Source: BarronSource: Barron’s

Last month Schlumberger (SLB) announced it would take a one time charge of over $1 billion pursuant to layoffs and restructuring efforts:

Schlumberger (SLB +2%) expects to take one-time charges of $1.2B-$1.4B associated with its ongoing restructuring and related layoffs, CEO Olivier Le Peuch says.

The restructuring, which will include cutting 17 product lines into four divisions and restructuring around just five key basins, is expected to permanently save ~$1.5B/year in costs, the CEO told the J.P. Morgan 2020 Energy, Power & Renewables Conference.

The sharp fall in North America land drilling triggered the write-off. Last year several oil services companies like Superior Energy (SPN), Halliburton (HAL) and National Oilwell Varco (NOV) announced layoffs. The trade war with China likely hurt oil demand; such layoffs implied E&P was already facing headwinds.

The coronavirus brought the economy to a hard stop, hurting business activity and demand for oil. Supply cuts by OPEC and Russia helped drive Brent oil above $40. Even at these prices it could be difficult for oil services firms to turn a profit. E&P for deep water projects are likely not economical. As the economy slowly reopens, vital signs are improving. Industrial production rose 5.4% in June and should rise over the next few months. However, industrial production was off over 40% Y/Y in Q2, which could put companies like Schlumberger until they see signs of a sustainable rebound.

In Q1 2020 the company reported revenue of $7.46 billion, down 9% sequentially. The rig count in North America fell by double-digits in Q1. This is important as North America is the company’s second-largest region. It was previously a catalyst for Schlumberger, Halliburton and Baker Hughes (BKR). Outside North America the company’s revenue fell 10% Q/Q. With oil prices just above $40, orders for Cameron’s subsea operations could dry up; it represented over 15% of Schlumberger’s total revenue. This likely explains the company’s restructuring efforts.

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Cost Cutting Opportunities

Schlumberger has been cutting costs for much of 2019. The company introduced furloughs and reduced compensation expense for senior management. EBITDA margins were 17.7%, down 270 basis points versus Q4. Still, the company was highly-efficient compared to its peers.

Schlumberger Q1 2020 Operating Costs. Source: Shock ExchangeSchlumberger, Halliburton, Baker Hughes and National Oilwell reported Q1 2020 operating expenses of $6.1 billion, $4.2 billion, $5.0 billion and $1.8 billion, respectively. Schlumberger’s operating costs as a percentage of revenue was 82%, slightly more efficient than Halliburton and far more efficient than Baker Hughes and National Oilwell.

Schlumberger’s $6.1 billion in operating costs are still sizeable enough for management to cut into. The drawback is that more cost cuts could potentially hurt service levels or employee morale.

Schlumberger’s Credit Quality Could Slide

Schlumberger has a debt load of $16.6 billion at 2.6x last 12 months (“LTM”) EBITDA, up from 2.3x in Q4 2019. EBITDA fell in the double-digit percentage range. Q2 results will likely worsen due to the knock on effects of the pandemic. This implies Schlumberger’s credit metrics could slide. Moody’s rates Schlumberger Holdings at BAA1, which is considered lower medium grade. Moody’s anticipates Schlumberger’s debt-to-EBITDA could rise above 3x in 2020 and fall below 3x next year. However, if Schlumberger’s debt-to-EBITDA rises above 3x and does not show any improvement then a ratings action could be warranted.

The pandemic has made projecting Schlumberger’s EBITDA, cash flow and credit quality seem like guesswork. I anticipate the company’s EBITDA and credit quality to fall over the next few quarters. It is smart for management to continue to rightsize the company in advance of headwinds for the economy and oil prices. Schlumberger’s credit quality could hang in the balance.

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Conclusion

The pandemic will likely cause the vital signs of the economy to fall hard in Q2. It could hamper Schlumberger’s EBITDA and credit quality. Over the long term I expect oil markets and Schlumberger’s business prospects to stabilize. I rate SLB a hold.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



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