We are reaffirming our HOLD rating on National Oilwell Varco (NYSE: NOV) as E&P customers continue to reduce capital spending and focus on strengthening their balance sheets and returning capital to shareholders. We expect this reduced spending to weigh on earnings at National Oilwell and other oilfield services companies, and believe that increased spending would require a sustained recovery in oil prices to the $45-$50 range.
Given slower North American drilling activity and moderating global GDP, we do not expect NOV’s customers to begin an active drilling program, especially in the U.S. land market, due to weak oil prices, modestly high crude oil inventories, and prospects of slowing global GDP growth in the near-term. As such, we believe that a HOLD rating on NOV remains appropriate.
On October 26 after the close, National Oilwell reported a 3Q20 adjusted net loss of $2.1 million or $0.02 per share, compared to an adjusted net profit of $4.2 million or $0.04 per share in the prior-year quarter. The loss was narrower than our loss estimate of $0.14 per share and the consensus loss estimate of $0.11 per share.
The swing to a year-over-year loss was primarily attributable to lower sales in all of the company’s operating segments, with particular softness in the Wellbore Technologies division, where the segment sustained an operating loss due to a sharp reduction in North American drilling activity.
Third-quarter 2020 revenue of $1.384 billion fell 35% year-over-year and 8% sequentially (the StreetAccount consensus was $1.370 billion). In the near-term, the company continues to focus on cost reduction and working capital initiatives, until drill spending by E&P’s improve.
The company has combined its Rig Systems and Rig Aftermarket reporting segments into a single segment called Rig Technologies. The company now has three reporting segments: Rig Technologies (31% of 2019 sales), Wellbore Technologies (37%), and Completion & Production Solutions (32%). Second-quarter segment results are summarized below.
The Rig Technologies segment generated revenue of $449 million, down 31% from the prior year. Adjusted EBITDA fell 73% from the prior-year quarter to $28 million. Declining rig activity, combined with COVID-19-related logistics issues, which were particularly acute in the aftermarket business, drove the declines in revenue and profitability.
In Completion & Production Solutions, revenue fell 18% from the prior year to $601 million. Adjusted EBITDA decreased 23% from the prior year to $68 million, as strong execution on international and offshore project backlogs was more than offset by declines in shorter-cycle (shale) businesses. The capital equipment backlog at the end of the quarter was $789 million, down 39% from the prior year. New orders totaled $169 million, down 68% from the prior year.
In Wellbore Technologies, revenue fell 55% to $361 million in 3Q20, reflecting weakness in international markets and lower drilling activity in North America. Adjusted EBITDA fell 84% from the prior year to $21 million.
During the third quarter, NOV recognized $62 million in restructuring charges, primarily due to severance costs, facility closures, and inventory reserves. As discussed in our prior earnings report, due to energy market weakness and the impact of the pandemic, NOV raised its cost-cutting target to $395 million. It had also lowered planned 2020 capital expenditures by approximately 25% to $250 million.
EARNINGS & GROWTH ANALYSIS
National Oilwell Varco does not provide a formal financial outlook; however, on the 3Q20 conference call, Chairman and CEO Clay Williams noted that the company would continue to focus on cutting costs until demand improves. Management now expects little improvement in revenue until mid-2021 at the earliest, similar to its earlier forecasts.
We are narrowing our 2020 loss estimate to $0.24 from $0.36 per share to reflect third-quarter results, which beat our quarterly estimate by $0.12 per share. We continue to see NOV’s cost reduction programs as a significant factor for the remainder of the year. The consensus calls for a loss of $0.30 per share.
We are also narrowing our 2021 loss estimate to $0.31 from $0.33 per share. We expect commodity prices to be modestly higher in 2021 than in 2020. The 2021 consensus calls for a loss of $0.31 per share.
FINANCIAL STRENGTH & DIVIDEND
We rate NOV’s financial strength as Medium-High, the second-highest rating on our five-point scale. The company’s debt is rated BBB+/negative by Standard & Poor’s and Baa1/negative by Moody’s.
At the end of 3Q20, NOV’s total debt/capitalization ratio was 31.6%, up from 28.7% a year earlier. The total debt/cap ratio is well below the peer average. It has averaged 18.7% over the past five years.
Outstanding debt totaled $2.554 billion at the end of 3Q20, down from $3.270 billion at the end of 3Q19. NOV had cash and cash equivalents of $1.49 billion at the end of the quarter, up from $1.31 billion at the end of 3Q19. It also has $3.0 billion of undrawn capacity on its revolving credit facility.
In the third quarter of 2015, NOV completed its share repurchase program by buying 10.85 million shares for $444 million. In all, the company repurchased 55.6 million shares, or 13% of its outstanding stock, under this authorization. The company has not announced a new buyback program since then and we do not anticipate one in the near term.
On May 20, 2020, National Oilwell suspended its dividend in response to weak energy markets. Prior to this announcement, National Oilwell had paid a quarterly dividend of $0.05 per share or $0.20 annually. It previously cut the payout from $0.46 per share.
The Oil Services, Drilling and Equipment industry is one of the most volatile and unpredictable industries in the S&P 500. The main investment risk is the overall health of the global economy, though the industry also faces significant geopolitical risk.
National Oilwell Varco is the result of the acquisition by National Oilwell of Varco International in 2005. The company designs, manufactures and sells major mechanical components and integrated systems for both land-based and offshore drilling rigs. It manufactures complete land drilling and well-servicing rigs, the largest line of lifting and handling equipment in the industry, a broad offering of downhole drilling motors, and specialized drilling tools. The company was founded in 1862 and is based in Houston.
NOV shares have traded between $7.70 and $25.81 over the past 52 weeks and are currently toward the low end of that range. To value the stock on a fundamental basis, we use peer-group and historical multiple comparisons, as well as a dividend discount model. In this case, valuation based on P/E is meaningless given our loss estimates for both this year and next.
On other metrics, the shares are trading at a trailing price/book multiple of 1.0, near the low end of the historical range of 0.9-1.4, and at a price/sales multiple of 1.7, at the high end of the range of 1.1-1.9. The price/cash flow multiple of 16.9 is above the midpoint of the eight-year range of 9.5-23.8.
Looking ahead, we expect NOV to face meaningful earnings pressure from reduced capital spending by E&P customers, and believe that renewed spending would require a sustained recovery in oil prices to the $45-$50 per barrel range. Given current slow North American drilling activity, moderating global GDP, and fallout from the coronavirus pandemic, we do not expect this to occur in the near term. As such, we believe that a HOLD rating remains appropriate.