National Oilwell banks on backlog

12/8/2008


  Recent Price
$23
  Dividend
$0.00
  Yield
0.0%
  P/E Ratio
5
  Shares (millions)
418
  Long-Term Debt as % of Capital
11%
  52-Week Price Range
$92.70 - $17.60

Even in its current sluggish state, the world economy still runs on oil. National Oilwell Varco ($23; NYSE: NOV) builds the equipment needed to keep oil flowing, regardless of whether pumping slows over the next year.

National Oilwell’s shares followed the run-up in oil prices over the past five years and were crushed when oil tanked in recent months. Yet the company’s results have not been badly hurt during previous sharp downturns. Sales and profits are directly linked not to the price of oil, but to the amount of money producers spend to drill for that oil. Drilling could fall off if oil prices remain low. But as long as prices rebound to a level at which drilling is profitable — which seems likely, given the expectations of Wall Street analysts and futures investors — we expect a modest loss of business.

National Oilwell, with a strong balance sheet and sizable order backlog, is a Buy and a Long-Term Buy.

Strong fundamentals
National Oilwell builds more than drilling rigs. It produces more than half of the coiled tubing used at the world’s oilfields and is the largest global provider of many smaller components used by drillers. That mix contributes to a book of business that can ride out an economic slump.

Free cash flow jumped 81% to $1.83 billion in the 12 months ended September, and the company holds more cash than long-term debt. While National Oilwell’s cash holdings and cash flow seem more than sufficient to cover operations, the company also has $2.5 billion in credit lines available for emergency use.

Even if drilling activity slows in coming months, National Oilwell’s backlog should help it avoid the worst of the market downturn. The $11.8 billion backlog represents nearly a year’s worth of revenue and has increased every quarter for three-and-a-half years. Most of the contracts are with established drillers, and National Oilwell expects minimal erosion. Contracts require large down payments, and clauses prevent work from being canceled for convenience or lack of financing. National Oilwell says, “We expect our backlog of projects to move ahead as planned in accordance with their contracted terms.”

The company expects to recognize almost $1.5 billion of the backlog in the December quarter and $5.7 billion in 2009. More than half of the backlog is contracted through well-capitalized shipyards, and only one customer has fallen behind on payments, representing risk to 1.5% of the backlog.

Through late October, National Oilwell said it has not seen any effects of the credit crisis on its mostly international business, though it expects orders to slow over the next three quarters as financing for large projects tightens. Meanwhile, National Oilwell’s strong cash position should allow it to scoop up distressed companies at attractive prices during the downturn.

Conclusion
National Oilwell earns excellent Quadrix scores of 99 Overall, 97 in Quality, 93 in Value, and 91 in Momentum. The stock trades at just 4.5 times the consensus profit estimate for the next four quarters, well below the five-year average forward P/E of 13. An annual report for National Oilwell Varco is available at 7909 Parkwood Circle Drive, Houston, TX 77036; (713) 346-7500; www.nov.com.


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