Friday, June 22, 2012

Initiating a commodites position - Boom or doom?

It was in the morning as I checked into my Singapore account. The previous night DJI slumped to 250 basis points as Moody downgrades the grades for up to 15 banks. How will STI perform today?

I believe everyone will agree that valuations for some of the blue chips that we have here is still expensive. Look at Keppel, Sembcorp, Telcos, Reits such as CMT, FCT, Cache, ....etc. As such, there's no point to enter at such valuations at these moments. The huge volume is currently at commodities play such as Noble, Sakari, Olam and Wilmar.

To date, my portfolios have mostly consist of dividend play which I will be looking to add more should the price gets attractive at valuation (currently eyeing CMT price in particular). Fortunately and unfortunately, the price has not gone down to my target price and as such, I decide to venture to a more risky investment into oil commodities play in the US market by initiating a small long position (will add further to average down when price falls further).

Two counters listed on the NYSE are Schlumberger (SLB) and Halliburton (HAL), which I thought at current price were severely beaten down and undervalued. Below are more details about the two companies which I have bought at US$62.50 and US$28.30 respectively (See "Recent Transactions")

1.) Schlumberger (SLB)

Company overview - SLB is a global provider of oilfield services company and the leading provider of exploration and production services, solutions and technology to the international petroleum industry.

Financial Performance - SLB reported EPS of $ 0.98/share for 1Q2012, which has increased 42% as compared to EPS of $ 0.69/share for 1Q2011.

1Q2012 1Q2011 % Change
Oilfield Services 9,918 8,122 22%
Distribution 693 594 17%

1Q2012 1Q2011 % Change
Oilfield Services
Reservoir Characterization 2,586 2,193 18%
Drilling 3,785 3,112 22%
Reservoir Production 3,539 2,808 26%
Eliminations & other 8 9 -11%
9,918 8,122 22%
Distribution 713 601 19%
Eliminations (20) (7) 186%
Total 10,611 8,716 22%

Outlook - The upstream CAPEX is expected to reach $1.23 trillion for 2012 and expected to rise to $1.64 trillion in 2016. Onshore CAPEX continues to have the largest share of CAPEX, but offshore CAPEX is expected to continue to outpace it in terms of growth and is expected to grow at a pace of 58% as compared to 39% for onshore drilling. It is also expected that exploration and drilling growth will be driven by interest in the Gulf of Mexico (U.S.), Brazil (Latin America), Saudi Arabia and Iraq (Middle East), Norway (Europe), Eastern Africa, and the Western Gulf of Guinea.

Summary: The company is financially strong at the moment and profitability of the company is expected to improve going further, based on technological improvements (IsoMetrix), superior service quality, increased CAPEX and OPEX by oil drilling companies, and a shift from gas to liquids-and-oil-shale production in the U.S. The stock is trading at a P/E ratio of 15.3x and offers a dividend yield of 1.68% (SLB increased a 10% dividend in early January 2012). The downside to the current price is due to the crisis in Europe and a fall in the oil prices, which I think has been severely priced in. With current valuation, the stock is trading at almost a 40% discount and while oil prices may fall further, current price is definitely too good to ignore - i.e given the risk vs reward.

2.) Halliburton (HAL)

Company Overview - HAL provides a variety of services, equipment, maintenance, and engineering and construction to energy, industrial and governmental customers. The company is made up of the following three business segments: Energy Services Group, Engineering and Construction Group, and Dresser Equipment Group.

Financial Performance - The EPS of $0.89/share for 1Q2012 has increased 46% as compared to EPS of $0.61/share reported in 1Q2011.

Total revenue has increased 30% from $5.2 billion in 1Q2011 to $6.8 billion in 1Q2012, which was primarily attributable to increased activity in North America, as the demand for production enhancement and cementing work continued to rise.

The cash flow from operations of $734 million improved by 30% as compared to $565 million for 1Q2011. The CAPEX of $782 million for 1Q2012 increased 11%, as compared to $704 million for 1Q2011.

Outlook - It is anticipated that the industry will witness volume increases since improved macroeconomic trends support positive upstream spending outlook and new rigs are expected to enter the market due to the prevailing international oil and natural gas prices. These trends will lead to increased demand for service equipment. It is expected that international pricing will remain competitive due to over capacity, and that the Oil Service Industry will witness increased unconventional oil and gas projects.

Summary: The financial position of the company is strong at the moment, though in the short term they may face some challenging profit margin. Based on the shift from gas to liquids-and-oil in the U.S., that the profitability of the company will improve, putting it at an advantage since it is a dominant service company in this field. It is currently trading at a P/E and P/B ratio of 8.69x and 1.88x, and offering a dividend yield of 1.28. It is currently trading at a 40% discount too and at current price, it is a good start to long.


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