Seeking Alpha
Deep value, special situations
Profile| Send Message|
( followers)  

Putting Cash Flow into Shareholder Pockets

Rare is a company that wants to produce shareholder return, while also having capacity to do so. Halliburton (NYSE:HAL) is putting their money where their strength resides, in its ability to grow cash flow. According to SEC financial statements, not only has HAL repurchased some 34M shares for $4.4B to date, but also have increased their dividend $337M versus 2012's $250M.

Recent Q3's per share earnings for HAL was $.79, or $706M with 894M shares outstanding. Compare this with Q2's earnings of $.69/share or $644M with 928M shares and one sees not only an organic increase in earnings value, but also a $.03 /share immediate value in HAL's share buyback initiative. Dividend is at $.38/share to date versus $.36/share without the buyback.

Cost of this buyback initiative has been paid by cash and a restructuring of capital. Of the $4.4B spent on buybacks, HAL assumed debt of $2.97B averaging a 3% cost. Change in capital structure shows 34M shares at $4.4B retired to treasury saving roughly 14% cost of capital on those shares. Net cash flow consequence, including strong but muted capital expenditure, shows a decline of $993M, with $1.5B in cash remaining on cash flow statement.

Not a bad proposition for both company and shareholders. HAL expresses a commitment to deploy 15% to 20% of its net income to dividends. With rig counts in decline, and pressure pumping capacity looming at 20% excess, one must explore sustainability of HAL's approach to shareholder value.

Halliburton's Capacity to Continue Shareholder Value

Interesting is HAL's efficiency initiatives supporting value initiatives. HAL has Battle Red and Frac for the Future (FFF), which have identified costs to cut. According to HAL's CFO in Q3 earnings call (transcript readily available thanks to Seeking Alpha), these efforts are "having a significant impact on the support and operational headcount needs of North America as well as equipment and inventory requirements." In Q3, adjusting for these efficiencies resulted in $38M in severance and other charges. Q4 efficiency charges look to be $29M.

Nonetheless, one can see the effect of efficiencies by contrasting HAL's recent trends against Q3 results. Where revenues have increased, cost of revenue (COR) has increased at a greater pace. For example, 2012 saw revenue increase 14.79% while COR increased 21.49%. The result was a decrease in gross profit growth and ultimately EBITDA. In 2011, COR was 79.8% of revenue while 2012 saw COR increase to 84.4% of revenue. By Q2, 2013, COR was 85.4% of revenue.

Q3 experienced revenue increasing only 2.1% sequentially, but this number enhanced down to the bottom line. COR didn't grow in Q3, but was flat resulting in it reducing to 83.6% of revenue, a 180 basis point reduction. SG&A declined by 7M or 8%. Result was operating income rose 12.65% and despite increased interest payments of $20M to $91M, net income increased $62M to $702M or 9.6%. Where share buybacks added $.03/share value and revenue increased only 2.1%, efficiencies were obviously realized. Reduced share count and cost reductions allowed EPS to increase 14.5% sequentially. Without efficiencies, earnings would have been flat, or negative in rate of growth.

Looking forward, efficiencies remain to be realized. But Q4 oil field activity looks slow and international operations really don't kick off until 2014.

North American Activity Marked by Reduced Rig Count, but Sustained Servicing

Starting in 2012 and going forward, trend in North America (N.A.) is multi-well pads and a sustained 20% overcapacity in pressure pumping. Where gas rig count has shrunk from 914 at the start of 2012 to 370s by mid October 2013, oil rig count went from 777 at the start of 2011 to 1,360s of recent. Result is a net total decline in rig count of 9.4% year to date, 33.9% for gas rigs. For HAL, fewer rigs have challenged revenue.

With multi-well pads, however, nature of servicing any one rig has changed, but intensified in terms of service needs for any one pad. When a rig engages in horizontal drilling and fracking, HAL experiences a revenue multiplier of 4x to 5x versus conventional vertical drilling. Multi-well pad dynamics appear to reduce the multiplier given well count increases against HAL's revenue.

HAL's N.A. revenue for first half 2013 showed a 9% decline versus 2012. Q3, year over year N.A. declines are less dramatic being down 2%. After considering steep gas rig reductions, it looks as if HAL has adapted and is addressing declining revenue trends in N.A. Implied is HAL's ability to find revenue opportunities while rig count decreases. Changing product mix probably accounts for revenue declines slowing. For instance, inland water and offshore rigs are up y/y 10% and 17% respectively.

Q4 does bring seasonal slowing to N.A., due to weather and holidays. Overall, revenue from N.A. looks muted for Q4. While Eastern hemisphere props HAL's revenue increases, Latin America shows Mexico with declining production, but perhaps reaching an inflection point with proposed legislation that could bring foreign technology to depleting fields. Brazil presents similar circumstances with restrictions on use of foreign resources.

Oil service industry is in a period of transition due to technological developments in N.A. HAL is transitioning accordingly and appears to be rescuing itself from declining returns. Q4 looks to be lackluster, while Q1, 2014 could be positively surprising if Mexico transforms and bleeds off some excess pressure pumping capacity.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Halliburton's Share Buybacks, Dividend Increases: Sustainable In An Evolving Market?