Oil Stocks: 3 Risks That Could Sink National Oilwell Varco Shares

By Markets Fool.com

Even after its oil-fueled stock slide over the past 12 months,National Oilwell Varco (NYSE: NOV) still faces several threats that could send shares even lower: a worldwide glut of offshore rigs, geopolitical risks, and a strong dollar hurting international sales. Let's examine these potential threats and see how you might turn them to your portfolio's long-term advantage.

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Offshore drilling downturn a possible long-term headwind
In 2014, 46% of the company's revenue came from its rig systems division,which, among other things, builds equipment packages used in the construction of offshore drilling rigs, including vital safety features such as pressure control systems and blowout preventers.

Among National Oilwell's top customers is Samsung Heavy Industries -- one of the world's largest builders of offshore drilling rigs -- which accounted for 7% of all company sales in 2014.

National Oilwell's largest division thus faces potentially significant decreased demand in coming quarters due to a large glut of offshore rigs that is likely to take years for the drilling industry to work off.

Source: Transocean Investor presentation.

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While this chart only addresses floating rigs, it illustrates the large oversupply facing the offshore drilling industry, particularly among its most profitable rig types. This giant rig glut ledCitigroupto predict that ultra-deepwater dayrates could plunge from their recent high of $650,000 to as low as $200,000 in coming quarters, which would likely mean many more cancellations or delays in the construction of new offshore rigs.

Offshore drillers are already adopting this tactic. For example, according to David Hensel, senior vice president of marketing for Ensco, Brazilian oil giantPetrobrashad planned on ordering 29 deepwater rigs through its Build in Brazil program. However now it is looking like only half that number of rigs might be built and their construction will likely be delayed due to difficulty in securing financing and lower oil prices.

Geopolitical risks due to global footprint
Speaking of troubling developments in Brazil, 32% of National Oilwell's current rig systems backlog -- $3.3 billion -- is from a contract to supply 22 drilling equipment packages for Brazilian offshore rigs.

During its last quarterly earnings conference call, management revealed that Sete Brasil -- a drilling company 10% owned by Petrobrasand the final customer of the drilling packages-- has been caught up in the oil company'smassive corruption scandal. Unfortunately, the news broke right before Sete was to secure financing for this massive contract, and bankers subsequently pulled out in a big way. This has forced Sete to scramble to raise $4.5 billion from state-owned banks in order to stave off a potential bankruptcy.

This is just one example of the risks inherent with operating in approximately 70 countries around the world, including politically volatile or sanctioned markets such as Latin America, Russia, the Middle East, and Africa.

In fact, seventy percent of National Oilwell's 2014 sales come from abroad,which also exposes it to potentially significant currency risk.

Strong dollar could havesignificantimpact on financial results
Because National Oilwell derives so much of its sales from abroad, the strengthening U.S. dollar poses a large risk to its earnings despite the company's aggressive hedging efforts -- $5.1 billion in currency hedges at the end of 2014 -- meant to minimize this risk.

For example, in the first quarter the strong dollar dented earnings to the tune of $418 million, or 57%, and resulted in net income of just $313 million.

If the Federal Reserve begins raising interest rates this year -- as most analysts expect -- it's likely the dollar will strengthen even further and potentially weaken National Oilwells' short- to medium-term financial results even more.

Bottom line: Solid industry blue chip, but keep these headwinds in mind
Don't misunderstand me: National Oilwell Varco is one of my favorite oil-service stocks, and I'm in no way warning you not to buy shares in one of the best blue-chip dividend growers in this industry. However, investors should understand some of the risks that could drive the company's stock down over the short and medium terms. In knowing this, you can be prepared to take advantage of market overreactions and accumulate shares if they become even more undervalued, hopefully setting yourself up for better long-term returns in the years ahead.

The article Oil Stocks: 3 Risks That Could Sink National Oilwell Varco Shares originally appeared on Fool.com.

Adam Galasholds no position in the stocks mentioned here but does leadThe Grand Adventuredividend project, which recommends National Oilwell Varco.The Motley Fool recommends National Oilwell Varco. The Motley Fool owns shares of National Oilwell Varco. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.