National-Oilwell Varco: Generate Income In Uncertain Market


By Alex Gavrish, Etalon Investment Research; author of “Wall Street Back To Basics

Halliburton and Baker Hughes’s merger

After yesterdays announcement that Halliburton Company (NYSE:HAL) and Baker Hughes Incorporated (NYSE:BHI) will merge, market participants were alerted and attracted to the oil and gas services sector. With declining oil prices, many stocks in the sector also declined. Baker Hughes, for example, declined 32% since a high of $75.35 in July of 2014. Some analysts believe that more deals are soon to come, as consolidation is a standard process during declining profitability or other industry pressures. One of possible targets could be National-Oilwell Varco, Inc. (NYSE:NOV), which can be acquired by General Electric Company (NYSE:GE). One can easily find oneself caught up in the excitement of all these news and developments. But what are investor’s options to profit from these events?

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Conservative strategy for uncertain market conditions


During periods of uncertainty in markets many investors find it hard to initiate new long positions. Some experts perceive the market currently as overvalued and propagate caution and restraint. Focusing on fundamentals and timeless value-investing principles will serve investors well during such periods. Combining value and fundamental valuation approach with a conservative options strategy can provide additional downside protection while generating attractive income. The approach involves selling insurance policies (put options) against the decline of individual equities. By selling such an insurance policy you agree to buy the stock of a specific company at a certain price during some period of time, which can be anywhere between a month to one year or even longer. In return for agreeing to do so, you receive a premium, just like an insurance company. In case the stock price declines below the price at which you have agreed to purchase it, you will have to purchase and own the stock.

Strategy performance

Both academic and business literature have proven that the approach of selling put options achieves better results than market averages over long periods of time with a volatility that is significantly lower than that of the market. The Chicago Board of Options Exchange (CBOE) has developed a Put Write S&P 500 Index, which measures the performance of a strategy wherein one sells an at-the-money put option with a maturity of one month on the S&P 500 Index, and continues to do this consistently each month. This strategy has outperformed both S&P 500 Index as well as Buy Write S&P 500 Index (a strategy of selling covered call options).

Let’s take a look at a possible put-write position in National-Oilwell Varco, a worldwide leader in the design, manufacture and sale of equipment and components used in oil and gas drilling and production operations, and the provision of oilfield services to the upstream oil and gas.


Dividend and recently announced share buyback program

On September 30th, 2014, company announced that its Board of Directors authorized a share repurchase program to purchase up to $3 billion of the company’s outstanding common shares. This announcement is timely and should certainly be viewed by shareholders in positive light, as company’s stock price declined by about 17% since August 29th, 2014 high of $86.4 per share. National-Oilwell Varco, Inc. (NYSE:NOV)also pays a regular quarterly dividend of $0.46 per share, which currently provides a 2.6% annual dividend yield.

Valuation and put-write position example

National-Oilwell Varco, Inc. (NYSE:NOV)’s market capitalization was $30.9 billion as of November 17th, 2014 Company is valued at an EV/EBITDA multiple of x7.6 (FY 2013, adjusted for Now Inc spin-off). Based on November 17th, 2014 closing prices, one could sell an out-of-the-money put option with a maturity of about one year (January 15, 2016), and exercise price of $65 for a premium of $6.35. By doing this, investor agrees to purchase National-Oilwell Varco shares for $65 per share in case the stock price declines below this price. Actual cost and breakeven price of shares for investor would be $58.65 as the investor receives $6.35 per share in premium upfront. At this cost base National-Oilwell Varco would be valued at an EV/EBITDA multiple of x6.2 (FY 2013, adjusted for Now Inc spin-off). In percentage terms, a decline of 18% from current stock price is required to get to this price – a nice downside cushion during uncertain times. If, on the other hand, National-Oilwell Varco’s shares will trade sideways or rise, investor will earn an annualized premium income of about 9.3% for taking the risk.

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