Author: Leo Nelissen

Introduction

It’s time to talk about oil and gas infrastructure. And what better way to do that than by discussing one of the world’s largest energy equipment and service providers Schlumberger (NYSE:SLB).

This Texas-based giant with a market cap of more than $60 billion is currently trading 25% below its 52-week high, as the market has shifted its focus from value to growth stocks, incorporating elevated recession odds, which hurts companies like SLB.

While this isn’t fun for existing shareholders, it’s great news for investors looking to buy (more) SLB shares. While I usually prefer low-cost drillers instead of equipment producers, SLB is a great way to benefit from much-needed global investments in fossil fuels.

The company understands that net zero isn’t happening the way it was designed to. The world needs fossil fuels, which we are currently finding out the hard way through elevated prices. I expect that to get much worse the moment economic demand bottoms.

Hence, it’s time to take a closer look at the new and improved SLB.

SLB Knows Net-Zero Isn’t Happening

This is the point where I need to clarify to new readers that I’m not against clean energy – far from it. While I have close to 20% oil exposure, I’m not a shill for fossil fuel companies and write content to somehow try to stop the trend towards clean energy.

No. I’m all for lower pollution, cleaner supply chains, less waste, etcetera. My point is that the energy transition is forced and technically just based on taxing fossil fuels to make expensive renewables more attractive. Not only do we not have enough materials to make net zero a reality, but we’re also pressuring fossil fuels so much that investments in that area are underwhelming, causing a supply gap that caused oil and gas prices to fly the moment post-pandemic demand rebounded.

While oil prices are well below their highs, they are still elevated compared to prior cycles, as supply growth is in a very bad place – I discussed that in this article (among many others).

One of Germany’s leading newspapers, WELT, recently covered net-zero developments – using reports from the International Energy Agency, which is highly biased towards renewables.

The report revealed that global investors are now putting more money into solar energy than oil production. However, the numbers suggest that this does not necessarily translate into significant progress in climate protection.

According to the IEA report, investments in fossil fuels have increased by 15% since 2021, while investments in green energy have grown by 24%. The report states that for every $1 invested in fossil fuels, $1.7 is invested in clean technologies.

While investments in renewable energy are growing, investments in fossil fuel extraction continue, which is incompatible with the United Nations’ goal of achieving net-zero greenhouse gas emissions by 2050. Expenditures for oil and gas production are expected to increase by 7% this year, reaching around $500 billion. This is roughly in line with pre-pandemic levels in 2019.

Enterprise Products Partners (EPD) highlighted the ridiculous 2050 goals, which essentially aim to erase more than 100 years of energy progress within thirty years – while the global population is still growing. There’s no way renewables can decarbonize the global economy.

Furthermore, investments in coal mining are also increasing globally by around 10% this year, surpassing pre-pandemic levels in 2019.

Again, I’m not against clean energy. I’m just against forcing a trend that cannot be forced – at least not without negative consequences.

With all of this in mind, Schlumberger – or SLB – recognized this and decided to incorporate it into its identity.

Last year, the company changed its name to SLB to highlight its vision for a decarbonized energy future and reflect its transformation into a global technology company dedicated to driving energy innovation. T

Essentially, the company aims to strike a balance between energy affordability, security, and sustainability by promoting innovation and decarbonization in the oil and gas industry, as well as advancing clean energy solutions. SLB’s new identity symbolizes its commitment to addressing current energy needs while leading the way in the energy transition.

I believe this is an incredibly corporate/fancy way of saying we’ll keep doing what we’re doing. We’ll just rebrand it a bit. After all, the company’s business remains focused on fossil fuel support:

Again, given my view on energy, that makes sense for SLB and its shareholders.

SLB/Schlumberger Is Doing Very Well, Seeing More Upside

In the first quarter, SLB generated $7.7 billion in revenue, which beat estimates by$240 million. The year-on-year growth rate was 30%.

The Digital & Integration division’s revenue decreased by 12% sequentially to $894 million, mainly due to lower APS project revenue and seasonally lower digital and exploration data licensing sales. Margins declined by eight percentage points to 30%.

However, strong digital growth, including a more than 50% increase in cloud and edge solutions, offset the decline in APS revenue. I expect cloud-based services to continue rapid growth in the years ahead. Also, margins are expected to improve in Q2 with the resolution of the pipeline issue in Ecuador and a sequential increase in digital sales.

The Reservoir Performance division reported a 3% sequential revenue decrease to $1.5 billion, primarily driven by seasonal activity reductions in Europe and Asia and lower revenue in Russia. Margins declined by 207 basis points to 16.1%. However, compared to the prior year, revenue grew by 24%, and margins increased by 291 basis points, fueled by strong international growth on land and offshore, which is essentially what we discussed in the first part of this article.

The Well Construction division saw a 1% sequential increase in revenue to $3.3 billion, which came with a 44 basis points decrease in margins to 20.6%. On a year-on-year basis, revenue grew by 36%, while margins expanded by 444 basis points. The growth was caused by increased activity, higher pricing, and a favorable technology mix across all areas.

The production Systems division’s revenue remained flat sequentially at $2.2 billion, with margins declining by 148 basis points to 9.3%.

This was influenced by seasonality and the activity mix in Europe and Asia. However, year-on-year revenue increased by 38%, and margins expanded by 217 basis points. Strong activity levels were observed in Europe, Latin America, and North America, while supply chain and logistics constraints continued to ease.

Especially the supply chain comment is important, as it could indicate that drilling becomes more affordable to some, which could increase margins for upstream drillers. That’s something I will be looking for in the next earnings season.

With that said, the company is very upbeat about its future.

In its earnings call, the company highlighted that the Production Systems Division is a long-cycle lever of growth, expecting cumulative bookings of $10 billion to $12 billion in 2023.

The Middle East and offshore basins are key market areas for SLB, and the company anticipates durable revenue growth and a significant installed base for services in the coming years, which is also in line with what we discussed in the first half of this article.

Also, the Deepwater subsea market remains essential to SLB’s growth opportunity, with the company strengthening its portfolio in that area.

Given how conservative SLB usually is, I believe that its focus on deepwater is a sign that the company is betting on sustained elevated oil prices.

CEO Le Peuch also mentions the sustained momentum and EBITDA margin growth expected in the subsea business. He believes that SLB is well-positioned to execute its returns-focused strategy, capitalize on international and offshore momentum, and expand margins.

Analysts agree with SLB management. The company is expected to boost its free cash flow to $6 billion in 2025, which implies a free cash flow yield of 9.5% using the company’s current $63.4 billion market cap.

According to the company, the Middle East, international offshore basins, and gas projects are expected to comprise a significant portion of global upstream spending, while North America will benefit from a positive demand outlook and commodity pricing. I agree with these comments, especially with the demand side, which is likely to have a very strong impact on commodity pricing and project profitability. That’s great for SLB, even if equipment growth rates are unlikely to go back to pre-pandemic levels (in my opinion). After all, most Western drillers aren’t eager to boost output anymore.

Hence, the company highlighted the Middle East and offshore markets as anchors of supply growth, with unprecedented investment visibility and potential for growth.

Especially the offshore sector is projected to experience its highest growth in a decade, with significant activity in infill and tieback projects, large development projects, and exploration and appraisal activities.

Hence, I believe that SLB is a more attractive investment than providers of onshore equipment in North America. In 2022, SLB generated just 16% of its revenues in the United States.

Valuation

SLB, which enjoys an A credit rating, is trading at roughly 8.9x 2023E EBITDA, which is based on its $63.4 billion market cap, $8.4 billion in expected net debt (1.0x EBITDA), and roughly $500 million in pension liabilities and minority interest.

I believe these valuations are attractive, even if estimates were to come down further due to economic headwinds.

SLB usually trades at 10x EBITDA, which makes sense given the company’s ability to generate free cash flow.

So, conservatively speaking, I believe that SLB is at least 40% undervalued, which would put the current fair value at roughly $63, which is in line with current consensus estimates of $64.

While SLB remains in a perfect uptrend, there’s a risk the stock breaks down due to cyclical headwinds, which are the biggest risk to the long-term thesis – at least temporarily.

Investors looking to buy equipment might enjoy buying SLB below $40. However, there’s a high likelihood that investors get the chance to average down. We’re not yet in a situation where oil is in an easy uptrend. I expect that to happen the moment economic growth expectations bottom.

At that point, we’ll likely see a massive surge in oil equities.

Takeaway

SLB is a global energy equipment and service provider that recognizes the importance of fossil fuels in meeting current energy needs. While supporting clean energy, SLB understands that the energy transition cannot be forced without negative consequences.

Hence, the company aims to strike a balance between energy affordability, security, and sustainability, driving innovation and decarbonization in the oil and gas industry while advancing clean energy solutions.

SLB has shown strong performance, generating impressive revenue growth and beating estimates. With a focus on digital solutions and strong international growth, the company is well-positioned for future success.

It anticipates durable revenue growth in key markets such as the Middle East and offshore basins, as well as opportunities in the deepwater subsea sector.

SLB is trading at an attractive valuation. While there may be cyclical headwinds in the short term, long-term prospects for oil equities are promising.

Investors interested in equipment providers may consider buying SLB shares below $40, with the possibility of averaging down in the future.

Introduction

Is Pepsi OK?

While I favor a cold glass of Coca-Cola (KO) over the Pepsi alternative, I prefer the company behind Pepsi over almost every single consumer staple stock on the market. PepsiCo (NASDAQ:PEP) accounts for 3.9% of my dividend portfolio. It currently is the only consumer staple stock and a company I have added to frequently and aggressively over the past three years.

Over the past ten years, PEP shares have returned almost 200%. If it weren’t for the current correction, PEP shares would have outperformed the S&P 500.

In this article, I will assess the attractiveness of the company’s current 2.8% yield and explain why PEP stock remains the cornerstone of defensive exposure in my portfolio.

Buying Top-Tier Consumer Exposure

I’m not a big fan of consumer stocks. I own just one consumer staple (PepsiCo) and one consumer discretionary, which is Home Depot (HD).

The reason I avoid consumer stocks is that I’m not in the business of predicting consumer trends, and competition is often fierce. That’s why I pick companies with relatively large moats and businesses that appeal to most people, regardless of race, age, sexual orientation, and whatnot.

PepsiCo is for people who like snacks. That’s a straightforward way of putting it. Unless PepsiCo makes a marketing blunder like Bud Light, I’m fairly sure the company will be fine.

PepsiCo is a leading player in convenient foods, particularly savory snacks, and it holds the second position globally in the beverage sector. PepsiCo has a significant market share in North America, with $49 billion in the United States alone, while the international segment accounts for 39% of its business, amounting to around $34 billion.

The company has been making strides in expanding its footprint in developing and emerging markets, which currently represent 31% of its business. Its food segment accounts for 58% of its total revenue.

While PepsiCo does have competition, it dominates the snack aisles in many nations. It owns go-to brands that come with strong pricing power, as generic brands often aren’t that good.

PepsiCo’s strategy is straightforward and simple, yet highly successful. In 2012, the decision was made to focus on all consumers, to deeply penetrate snack aisles, capturing a wide range of potential customers. This is what the New York Times wrote back then:

Now, though, Frito-Lay, a unit of PepsiCo, is building a “company within a company” to pursue what might be called a 1 percent-99 percent strategy: creating high-end snacks as well as those that appeal to what it diplomatically calls “value” customers.

[…] Frito-Lay has until now largely left the premium end of the market to niche competitors like Pop Chips, Pretzel Crisps and Pirate’s Booty and ceded the bottom to grocery store brands.

“These traditionally have been niche markets dominated by small players and regional brands,” said Harry Balzer, the chief food industry analyst at the NPD Group, a research firm. “That leaves a lot of room for a mass player like Frito-Lay to come in and gain market share.”

I’m quoting a newspaper from more than ten years ago. However, the strategy has worked perfectly.

While other factors cannot be ruled out, 2012 is when the relative performance of PepsiCo shares versus the SPDR Consumer Staples ETF (XLP) bottomed. Since then, PEP has consistently outperformed its peers. PEP has a 10% weighting in the XLP ETF.

Now, the company is updating – or streamlining – its strategy, as outlined in this year’s CAGNY Conference.

PepsiCo outlined its efforts to accelerate performance and transform the company to ensure long-term sustainability, which is what it’s all about.

The company implemented a strategy called winning with pep+ (PepsiCo Positive), which focuses on growth and serves as the guiding principle for its operations.

Over the years, PepsiCo has made key decisions to enhance its performance, including increasing advertising and marketing investments by 24% and significantly expanding net capital investment.

These investments have yielded positive results, with the company achieving an average growth of 9.4% in net revenue and 8% in earnings per share in 2022.

1Q23 numbers also confirmed this. While volumes were weak (3% contraction in foods), the company had significant pricing power leading to 13% organic revenue growth.

Additionally, PepsiCo focuses on offering positive choices to consumers, like zero-sugar options in beverages and healthier snack alternatives. The company has successfully extended its brands into new spaces, premiumizing products like coffee and colas and exploring new substrates and cooking methods.

PepsiCo also leverages packaging innovations to provide consumers with new occasions and personalized experiences.

But wait. There is more.

PepsiCo has been investing in e-commerce to ensure its products are readily available to consumers. The company has also embraced direct-to-consumer initiatives, allowing consumers to personalize their purchases and order products directly. Also, this supports margins, as it cuts out the middleman.

This includes expanding its presence in the away-from-home sector, creating solutions for retailers, and exploring opportunities in unattended retail.

What Does This Mean For The PEP Shareholder?

There’s good news. Very good news.

Over the past few years, free cash flow has been unchanged. This was partially caused by rising capital expenditures needed to take the PepsiCo business to the next level.

Now, this is paying dividends – literally.

This year, the company is expected to generate $8.7 billion in free cash flow, followed by more upside to $10.6 billion in 2025.

This paves the way for a 4.2% free cash flow yield, which supports the company’s 2.8% dividend yield and future dividend growth.

Based on this context, PepsiCo’s capital deployment strategy focuses on capturing growth opportunities and delivering value to its shareholders, which is somewhat obvious.

The company’s top priority is investing in its business to drive growth, which includes investing in capacity, digitalization, optimization, and creating new advantages for its operations. This covers investments in manufacturing capacity, warehousing, supply chain improvements, and leveraging IT for both productivity gains and growth opportunities.

Dividends are another key area of focus for PepsiCo. The company is committed to providing its investors with increasing dividends each year.

This commitment is confirmed by 51 consecutive annual dividend hikes, making the company a dividend king.

• Over the past five years, the company has hiked its dividend by 7.4% per year (on average).
• It maintains a 66% payout ratio.
• On May 2, the company announced a 10% dividend hike.

Additionally, share repurchases are used to indirectly distribute cash depending on the available capital after priority investments and portfolio decisions have been made. Share repurchases are part of the company’s overall strategy to maintain sustainable business performance and enhance shareholder value.

Over the past ten years, PEP has repurchased 11% of its shares.

PepsiCo expects its capital expenditure levels to remain between 5.5% and 6% in the coming years. Investments will primarily focus on growth, including capacity expansion, supply chain improvements, and IT advancements. As the benefits of these investments are realized, especially in IT, capital expenditure levels are expected to decrease in the future, which could fuel future free cash flow even more.

In other words, the mix of its success with consumers, its ability to use pricing, and accelerated investments provide strong long-term tailwinds, especially because they are expected to come with a significant increase in free cash flow.

Note that while the company has $33.4 billion in net debt, it’s just 2.0x 2023E EBITDA. This is healthy. The company has an A+ credit rating. There is no need to prioritize balance sheet health, which is beneficial for shareholders.

Valuation

The PEP valuation is fair. It’s not overpriced and not undervalued. The stock is trading at 24x 2024 free cash flow. It’s trading at 48x LTM free cash flow. It’s trading at 17.5x NTM EBITDA.

The current consensus price target is $200. I agree with that. However, I’m not buying shares at current levels. While waiting for the downside comes with risks, I would be a buyer close to $170.

On a longer-term basis, I expect PEP to outperform its peers and the market.

Takeaway

I believe that PepsiCo is an exceptional company and a valuable addition to my dividend portfolio. Over the past decade, PepsiCo’s shares have performed impressively, and its consistent outperformance of the S&P 500 demonstrates its strength.

As an investor, I am cautious about consumer stocks due to unpredictable trends and intense competition. However, PepsiCo’s dominant position in the snack market, along with its well-known and high-quality brands, provides it with a significant advantage.

The company’s straightforward strategy of appealing to all consumers and expanding into new markets has proven successful.

PepsiCo’s recent efforts to enhance its performance and focus on sustainability further solidify its position as a compelling investment.

With steady free cash flow generation, a commitment to dividend growth, and strategic capital deployment, PepsiCo offers attractive prospects for long-term investors.

While the current valuation may not be ideal, I anticipate that buying opportunities may arise in the future, and I remain optimistic about the company’s prospects for outperformance.

Introduction

What about Nucor Corp. (NYSE:NUE)? This is one of the questions I was asked a lot in prior weeks – especially after covering its smaller peer Cleveland-Cliffs (CLF).

Steel stocks are currently suffering. NUE shares have lost roughly a quarter after peaking earlier this year.

While losing a quarter of equity market value isn’t great, it’s still a good performance, given the state of manufacturing expectations. Investors now expect a recession. Historically speaking, this has caused much steeper sell-offs among cyclical steel companies like Nucor.

40% to 50% stock price weakness is rather common during manufacturing recessions.

This time, however, Nucor benefits from secular tailwinds, including the massive CHIPS Act. Nonresidential construction demand is completely ignoring recession warnings, which is helping Nucor, thanks to high-value-added steel products.

Hence, in this article, we’ll take a closer look at the risk/reward at current prices.

An Unusual Recession

There are many ways to show the increasing odds of a recession. I usually cover most of them in my many macro-focused articles. In this case, I want to show you Richmond Federal Reserve manufacturing numbers, which haven’t been this bad since the pandemic. In this case, we’re looking at new manufacturing orders. While these numbers are highly volatile, they are essentially in line with the decline in other indicators like the ISM Manufacturing Index.

While the data below only goes to March, we see that the decline in economic confidence last year did not translate to lower steel orders. This is very unusual.

Needless to say, the same goes for Nucor. America’s largest steel corporation delivered a strong first quarter, as it generated roughly $1.9 billion in EBITDA and $1.1 billion in net earnings, translating to $4.45 per diluted share.

The profitability of its steel products segments and increased volumes and margins at the company’s steel mills segment contributed significantly to this performance.

While net earnings in the steel products segment were down 10% from the previous quarter, they remained 42% higher than the prior-year quarter and well above historical averages.

Shipments from steel mills increased by 18%, reaching a utilization rate of 80% in Q1 compared to 70% in the previous quarter. The raw materials segment also saw improved performance in the first quarter due to higher volumes.

Furthermore, in the second quarter, the company expects earnings from the steel mill segment to increase compared to the first quarter, driven by modestly higher shipments and improved margins, particularly in the sheet business.

However, the steel product segment’s performance is anticipated to be slightly moderate due to lower pricing offsetting the seasonal increase in volumes. The raw materials segment is expected to continue improving based on higher shipment volumes.

What’s interesting is that despite deteriorating economic growth expectations, the company’s comments make sense. After all, hot-rolled coil futures, a good benchmark of steel prices, have increased significantly since the end of last year. COMEX HRC futures are trading above 2018 highs.

Hence, Nucor wasn’t just upbeat about 2Q23, but it also remained optimistic about 2023, anticipating another strong year of earnings. Factors like federal support for infrastructure projects, clean energy investments, and positive trends in nonresidential construction, automotive, and energy sectors are expected to drive demand. Nucor’s growth strategy positions the company for long-term strength in the industry.

Nonresidential construction represents over half of Nucor’s overall mix, which comes with a deep understanding of the market and good connections with buyers.

In its 1Q23 call, the company mentioned that the demand picture for nonresidential construction is healthy and resilient. Backlogs for downstream construction products remain historically strong, with some segments experiencing a 56% increase compared to the 2017-2019 average.

Essentially, three pieces of legislation—the Infrastructure Investment Act, the Inflation Reduction Act, and the CHIPS Act—provide substantial funding and tax incentives, potentially generating up to 8 million tons of incremental steel demand per year over the decade. Needless to say, that’s a big deal.

But wait, there’s more!

Investments in clean energy are expected to add 2-3 million tons of annual steel demand, and the CHIPS Act has led to multiple steel-intensive semiconductor projects.

According to Nucor, its domestic production capabilities and low carbon footprint position the company favorably to supply steel for these projects.

Furthermore, Nucor has several large capital projects in progress to drive earnings growth, market share gains, and margin expansion in its core steelmaking businesses.

This includes the ramp-up of Nucor Steel Gallatin’s production, which is expected to reach its full run rate of 2.8 million tons during Q2, contributing to profitability in the second half of 2023.

Progress also continues with the construction of a new sheet mill in West Virginia, which is awaiting final federal permits. Once completed, the mill will have an annual capacity of 3 million tons and enhanced capabilities for high-quality, low-emission carbon steel products.

Balance Sheet & Valuation

Another (long-term) benefit is that Nucor’s balance sheet remains strong, with over $4.7 billion in cash and short-term investments at the end of the first quarter.

The company’s $1.75 billion revolving credit facility remains undrawn, which provides flexibility and resilience amid potential economic uncertainty.

Furthermore, the company’s net debt ratio remains well below 1x EBITDA. The company has a strong credit rating. Two of the three major rating agencies maintain an A- rating.

Hence, the company is able to focus on shareholder returns. During the first quarter, Nucor repurchased 2.7 million shares valued at $426 million and paid dividends of $131 million.

This represents a total return to shareholders of $557 million or 49% of net earnings. Over the last three fiscal years, Nucor has returned $7.6 billion to shareholders, which is roughly half of the net earnings for the period.

• The current NUE dividend yield is 1.5%.
• Over the past five years, the average annual dividend growth was 5.9%.
• In December 2021, the company hiked its dividend by 23.5% while announcing a $4 billion buyback plan.
• In December 2022, the company hiked its dividend by 2%.

With that said, the company’s free cash flow is expected to decline until 2024. This is caused by the normalization of steel prices after a blockbuster year in 2022 and higher capital expenditures.

In 2022, the company spent $1.9 billion on CapEx. That number is now expected to increase to $3.1 billion in 2024 before falling to $1.5 billion in 2025.

Right now, NUE is rapidly expanding its capabilities. If cyclical steel demand bottoms early next year, we could be looking at a multi-year upswing which is likely to benefit shareholders tremendously.

Valuation-wise, the stock is attractively valued. NUE is trading at 5.3x NTM EBITDA. However, that number is likely to increase (based on an unchanged stock price), as 2024 EBITDA is expected to fall by at least 20% versus 2023. That’s based on the aforementioned normalization of steel prices.

Given the bigger picture of strong secular tailwinds and mid-term cyclical headwinds, I believe that NUE is a great buy if it comes close to $100.

The problem is that there’s a likelihood that NUE won’t fall that far if economic growth bottoms soon (which wouldn’t be a bad thing).

However, that’s a risk I’m willing to take. I have close to 50% industrial exposure and 20% energy exposure. If I add new cyclical exposure, I need a great risk/reward.

The $100 to $110 range is what I consider to be a great risk/reward zone, with a decent probability that NUE’s stock price might get there if economic conditions continue to deteriorate.

Takeaway

Nucor Corp. has shown resilience in the steel industry despite challenges faced by steel stocks. While its equity market value has declined, it has outperformed expectations in a manufacturing recession. This is due to secular tailwinds, including the CHIPS Act and strong demand for high-value-added steel products in nonresidential construction.

In Q1, Nucor delivered strong financial performance, with increased volumes and margins contributing to profitability. The company’s positive outlook is supported by federal infrastructure support, clean energy investments, and promising trends in nonresidential construction.

Especially in nonresidential construction, NUE benefits from strong demand and high exposure.

Nucor maintains a strong balance sheet and is committed to shareholder returns through share repurchases and consistent dividends.

Despite near-term challenges, Nucor’s long-term prospects appear favorable. Investors looking for exposure to the industrial sector may find NUE an appealing investment choice if its stock price offers another correction opportunity.

I believe there’s a high likelihood of another buyable correction in the months ahead.