About a decade ago, the energy sector’s mantra was “Go big.” In order to grow, the basic idea was that you needed to become as integrated as possible. From E&P firms to refiners, many firms — including those in the oil services sector — acquired their way to greatness.
Well, it seems that bigger isn’t always better, and the energy sector continues to see wave after wave of spinoffs and asset sales in a big push to make themselves smaller and more nimble.
Case in point: Drilling rig equipment superstar National Oilwell Varco (NOV). The oil services stock recently spun off its low margin transmission/supply chain division as Distribution NOW Inc. (DNOW).
Now that the spinoff is complete, should investors stick with the former parent or move on to the upstart spinoff? The answer may not be so simple, and the whole situation might be a case of just sit back and wait.
A Tale Of “No Other Vendor” & The Actual Vendor
At this point, it’s no secret that National Oilwell Varco is the king of drilling equipment. The joke around the energy sector is that NOV actually stands for “No Other Vendor,” and roughly 90% of all drilling rigs on the planet have at least one of the firm’s parts somewhere in its mix. That dominance has made NOV stock a top performer over the years — outperforming the XLE over the past five years — and even attracted interest from America’s favorite value investors: Warren Buffet.
Yet, while advanced drill bits and fracking fluid control products have been racking up big profits from NOV, getting those parts into the hands of customers wasn’t doing much for its bottom line. Its slow-moving supply chain and distribution business was deemed as basically holding back the potential of NOV stock.
To that end, NOV said sayonara to the business and NOV Wilson became publicly traded as DNOW. And that spinoff could actually be a huge win for shareholders of DNOW and NOV stock.
The appeal for the former parent is pretty obvious. By spinning off its wholesale supply unit, NOV is now operating under a more simple business model: drilling rig parts. That should help investors and analysts value the firm accurately compared to less streamlined peers like Dril-Quip (DRQ). It should also help drive up the multiple on shares — after all, this is the king of drilling parts. And revenues for the various products needed across space are growing like weeds.
National Oilwell Varco’s rig technology business segment — which includes all the products for horizontal drilling — currently has a record order’s backlog of $16.3 billion. All in all, the latest earnings report from NOV stock showed that the business segment generated revenue growth of 16% over the third quarter of 2013 and 14% over the fourth quarter of 2012. Meanwhile, its petroleum services unit — which includes engineering and other value-added services — managed to grow its revenues by 6% versus a year ago.
All of this continued growth has helped free-cash flows and profits at NOV. In fact, management recently announced a 77% increase to NOV stock’s quarterly dividend. And increases like that should continue as National Oilwell Varco is now free of the wholesale/distribution division. That division — which is now DNOW — managed to see a 7% reduction in revenues in the fourth quarter of 2013 vs. the third quarter.
Yet, investors still may want to hold onto their new DNOW shares.
Distribution Now isn’t exactly a slouch of firm. It’s a multi-billion company and a leader in the sector: DNOW reported $4.3 billion in revenue for fiscal year 2013.
The firm operates 300 locations in more than 20 countries and stocks roughly 150,000 products in its catalog. That product catalog should grow because DNOW is now able to sell additional drilling products not produced by NOV. Varco maybe the “king”, but it’s not the only oil equipment stock in town.
The spinoff basically allows DNOW to be the “No Other Vendor” of Vendors. Already, management has hinted at that fact, promising to use the wholesale firm’s hefty cash flows — $262 million for the last reported quarter — to do just that.
As for the management, DNOW is getting former NOV CEO, Pete Miller, to serve as its leader. Miller was the driving force behind making National Oilwell Varo the monster it is today. It stands to reason that Miller will apply the same tenacity to the distribution business in order to help make it grow. So while it may seem like a slower business, DNOW might actually surprise investors with some pretty nice swiftness.
Even better: It should start kicking out some hefty dividends of its own down the road.
Keep Both DNOW and NOV Stock
For investors, both NOV & DNOW stock are actually pretty attractive longer-term holds. If you owned National Oilwell Varco before the spinoff and now hold shares of both firms, you could do a lot worse than just holding onto the duo. NOV should be the faster moving of the pair, with its dividend growth tapering off. That 77% jump was a really a one-time monster increase. Capital gains should drive most of the total return for NOV stock in the future.
Meanwhile, DNOW should start churning out its dividends sooner than later. It’ll be slower moving, but should still be a steady provider of gains, with most of that coming from dividends. It’ll take a few quarters to really analyze its dividend growth potential.
As for buying shares today, it depends on what you’re really looking for. Do you want a steady play or something more exciting? Shares of both firms are cheap, with NOV stock trading at a P/E of 13, while DNOW trades at a P/E of around 17. Over the longer term, you’ll probably do just fine with either of the firms.