NOV (IL/A): Reinstating with an In-Line Rating March 31, 2005
The merger between National Oilwell + Varco was recently completed + we are reinstating a rating of IL/A on NOV having moved to Not Rated (NR) on National Oilwell (NOI) on August 12, 2004 in compliance with Goldman Sachs policy. We are raising our 2005-06 EPS estimates to $1.92/ $2.50 from $1.80/$2.40 to reflect stronger rig count, capital equipment order + pricing trends. Our fair value estimate increases to $55 (22x 2006 PE) from $51 = 20% upside potential. Prior to Aug. 12, 2004, we rated NOI Outperform, but shares have outperformed the OSX/ SPX by 27%/47% since then + are +21%/+33% relative YTD. Our OSX fair value estimate of 173 implies 28% upside, with Outperform-rated RIG, DO, BHI, SII + SLB having 30%+ upside potential. We see upside to NOV estimates, but also normal merger challenges. We would be buyers on weakness given NOV's late cycle leverage as a leading rig capital equipment provider + our view that the drilling rig renewal cycle is in its early stages.
VALUATION - EXECUTION OF MERGER INTEGRATION KEY FORWARD FACTOR
NOV is currently trading at 23.9X/ 18.4X our 2005/06 EPS estimates, or a 4% premium/6% discount to the mid cap peer group of SII, WFT, CAM, and BJS. On 2005-06 EV/EBITDA, NOV is trading at 12.0X/9.7X vs a peer group average of 11.7X/10.4X. Assuming NOV executes a solid merger integration and capital equipment order trends and incremental margins continue to expand, we believe NOV can trade at parity with its mid cap peer group.
MERGER OF NATIONAL OILWELL + VARCO = SUM OF THE PARTS GREATER THAN THE WHOLE
We believe the merger of NOI and VRC will prove to yield significant synergies for years to come. NOI needed to diversify into more drilling & completion oriented segments and has done this, in our view. The combination of capital equipment businesses should enhance product quality, service, scale and potential market share and pricing power. The platform for growth via organic technology development + additional acquisitions is far stronger, in our view, our view and NOV is a much more significant entity from the capital markets perspective as symbolized by the company recently being added to the S&P 500.
WHERE ARE THE POTENTIAL INTEGRATION RISKS?
We believe investors should recognize the inevitable/ typical merger integration/ transition issues associated with deals like NOI/ VRC. NOV has disclosed that asset write-ups related to the deal should add $10 million per quarter to depreciation, but this number could move higher - perhaps to the $10-15 mln/ qtr range. There are also likely to be $30 mln of deal costs (legal, advisory, etc), which the market is likely to look through, and another $30 mln of operating-related merger costs. It is not clear that consensus estimates have been adjusted for merger costs, which have not been quantified by mgt to date for obvious reasons - i.e. these are very difficult to pinpoint. Nonetheless, stronger rig count trends than consensus appears to be assuming suggests the impact may to be a dampening of the short-term upside to estimates more than absolute downside risk.
I, Terry Darling, hereby certify that all of the views expressed in this report accurately reflect my personal views about the subject company or companies and its or their securities. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report. |
