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Dumb Money Alert: Don’t Buy This Energy Stock

By John Persinos on October 20, 2016

We all know the expression that a fool and his money are soon parted. But as we observe the irrational actions of energy traders lately, it begs the question: How did these fools and their money get together in the first place?

Case in point: The irrational exuberance now bidding up the shares of oilfield services giant Schlumberger (NYSE: SLB). In recent weeks, analysts have been bullish over Schlumberger. Most recently, the strategists at investment banking firm Societe Generale upgraded Schlumberger to “Buy” from to Hold.”

Don’t believe them. As we explain below, SLB is a stock to avoid.

To be sure, oil prices have generally recovered from their lows of around $20 a barrel posted in February, but they’re still whipsawing investors. And potential triggers abound for another collapse in oil prices.

Meanwhile, OPEC is at it again and is desperately trying to finalize an oil production cut reached in Algiers last month. First the Saudi-led oil cartel wants to throw open the spigots, and then it wants to tighten them. Negotiations are scheduled with big fanfare; then they just fizzle.

Through it all, the price of oil has been on a wild roller coaster ride.  It’s enough to make investors reach for the Dramamine. Amid this uncertainty, at least one thing is certain: oil price volatility is here to stay.

Which brings us to oilfield services firm Schlumberger, shares of which have risen nearly 19% year to date, compared to a gain of 6.75% for the S&P 500 and a gain of 11.5% for the benchmark iShares US Oil Equipment & Services ETF (NYSE: IEZ).

Several analysts are now bullish on SLB; we beg to differ. 

For starters, this oil price rebound is tentative at best. All it would take is poor economic data in the U.S. or an overseas crisis to send oil prices reeling again.

Meanwhile, the latest oil inventory and supply data is bearish, amid global economic growth that’s on track but tepid at best. Expectations that indebted and struggling Schlumberger will somehow reverse its fortunes in the face of these headwinds are wildly optimistic.

Schlumberger provides the equipment needed for companies to find and drill for energy sources, including seismic services, well completions, drilling equipment and pressure pumping. The company’s global roster of exploration and production clients have drastically cut back activity and show little sign of even remotely returning to the “go-go” days when oil hovered at $80 to $100 per barrel and SLB took on debt to expand.

With a market cap of $114.5 billion, SLB’s return on equity (ROE) is 3.97%, compared to the average ROE of 5.4% for its peers. The oil and gas services industry’s net profit margin is 3.8%; SLB’s is -5.64%. The average analyst estimate for SLB’s earnings per share (EPS) for full-year 2016 is $1.12, compared to $3.37 in 2015.

With total debt of $21.66 billion, SLB’s total debt-to-equity ratio stands at 0.51, only slightly lower than the industry’s unacceptably high ratio. Oil prices are indeed higher this year, but they’re barely touching the $50 per barrel threshold that the industry needs to break even. At least 58 producers have filed for bankruptcy so far in 2016, representing about $50.4 billion in debt, far exceeding last year’s $17.4 billion debt accumulated from the 44 companies that went belly up.

Don’t get fooled: SLB could easily start tumbling again. The notion that oil markets will find equilibrium is a myth. More than ever before, oil prices are fluctuating with the ebb and flow of investor passions. Ignore all of the yapping on CNBC and in the financial press. Oil price predictions are tales told by idiots, full of sound and fury, signifying nothing (apologies to Shakespeare).

Through it all, volatility seems here to stay. Our advice: Stay away from Schlumberger, at least for now. The energy markets remain too volatile and SLB is too vulnerable. There are better places for your money.

As we’ve just explained, Schlumberger is a stock to sell or avoid right now. If you’re looking for better moneymaking opportunities, there’s an ingenious trade that allows you to make money on the price of oil, regardless of whether it goes up or down. It’s a trade that has you covered on both sides. For this trade to make money, the price of oil merely needs to keep moving. Amid all of the uncertainty in today’s energy markets, at least one thing is certain: Oil price volatility is here to stay. To learn the details of this energy trade, click here.

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