Halliburton Company (NYSE:HAL)
UBS Global Oil and Gas Conference Call
May 21, 2013 08:30 am ET
Mark McCollum – Executive Vice President & Chief Financial Officer
Angie Sedita – UBS Securities
Angie Sedita – UBS Securities
Alright, good morning and welcome to UBS’ Global Oil and Gas Conference. Our first presenter is Mark McCollum who is Executive Vice President and Chief Financial Officer of Halliburton, a position he’s held since January, 2008. Prior to that he had been the Senior Vice President and Chief Accounting Officer of Halliburton from 2003 to 2007.
We believe Mark has been part of one of the very best management teams in the oil service sector today, and we’re very pleased to have Mark and Halliburton here to kick off the UBS Global Oil and Gas Conference.
Thanks, Angie, and good morning everyone. It’s great to see you in Austin, Texas. I always enjoy when the conferences are a little closer to home. And so it’s a well-attended conference – I always enjoy coming over for this and we appreciate the welcome that UBS has for us.
I’m going to spend a few minutes this morning talking a little bit about some strategic initiatives we’re working on this year to try to give you a little bit more insight into how we’re thinking about margins and things going forward. And I also want to spend a few minutes updating activity, sort of walk around the world and talk about where things stand in Q2 and as we look out over the rest of the year; and then close with some time for questions.
Obviously do take an opportunity to read our Safe Harbor language, that there will be some forward-looking statements that I’ll make today – just don’t hold me to them in case they turn out otherwise.
We have for a long period of time been articulating what our strategic growth drivers have been for our business. As we look at the market going over the next decade, decade and a half, we are very, very confident inside of Halliburton that there are three key areas where our business is going to grow more than other places. And it’s where we’re putting our investment dollars, it’s where we focus our technology, it’s where we focus our sales efforts. Those three areas are deepwater, unconventionals, and mature fields.
Everything that we’ve done and everything that we will do over the next several years will relate to these key drivers. We believe that they’re going to be the fastest growing areas. Clearly deepwater, the market itself not only has been growing but as we look ahead through the rest of 2013 and 2014 there are a huge number of deepwater rigs that are coming into the market. This is where we have focused a lot of our market share aims in terms of growing our international market share.
Our goal has been to grow 25% faster than the deepwater market overall. We believe that we have been successful in that effort. We will continue to try to grow that in that particular area. Why? Because deepwater is much more service-intensive than other areas and provides a higher margin and higher technology opportunities in other areas.
Unconventionals, that’s been the story in North America but we think over the next five to ten years will be the story of the international markets as well as unconventional gas begins to take off in certain key markets. Because we’re the unconventional leader in North America we believe that it’s an important strategic thrust for us to continue to expand our presence, to be ready to work for customers around the world in unconventionals.
And then in the mature fields area, while we’ve expanded our portfolio of businesses and assets to work in those areas we think over time as the oil and gas reserves around the world get increasingly more difficult to find more and more of our customers are going to go back in to try to look at mature field redevelopment – the ability to enhance production. And it plays very much into our other portfolio of assets in the production enhancement area, hydraulic fracturing, completions and other areas.
So we’re going to continue to grow our portfolio to address mature fields. While it’s still a relatively small percentage of our overall business each and every year it’s growing and we hope within the next year or so it will reach up to about $3 billion of our revenue base and grow from there.
Because we’ve been targeting these specific areas we believe that that’s been providing some success for us in terms of our growth relative to our peers. And I put this slide up – it’s not a new slide, we’ve seen this, but both in North America as well as international you look back over the last three years we’ve been the fastest growing entity in the service space. This is compared to our two primary competitors.
This has been largely obviously driven by those strategic thrusts, not just in North American, not in unconventionals but in the international space by targeting and winning share in the deepwater market. And as you can see on an index basis we think that we’ve been growing much more dramatically than our peers and we’re poised to continue to do this based on these key strategies.
We also have been providing the highest returns in the peer group, and whether you measure it on a return on capital employed or whether you look at it on a TSR, total shareholder return basis we believe we’ve been providing leading shareholder returns over that period and are very proud of this particular fact – particularly you know, it’s driven on our part we think by a better level of capital discipline and cash flow discipline.
Now, when I look at this slide though it tells me that there’s opportunity. I don’t like the trend. For us, you know, the last several years it’s gone down as we’ve invested heavily in the North American business, as we’ve invested heavily in our international businesses. And of course in 2012 as pricing came down in our North American markets relative to pressure pumping and our costs went up in North America relative to things like guar gum – all of those things have impacted our overall returns.
So we at Halliburton aren’t sitting on our laurels here and believe this is a battle that we’ve got to fight every single day to generate these leading returns. One of the key reasons why we believe our returns are better than our peers’ isn’t just the fixed asset side but it’s also the working capital side, and I’ll focus in on this slide. We have for a long period of time as we measure working capital days of sales, have had an advantage over our peers relative to these key metrics.
For us, one day of working capital is worth about $80 million of cash. So as I look at that there’s a big opportunity. The interesting thing on this chart and where it measures at the end of Q1 is that we actually, if you look at us, you look at our peers – we all lost ground in Q1 in DSOs, in days sales outstanding. For Halliburton I’ll just tell you, we lost about seven days of working capital in Q1. We’re not happy about that at all and we’re focused on trying to bring that down.
In North America as an example, when we look at working capital here our average DSOs run about 50 days and our terms are 30 days, and so as I look at that there’s a huge opportunity there that exists that we are working hard to go after. So as we look at it inside of Halliburton, the size of the overall strategic growth drivers that drive the top line we are very, very focused on other things that can also improve returns both on the capital efficiency side and the working capital side.
Some of those strategic initiatives we’ve talked about, and we’re going to try this year to do a better job of coalescing for you and Wall Street what kinds of opportunities these things will provide. One of the areas that we’ve done is we’ve actually been expanding our manufacturing footprint out of North America. We’ve recently opened our Singapore completion tools manufacturing facility – it’s up and running. It’ll probably reach its critical mass later this year. We’re currently adding a technology center adjacent to the Singapore manufacturing facility.
We’ve also shifted more of our repair and maintenance facilities for Sperry Tools over the last several years outside of North America and moving them around the world. We have a technology center open in Brazil today. Why are we doing that? Well, all that’s designed for a couple reasons. One is it allows us from a supply chain standpoint to manage our supply chain through Asia and other lower-cost areas, right? Instead of managing through North America we can manage it cheaper.
The second thing that it provides is it allowed us to create a foundation and then which we went forward and did a legal entity reorganization or a realignment of our businesses. We believe that the future growth of our business will be largely international – although North America is strong it will be more international. And by moving manufacturing and moving our supply chain operations outside of North America we can better address the growth of our international businesses.
So combining the manufacturing with the legal entity reorganization, it’s allowed us to take advantage of lower tax rates around the world. And we’re just beginning that process. We have moved all of our intellectual property offshore today; all of our Sperry Tools are owned outside of North America. The completion tools operation is actually run out of Singapore today.
Some of those initial things that we’ve done have allowed us to drop our tax rate in 2013 by 300 basis points which is a huge impact on returns and we believe that there’s more to go. This is just the first phase of a realignment that will allow us to better manage our business as we grow internationally.
In North America the key things that we’ve been focused on are two projects. One is Frac of the Future and one is Battle Red. We’ve talked about those, used those monikers and so I wanted to spend a minute and talk about what they are and what they address just to make sure there’s no confusion.
The Frac of the Future we’ve been talking about for some time, since our last Analysts Day is really where we introduced it. And it’s really designed around capital efficiency and operating efficiency in the field. The Frac of the Future itself addresses a different pump design, our Q10 pumps that are rolling out that reduce maintenance costs.
They reduce operating costs. Because they run much more efficiently we can actually… We’re trying to measure right now but our early indications are about a 20% to 25% efficiency level on capital. That means that I can have you know, one less truck out of four in the field. If you think about that that’s pretty dramatic in a 24,000 horsepower to 40,000 horsepower spread – the ability to take 20% to 25% of those trucks out and not only create a capital efficiency but also create a labor efficiency as well.
The SandCastles, the new sand delivery system that we’re running allows, because they’re solar powered they don’t require diesel. They measure more efficiently and it allows us to do more adjusting time inventory deliveries of sand and other materials to the well site, reducing our demurrage costs and our transportation costs.
So when we look at the Frac of the Future, the Frac of the Fuutre itself is going to have an operating income. It’ll have an operating margin impact. It will also reduce our overall capital on a well location overall, so that’s what we’re driving through the Frac of the Future initiative.
The Battle Red initiative is a back office initiative that’s really wrapped around mobility tools as well as a centralized billing process. Believe it or not in our industry we’ve been very paper-centric. From the time that we take an order to the time that we run an invoice, it’s a paper flow, stacks of paper – files two, three inches thick.
In our business alone at Halliburton I’m not ashamed to say this – it’s taken us somewhere between five and ten days between the time a job is completed and the time a bill goes out. And part of the reason our DSOs are as high as they are is that because there is so much manual intervention in the process there tends to be many errors that aren’t caught until later in the process.
So the Battle Red initiative is streamlining and basically systematizing the order to cash process from end to end and using mobility tools in the field that not only do time tracking and inventory tracking but also allow us to get electronic signatures in the field that we can then go and basically bill before the folks demobilize from the field. So the ability to pick up five, six days of working capital in this area – and you remember, I talked about $80 million of sales, it’s a significant cash driver.
There’s a corollary project inside the Battle Red that’s also addressing the procure to pay process as well and we believe we can continue to add days to our DPOs as well, so that in overall when we get Battle Red accomplished and then begin to roll it around the world, the opportunity to pick up somewhere between $0.5 billion and a full $1.0 billion of cash flow from just the changes in working capital is a real opportunity that we’re going after.
So we’re focused on these. The Battle Red initiative, we’ll begin to see the results of it later this year as some of the key pieces of that technology are finally fully implemented across the whole of North America.
Let’s talk a minute about the outlook for our business. As you know, we at the end of Q4 announced it that we called the bottom on our North America margins. For us, we felt confident that we could do that because we had a fairly significant hole in our margins relative to commodity costs for guar gum that we’ve been working out of our inventory this year.
For the full year we thought that we had about 450 basis points of opportunity to add to our margins in 2013 as a result of that. We got about 300 basis points of that margin uplift in Q1 so there’s still another 100 basis points, 150 basis points that we think we can get as we move forward through the rest of the year.
We also saw some activity increase in Q1 for us as we saw, while the overall rig count increase was fairly anemic, when you looked inside the numbers the increase in horizontal rigs as well as the increase in the rig allocation to our particular customer set indicated that there was some opportunity there. And so we got some uplift in our margins in Q1. We expect that that will continue over the rest of the year.
Our outlook continues to be that we’ll add probably 100 to 150 rigs through the rest of this 2013 year. That will help us continue to add some marginal improvement based on activity. Now, pressing against that I would tell you that there’s still pricing pressure in our markets. We had some pricing degradation, particularly in pressure pumping in Q1; there will be some in Q2 as well. We think as we go through the rest of the year that that will begin to abate but it’s going to be a factor of what happens with excess capacity in the market and how quickly can that excess capacity be absorbed.
As we look ahead, one of the things that we’re very encouraged about in this year, even though the rig count sort of would belie that activity is getting better – when you look at what’s happening with the rig count, well efficiency is gaining dramatically. We saw about a 15% increase in well efficiency just last year. When we look at this year we’re continuing to see it.
You see it in the Eagle Ford, you see it in the Bak and many customers who last year were still drilling wells to delineate their acreage and where the reservoir had moved to pad drilling this year. And with that you’ve seen an increase in our 24-hour operations and the efficiency of when you go to pad drilling it allows us to create a factory approach to the way that we conduct our business. And so PacWest I think who provided this data, just looking at horizontal rigs is forecasting about a 13% increase in well efficiency in 2013.
We think when you take the whole of the rig count including verticals that translates down to sort of a high single-digits increase in well efficiency. But for us, this combined with a modest increase in the rig count and the fact that our competitors as well as us are not adding net capacity to the market, we believe by the time that we exit 2013 we will be maybe not quite an imbalance but very, very close to an imbalance and at least close enough that the pricing pressure itself in the marketplace has essentially abated, particularly relative to the largest competitors in the space.
Looking at Latin America, of course for us, we’ve had some fairly significant wins in Brazil. The low-end drilling contract was awarded last quarter. We are mobilizing for that. There’s a couple of tenders, or the testing tender that we’re mobilizing for. There’s another tender out there that has not been yet announced but we feel very, very well-positioned for that so we’re busy mobilizing. Some of that is impacting our costs temporarily as we do that but overall we feel very good about the Brazil market. At an exit rate we believe we will be the largest service company in the Brazil market.
Venezuela post-elections has actually gotten a little bit better. Activity remains strong, bills are being paid. At least there’s some level of detente in terms of how we approach that market and so we’re cautiously optimistic that Venezuela will be better than where we had originally forecasted it will be.
As we look at Latin America, our largest issue right now is Mexico. Mexico last year, it was kind of interesting – in 2012 it started very slow. In the back part of  they actually overspent their budgets and had very strong activities particularly in the northern regions – Burgos and Chicontepec. As we come into this year the PEMEX has indicated that they’re going to be tendering a significant amount of business in the north, particularly in Chicontepec for some incentivized contracts.
We saw in Q1, if you listen very carefully I think us and our competitors saw that PEMEX was reducing our rig allocations in the Chicontepec and the Burgos basins. I think we went down from seven to two in Q1; some of the others did as well in advance of those incentivized contracts. We have now gone to zero in Chicontepec and in Burgos, and as we look across the whole of Mexico right now in the project management areas which we kind of consider Burgos, the Chicontepec area, the Tertiary and Mesozoic areas – the project management rig allocation is dropping from like 80 some odd rigs to 30 some odd rigs, about a 47- to 50-rig drop. Pretty dramatic.
So we know our rig allocation overall in the project managements has dropped from 17 to 6; Schlumberger’s has dropped from 16 to 7; Weatherford’s has dropped from 22 I think down to 14, I think something like that. So everyone is dropping rigs and so it’s having a significant impact on Mexico, more dramatic than we had indicated that we thought it would be when we did our Q1 conference call.
I will tell you we’re not really optimistic about this. If indeed they’re dropping these rigs in advance of the tender process on these incentivized process, the tenders are all due in July, at least that’s their targeted timeframe. But they would, if they go through the award process the work would not start until January of 2014 which means that that creates a significant hole.
Now, the rest of Mexico – the southern regions, offshore all continue to do pretty well. But the rigs in like I said Burgos, when you look at overall Chicontepec I think it’s a 40-rig reduction in the Chicontepec area that we’re seeing across the market. And so we, our competitors will all be impacted by that and it’s going to be more dramatic at least based on what we see today than we saw at the end of Q1 when we all did our announcements. So we’ll just wait and see.
The other area that we always see in Mexico is some timing areas around the signing of contracts like, we call them blanket orders but they’re annual contracts. Typically the signature process takes a long time but that’s not an unusual situation and so it creates some choppiness in that area.
In the Eastern Hemisphere we’re continuing to feel pretty good. It’s a slow and steady ramp-up. The Saudi area we’re continuing to see rigs coming into that market and anticipating that it will be to about 170 rigs by the time we get to the end of the year. We’ve seen good progress in those areas. There’s some big tenders that are happening in [Karas] and other areas that we’re enthusiastic about.
Iraq operations continue to get better. We’ll be out of the Majnoon project by the time we get to the end of Q2 which will have a fairly immediate improvement impact on our margins in Iraq as well as the Middle East. And of course the interesting thing is to look across, you see strong North Sea activity and all but Asia-Pac, believe it or not as you look at the whole Asia-Pac looks like it will be our strongest international region in 2013.
And I can’t put my finger on one project but as I look across the whole everything seems to be doing well, projects are moving forward very rapidly and of course the opening of our manufacturing center and some of the other things that we’ve done there are all serving to improve our Asia-Pac outlook and we feel very good.
So the Eastern Hemisphere story kind of remains intact, a slow and steady increase. We’ll be increasing margins as we do that as activity goes. We’re not seeing a real price inflection, not seeing an opportunity for a significant price inflection. Big tender activity continues to remain competitive and therefore it’s not that pricing is going down but certainly not many opportunities to increase pricing on the big tenders.
But we are working hard on direct-award, smaller tenders; being very surgical in terms of creating opportunities to increase our margins. And we expect as the year progresses that our margins in the Eastern Hemisphere will move into the upper teens and will be a nice exit rate going into 2014.
So as we look at it I guess in summary, I’ll just say we believe that our key strategic themes are going to continue to drive superior growth on a relative basis to our competitors. We are not abandoning that. We feel very, very strong about those. Of course for us the key issue is about returns, and so beyond just the growth we’re not counting on a lot of pricing help this year.
Our focus internally is on better capital discipline, a working capital discipline and on doing things that continue to drive opportunity to improve returns on a more unique basis than what we see some of our competitors doing.
And we think that these strategic initiatives are going to provide not just a return advantage but create some competitive advantages in some of our key markets like in North America where we’ll have a unique product offering, a more efficient product offering that allows us to go to market and reduce our customers’ costs on a per-barrel equivalent basis as well.
So we’re excited about that, and as we close out Q2 we hope to give you more specific guidance about what those initiatives will add in 2013 and beyond. But we feel very, very confident that we will continue to lead the pack on growth and returns for the foreseeable future.
With that I’ll open it up for questions.
Angie Sedita – UBS Securities
Yes, I don’t know if everybody heard the question in the back that basically was given the sort of change in outlook in Mexico does that change the margin outlook in terms of what we think. And I think the answer is yes. At least for Latin America it’s going to have a… We had talked about margins basically increasing and being tucked under the mid-teens in Q2. I think that’s going to be difficult. These rigs that are dropping in Mexico are high-end rigs, they were very profitable full services particularly in Chicontepec.
What’s most disappointing about it is that we were creating significant value for Mexico in Chicontepec. It was a highly successful lab and to go all of a sudden to zero rigs just is very frustrating. And then of course there’ll be some fixed costs around that because those are our rigs and they’re contracted so we carry some of that cost. So yeah, it does change the margin outlook.
I’ve been hesitant on Mexico because the significant drop in rigs didn’t necessarily make a lot of sense to us given that they’re essentially delaying significant activity until 2014. If I think about what happened in 2012, in the early part of 2012 I was ready to give Mexico up for dead and of course it became our best international country for the whole of 2012. So I’ve been a little nervous to sort of suggest us down but I think as we look at the rig allocation, we talk to PEMEX officials and we look at what’s happening across the board, not just for us but for our competitors as well it seems like this is sort of at least a shift that will create a bubble in 2013 going into ’14.
Angie Sedita – UBS Securities
And then one more on the cost cutting in North America with the Battle Red and the Frac of the Future. You’re spending $30 million a quarter which will go away towards the end of the year. I know you’re going to give more color later but could that be additive to your margins by 100 basis points or more as we go into the second half of the year ignoring activity?
Clearly the Battle Red initiative will start reducing in the second part of the year. It’s not going to go to zero. We talk about it being about $0.03 in Q1, another $0.03 in Q2. I think it will drop off to about $0.02 in Q3 and maybe $0.01 in Q4 in terms of its relative impact. I’m hopeful as we go into 2014 it’ll be out of our numbers and be there although given, if it’s very successful in North America we may turn quickly to try to get that rolled out through the rest of the world as well. So that would be the only thing that would drive it, is how fast we roll it out to the rest of the world.
(Inaudible) contracting structure that PEMEX is going to and do you see that trend of using incentivized contracts perhaps spreading to other regions as well?
That’s a great question and obviously we’re working on it right now. The incentivized contract structure in and of itself is sort of one step beyond the project management that we’ve done in the past, right? You do a turnkey project, you’re essentially establishing price and you kind of are obligated to deliver over a certain period of time. What’s good about the incentivized contract structure is that they create a mechanism for cost recovery in them, so if you do your planning right, if you understand your cost you can build in a mechanism where you can provide a fairly good recovery of cost.
The challenge in the incentivized contracts is these things are 30 years, 14 years at a minimum and they go out for many, many years. It’ll be the next management team that will have to pick up the pieces if we get it wrong, so that requires a lot more thorough study. Historically I would say the service companies are not capitalized to do these types of projects. We are. We have to think differently about returns, given the fact that we’re taking reservoir risk in this and so it is a little bit different.
We’ve done projects on a very small scale and doing projects where we take some reservoir risks but these are a multiplier factor. These are not the first – actually there were some incentivized contracts that were led in Ecuador about two years ago I think it was. And so it’s not new but the way that PEMEX is drafting these things appears to be unique and so we’re watching it very carefully. We don’t have all the information yet but we’ll look at it when it comes and decide how we’ll go, but for us – I’ll just remind everybody, we’re a return-driven company and we are not going to give up returns to take on a different contract structure like this. And we’re going to be very thoughtful in our approach if we want to do them.
(Inaudible) more on the pressure pumping side. You indicated that given the wells that you see and the [growth] in the rig count that by the end of the year the market could be nearing imbalance on the pressure pumping side. So thoughts on 2014 – do you think that you would have the ability to start to move and see some movement on pricing as we go into the year or is it still too early to tell, number one? And number two, I was just recently on the road with your team and they indicated that they are seeing some signs of a bottom in process in that there’s some interest for two-year contracts as a sign to pick up the bottom. Are you seeing anything else over the near term that’s indicating that we could start to see the bottom in pricing today?
Yeah, so I’ll take the second part of the question first. What they told you is absolutely right. We are seeing customers interested in longer-term contracts. We do feel that prices are bottoming out. That’s why I said I think that actually the largest impact on pricing will be in the front half of 2013. As we go into the back part I think it will be a fairly negligible impact on our overall margins.
But it may be a little too early to see whether we’re going to get an inflection in price going into 2014. As we look at the year we think right now we’re about 20% over supply in the pressure pumping market. We think that that could be worked off about half during the course of 2013 – I’m giving you very rough numbers. And so what remains if you only have about 10% over supply is not equipment that’s really competitive with Halliburton, it’s not the stuff that’s in our space.
I think what would create the biggest opportunity for us on the pricing side is if gas shows a rebound going into ’14. In other words, as we look at our contract rollover process in the latter part of the year – Q3, Q4 – as customers come forward with new capital budgets it’ll be interesting to hear the dialog: “Okay, we’re doing all this work in oil that we’ve been doing but by the way we’re going to stand rigs in the Haynesville or in the Barnett and some other areas” given what they’re seeing in the gas strip at that time.
I think that would create the opportunity to have a different pricing discussion because right now there’s not a lot of equipment in those areas and it will require sort of a decision of do we want to move equipment to address their needs given what opportunities exist in this current market? So I’m actually somewhat optimistic that if we see continued improvement in the gas strip and some gas rebound in 2014 we’ll have that ability to bump price some. But that still remains to be seen, right?
Angie Sedita – UBS Securities
Well, we want to thank Mark McCollum and Halliburton for being here this morning.
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