have quite a smart strategy.

  • They view themselves as an expertise company; they have a large R&D budget, acquire companies with a view towards new capabilities, and forge ties with leading universities in most countries where they work
  • They work very well cross-culturally; many employees, including managers, in each country where they work are natives; the top management team comes from several different countries
  • National (i.e. government-controlled) oil companies now own most of the world's reserves; Schlumberger works very well with these companies by not competing for reserves and by training the locals

Here are the data on revenue, cash flow, income, and dividends for the last 10 years (2010 numbers are annualized from the results for the first three quarters):

That big drop in earnings in 2002 was due to one very big mistake: overpaying (by several billion) for an IT company during the internet bubble, and then writing it down later. Other than that, revenue and earnings mainly follow the oil price and hence the general level of enthusiasm for exploration and development.

It is very hard to know what sustainable earnings might be, but if we assume that the average level of the last five years is a reasonable guess on the future, that gives a price/earnings ratio of about 24. That is borderline. It is not inconceivable that earnings will double in the next few years, bringing the forward-looking P/E to more like 12. It is also not inconceivable that the credit-driven growth boom in several large countries will slow and earnings will stay fairly constant, leaving a P/E of 24 as looking quite rich. My overall feeling is that, from an earnings point of view, the price is somewhat, but not extremely, high.

Besides the acquisition mistake in 2001, there are two other trouble spots that lower my enthusiasm somewhat.

First is the state of the retirement plans.

  • One defined contribution plan was switched in 2009 to a defined benefit plan – this is moving in the wrong direction
  • The company contributed $1.1bn to pension plans in 2009; this did reduce the unfunded liability by $0.8bn, but it shows the unfunded liabilities are large enough to have noticeable effects on net income
  • Post-retirement health benefits are almost completely unfunded, and the unfunded liability is $0.9bn

All in all, the retirement plans are not going to sink the company, but they are not being managed very prudently either.

The second area is share buybacks. Share buybacks have been running at about 15-35% of income for the last few years, so this is a large repurchase program. The buybacks have NOT been concentrated in years when the stock price is low. Overall, I do not find this an impressive use of revenue; it looks more like a constant attempt to prop up the stock price than like an intelligent use of money.

Even with these issues, I continue to like the company, and may well take a position again after a market correction. My sale of the stock was based on a feeling that (1) the stock is somewhat overpriced currently, and (2) the overall market may well experience a correction, and I would prefer to own only assets that I think are fairly or under-valued.