Cash flow concerns at Schlumberger

The US stock market is full of world-leading businesses. But being number one is of little consolation when your sector is in terrible shape, as oilfield services giant Schlumberger (US:SLB) knows only  too well. With revenues from the previously red hot North American shale industry declining, and international business essentially flat, Wall Street expects a second straight quarter of falling earnings per share (EPS) when the group releases an earnings report next week.

In short, the dramatic rebound in contracting activity many expected seems to have stalled, just as it has for UK peers Wood Group (WG.) and Petrofac (PFC). So even assuming a pick-up in trading activity in the second half of 2019, profits are still forecast to flatline year on year. Consequently, Schlumberger will do well to arrest declines in its pre-tax operating margin, which last year edged down 12 basis points to 12.8 per cent.

The market reaction to all of this has been brutal, and the shares now trade 43 per cent below their one-year high, or 64 per cent down on the 2014 peak. But with analysts expecting an eventual rebound in oil and gas project sanctions, income-focused investors are salivating at the prospect of bagging a $2-a-share annual dividend at the trough.

They would appear to have history on their side, too, as Schlumberger has maintained or increased its dividends every quarter since it floated in 1962. Unfortunately, for each of the last three years of its time as a public company, EPS – adjusted to exclude the benefit of disposals – has failed to match distributions. In 2019, JP Morgan expects the dividend cover to reach just 85 per cent.

This could abruptly change if Schlumberger’s customers start to act on “the need to invest in their resource base simply to maintain production at current levels”, in the words of chief executive and chairman Paal Kibsgaard. But doing so could prove tricky for onshore North American operators, which comprised 37 per cent of Schlumberger’s business in 2018, and whose increased cost of capital is reportedly straining free cash flow.

In part because of this Schlumberger’s own free cash flow is a concern in the year ahead. Mr Kibsgaard does not want to increase net debt, which sits at around two times earnings before interest, tax, depreciation and amortisation, which in turn leaves a big question over the near-term sustainability of shareholder returns. Perhaps the clearest indication of this is the dividend yield itself, which prior to 2017 was last seen above 3 per cent in 1989.