Red Flags Keep Flapping at Weatherford

by Aaron Levitt | November 16, 2012 11:15 am

With drilling rig counts falling across the U.S. due to historically low natural gas prices[1], the oil services sector recently hasn’t lived up to its long-term potential. So far throughout this earnings season, industry stalwarts like Baker Hughes (NYSE:BHI[2]) and Halliburton (NYSE:HAL[3]) have fallen victim as the North American natural gas glut slams energy services pricing.

Investors can add Weatherford International (NYSE:WFT[4]) to that list.

However, unlike Baker and Halliburton, Weatherford has problems that are uniquely its own: significant accounting and tax irregularities.

Those issues are enough to make investors think twice about buying into the fourth-largest oil services provider, no matter how cheap its shares get.

Overall, Weatherford provides a wide range of equipment and services for the energy industry and operates around the world. This includes hot spots like North America’s vast shale formations, the Middle East (most notably Iraq[5]) and Russia.

And like its peers, Weatherford saw its third-quarter operating earnings grow in all regions except North America. The slowdown in drilling activity in places like the Eagle Ford and the Barnett shale caused earnings in North America to fall by 16% versus a year ago.

For the quarter, Weatherford recorded a 13% year-on-year increase in revenue to $3.82 billion, and pre-tax net income of $191 million. Revenue fell below analysts’ expectations of $3.9 billion, and net income would have been higher — if not for the inclusion of $73 million in pre-tax losses. Weatherford did not report earnings per share. However, the company gave earnings guidance for the fourth quarter of 20 cents per share[6]. That compares with the average analyst estimate of 28 cents.

All in all, Weatherford reported a mixed bag, like its peers. However, the issue isn’t with what the company reported — after all, analysts expect weakness[7] in Q3 and Q4 for most of the oil services world, except perhaps for Schlumberger (NYSE:SLB[8]) — but how.

Weatherford is still reporting earnings on a pre-tax basis as it continues to work through the “material weakness” in its internal controls. Those issues are based on how it reports current taxes payable, certain deferred tax assets and liabilities, reserves for tax positions and current/deferred income tax expenses.

Those “material weaknesses” that the company and its external auditors have uncovered have already led to hundreds of millions of dollars of additional expenses over the last five years.

The massive tax remediation efforts have included the need to restate prior-periods’ results. That includes Weatherford’s fiscal years 2009 through 2011, the first quarter of 2012 and the most recent period because errors have occurred “relating to the accounting for a percentage of completion contract in Iraq.” The company has already identified more than $800 million in additional tax charges for the past five years.

Included in this last earnings release was this gem of a statement: “… [The] Audit Committee of our Board of Directors concluded, on July 24, 2012, that investors should no longer rely on our previously issued financial statements.”

Weatherford said it plans to re-file for the first nine months of this year, along with restated numbers for several periods before that, by the end of this month. However, those updated filings are no guarantee because Weatherford has promised to get to the bottom[9] of the issue before. So, the forthcoming restatements may be yet subject to additional revision.

Weatherford actually moved its corporate headquarters to Switzerland a few years ago to reduce its tax liabilities. I’m sure investors haven’t appreciated the irony, with shares plummeting 16% and reaching a new 52-week low.

Despite Weatherford’s new low, I still don’t think shares are a buy. For investors to make educated decisions, a traded firm’s filings need to be accurate and timely. So far, Weatherford hasn’t fulfilled that need.

While it may return to the ranks of desirable companies from an investment perspective, the current scope of its tax problems are quite daunting and distracting Weatherford from its core mission[10]. In conjunction with its earnings “release,” Weatherford also announced that it plans to sell $1 billion worth of assets to raise cash. Analysts have speculated that this is to help pay for additional tax liabilities stemming from poor cost controls.

Overall, the oil services sector remains one of the best ways for investors to profit from the world’s growing hunger for energy. However, Weatherford’s lack of internal controls is a huge red flag. Investors should look elsewhere to get their energy services fix[11].

As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.

Endnotes:
  1. historically low natural gas prices: http://investorplace.com/2012/10/new-pipelines-could-chill-natural-gas-prices/
  2. BHI: http://studio-5.financialcontent.com/investplace/quote?Symbol=BHI
  3. HAL: http://studio-5.financialcontent.com/investplace/quote?Symbol=HAL
  4. WFT: http://studio-5.financialcontent.com/investplace/quote?Symbol=WFT
  5. most notably Iraq: http://investorplace.com/2012/11/exxons-move-out-of-iraq-is-puzzling/
  6. fourth quarter of 20 cents per share: http://www.reuters.com/article/2012/11/13/us-weatherford-results-idUSBRE8AB1BJ20121113
  7. analysts expect weakness: http://investorplace.com/2012/11/novembers-pain-could-be-decembers-gain/
  8. SLB: http://studio-5.financialcontent.com/investplace/quote?Symbol=SLB
  9. get to the bottom: http://investorplace.com/2012/10/is-canadas-energy-hotbed-cooling-off/
  10. its core mission: http://www.reuters.com/article/2012/11/13/weatherford-focus-idUSL1E8MD3U220121113
  11. energy services fix: http://investorplace.com/2012/10/5-oil-services-buys-beyond-the-big-two/

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