[This article originally appeared on Forbes.com]

One glance at the chart below is enough to prove that it’s been a tough ride for shareholders of the oil drilling equipment maker better known by its nickname “No Other Vendor”. We set out to figure out if NOV’s stock price was near any kind of valuation “floor” for the company.


Figure 1.

In our investor education courses, IOI teaches that the best directional investors in the world are particularly sensitive to big-picture issues like demand. To start to answer our question about what a floor value is for NOV, let’s first start by digging into the demand environment.

Born through a private-equity backed merger of National and Varco, NOV cobbled together the number-one powerhouse in offshore oil drilling equipment through a series of smaller acquisitions. The last two years saw the firm buying more firms related to the North American Shale Boom, but its position in that business is not as dominant as its position in offshore drilling.

NOV manufactures equipment installed and used on offshore and onshore oil and gas drilling rigs – everything from Blow-Out Preventers (BOP) to drill bits – and provides services to keep the equipment running – everything from monitoring and training to drilling waste disposal.

This combination of product lines means that NOV sells some capital goods – long-lived equipment meant to be used over years – and some consumable or service-related ones. Both capital equipment and consumables are used for offshore and onshore projects.

NOV’s “best” revenues come from products and services for the offshore market – you can see this clearly in the figure below.

Figure 2. Source: Company Statements, IOI Analysis

Figure 2. Source: Company Statements, IOI Analysis

Rig Systems and Rig Aftermarket segments are skewed toward the offshore business (representing from 60%-75% of revenues), and together these two segments represent a whopping 81% of NOV’s 2015 operating profits.

Drilling companies have drastically cut back its new offshore projects due to the very high development costs – these costs to drillers represent for NOV its “best” revenues.

We don’t expect a quick or robust recovery for this best part of NOV’s business until oil prices recover sufficiently to provide positive returns on new projects. Our research indicates that many new deepwater projects require oil prices in the $60-$90+ / barrel (bbl.) range to start generating positive returns, and these prices would have to be sustained for some time before drillers would likely feel comfortable making the capital commitments to exploit them.

NOV’s remaining two segments – Wellbore and Completion & Production – are not as skewed to the offshore business, and tend to sell more consumable equipment and services. The nice thing about a business selling consumable drilling equipment is that as long as drilling is taking place, the business has the potential to generate revenues. While the number of rigs operating in North America has hit a multi-year low, North American oil production has dipped just slightly from its peak as seen in figure 3.

Figure 3.

Figure 3.

Demand for NOV’s consumable equipment and services has waned due to the same offshore dynamics mentioned above and customers’ “cannibalization” of idle drilling rigs onshore. Shale drillers, strapped for cash, would rather strip parts from an idled rig than pay cash for a new piece of consumable equipment.

We believe that demand for these consumable items should turn around sooner than the offshore rig business and provide some floor for NOV’s revenues, but only once the short-term oversupply of idle rigs works through the system. The oil price recovery needed for a bounce-back in domestic land-based drilling is likely more modest (circa $50-$60 / bbl) than that required for a recovery of demand for deepwater rigs, thanks to technology-based gains in drilling efficiency.

Net, it is unlikely that demand has bottomed for NOV. As the complex, high dollar offshore drilling rigs under order are built, it is doubtful that backlog will be fully replaced as long as oil is under $70 / bbl. While nearer-term recovery of the consumables and services business can provide a floor for revenues, it will be NOV’s ability to pivot its revenue growth toward less expensive (and less lucrative) onshore production that puts a floor under the Company’s share price. A material recovery in offshore production looks to be some years off.

Our next step is to complete and post a Step-by-Step valuation article on Forbes with a definitive value range. We strongly believe that an investor should have a good understanding of a company’s business and its value drivers before structuring an investment in a way we teach in our training classes. After estimating a value for a company, a stock investor has a black and white choice – buy or sell. The beauty of options is that they can be used much more flexibly to tailor investment exposure to a company. We’ll also post an example and explanation of an option-based investment structure for NOV.

Joe Miramonti with research and assistance by Brent Farler

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