Schlumberger (SLB) looks to beat oil crisis, market turmoil by tweaking capital allocation

Oilfield services company Schlumberger Limited (NYSE: SLB) suffered a double whammy in the early months of the fiscal year, losing significant market value after being battered by the coronavirus-related disruptions and the free-falling oil price. The low valuation resulted in a hefty goodwill impairment charge that weighed on the bottom-line in the first quarter of 2020.

Check Schlumberger’s (SLB) Q1 2020 Earnings Infographic

Despite weakness in the key metrics – lower revenues and earnings – the stock made a modest recovery from the multi-year lows seen early last week as earnings came in above the forecast. The management also slashed the dividend with the aim of easing the pressure on liquidity.

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The Houston, Texas-based company typically stays resilient to market headwinds, thanks to its healthy cash position and diversified portfolio. But the complexity of the situation at hand demands harsh measures, and the company is on a drive to reduce costs and suspend operations in select fields, besides rightsizing the business wherever required.

Strategy Shift

A slew of measures is on the cards, with focus on reallocation of capital. It has been decided to reduce the capital investment program by 30% and cut research and engineering investment by 20% in the second quarter. In the near term, the dividend cut will help the oil and gas giant maintain stable liquidity and remain flexible while facing unforeseen fiscal setbacks going forward. Debts maturing this year will be refinanced so that the strong investment-grade credit can be retained.

The world economy is forecast to face a severe recession in 2020, declining by 1.5%, following a of growth of 2.9% in 2019. Following signs of improvement at the beginning of the year, expectations for global economic growth were burdened by the impact of the COVID-19 pandemic. pic.twitter.com/D54sZ8BTXQ

— OPEC (@OPECSecretariat) April 20, 2020

A key aspect of the business that needs proper attention is the potential impact of payment delays, on the part of customers in the epidemic affected areas, as it could be a drag on working capital.

Bleak View

Overall, the outlook for the oil sector remains bearish, with no end in sight for the Saudi-Russia price war and dismal demand conditions. Worse, the chaos linked to the shutdowns imposed by various US states point to a highly unpredictable future. It is estimated that customers in the energy exploration industry would resort to massive capital spending cuts, weighing on Schlumberger’s prospects in the coming months.

“In this environment—the duration of which remains uncertain—we have planned for a range of scenarios and have taken a number of actions. We have reduced our capital investment program by more than 30% and will allocate resources to the more resilient markets while remaining focused on capital stewardship and maintaining our commitment to a strong balance sheet.”

Olivier Le Peuch, CEO of Schlumberger

At the post-earnings conference call, Le Peuch expressed hope of operations stabilizing in the second quarter, though it would depend very much on how the COVID-19 situation emerges and the decisions being taken by leading OPEC members.

Favorable Mix

On the positive side, almost 50% the company’s revenue comes from fixed tariff related to service fee, while the remaining half tends to fluctuate as it is exposed to oil and gas prices. Since the latter category has already been set at the contractual minimum in the case of Schlumberger, the impact of any further slump in oil prices would be minimal.

Unlike some of its peers, North America remains a weak point for the company. In the first quarter, production weakness in the region more than offset the positive outcome in other areas, including Europe. Consequently, revenues dropped 5% annually to about $7.5 billion and adjusted earnings fell 17% to $0.25 per share.

Dividend Cut

With the board of directors approving a 75% cut in dividend to 12.5 cents, there will be a high level of caution among investors until the market returns to normalcy, which is definitely going to take a long time.  

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The ongoing market turmoil has erased several millions from Schlumberger’s market value and the shares plunged to a 25-year low last week. The stock lost 66% in the past twelve months.