The share price of Halliburton (HAL) has returned 23% over the past 12 months. Although the shares are trading near their 52-week high, there are a number of reasons suggesting ample room for further price appreciation:
1. Halliburton has a cheap valuation relative to its peers. According to the chart shown below, the company's consensus revenue, EBITDA, and EPS growth estimates are below the peer averages, but the difference is not significant. On the profit side, however, Halliburton demonstrates a superior performance as its various margin and capital return metrics are markedly above par. In terms of debt and liquidity, Halliburton is less leveraged relative to the peer group as reflected by its below-average debt to capitalization and debt to EBITDA ratios. As such, its interest coverage ratio is above the comps average. Both the company's current and quick ratios are considerably above par, reflecting a healthy balance sheet condition.
Given Halliburton's slightly below-average growth potential as well as its solid profitability and liquidity performance, I believe the stock's fair value would not trade at a notable discount to the peer average level. Nevertheless, the current price multiples at 6.3x forward EBITDA and 12.4x forward EPS (next 12 months) are on average 10.4% below the same peer-average multiples. After accounting for the 5-year earnings growth estimate, Halliburton's 5-year PEG of 0.6x is still 12% below the peer average at 0.7x, suggesting market has likely not given sufficient credits to the firm's strong profitability and liquidity condition and thus the stock is modestly undervalued relative to the comps in terms of financial performance (see chart above).
2. Halliburton's forward P/E multiple is currently trading at a 17% discount to the same multiple of S&P 500 Index, which stands at 14.9x now (see chart below).
This relative valuation level appears very attractive as the market discount seems to be exaggerated provided that 1) the market discount has increased from 4% to 17% over the past 3 months, however, Halliburton's consensus revenue, EBITDA, and EPS estimates for 2013 and 2014 have actually trended up slightly over the period (see charts below); and 2) the company's consensus 5-year earnings growth estimate at 20.5% is overwhelmingly above the average estimate of just 8.2% for the S&P 500 companies.
3. Analysts are very bullish on the stock. Of the total 33 stock ratings compiled by Thomson One, there are 14 strong buy and 16 buy ratings. Sell-side's average 1-year price target at $51 is 20% above the current share price. Given that Halliburton should command a 12% cost of equity based on the capital asset pricing model (see chart below), the average price target implies that analysts on average believe the stock remains undervalued even after the solid price appreciation.
4. On April 24, Credit Suisse added Halliburton to its US Focus List and cited the following rationales (sourced from Thomson One, Equity Research):
"Since we initiated coverage in October, we have been discussing the seasonality of the U.S. rig count - we now believe the U.S. rig count will begin to increase from current levels (+130 - 170 rigs) through the end of 2013. Efficiency gains and pad drilling adoption by E&P companies is leading to rising well counts, hydraulic fracturing stages per well, and footage drilled. It is these later variables (service intensity) that will drive significant revenue and margin increases for HAL through year-end and into 2014 and beyond. HAL offers the most exposure to the improving fundamentals in the North American market but is also demonstrating best in-class international revenue growth and increased deep-water rig market share."
5. Halliburton has a track record of beating estimates. The company's revenue and EPS exceeded consensus expectations in 7 of the past 8 quarters.
Bottom line, investors should continue buying as the stock remains undervalued given the solid fundamentals and promising prospects.
All charts are created by the author except for the consensus estimate tables, which are soured from S&P Capital IQ, and all financial data used in the article and the charts is sourced from S&P Capital IQ unless otherwise specified.