Before selecting a stock, there are a number of things that you need to consider in order to ensure that you are buying the stock of a high-quality company whose shares are poised to grow in value over time. Some of these concerns include what the company does, its competitive advantages, valuation, dividend payouts and sustainability, and earnings consistency.
Another important thing that you need to consider is the financial condition of the company in question. You want to know if the company is able to continue paying its bills, and how much debt it carries. The balance sheet is one of the most effective tools that you can use to evaluate a company's financial condition. In this article, I will discuss the balance sheet of Halliburton (NYSE:HAL), in order to get some clues as to how well this company is doing.
I will go through the balance sheet, reviewing the most important items, in order to assess Halliburton's financial condition. The information that I am using for this article comes from the company's website here. Note that this article is not a comprehensive review as to whether Halliburton should be bought or sold, but rather, just an important piece of the puzzle when doing the proper due diligence.
This article might be a bit too basic for some and too long-winded for others, but I hope that some of you can derive benefit from it.
Halliburton is a provider of products and services that are used in the energy industry for exploration, development, and production of oil and natural gas. They serve major oil and natural gas companies throughout the world, operating in 80 countries.
The company operates in two segments. They are Completion and Production, and Drilling and Evaluation. The Completion and Production segment offers optimization services for oil and natural gas production through pressure pumping, nitrogen services, and hydraulic fracturing. This segment also does bonding of the wells and well casing, also known as cementing. They offer numerous well completion products and services, equipment rental tools and services, as well as oilfield production and completion chemicals that address production, processing, and transportation issues. The Completion and Production segment accounted for 60% of Halliburton's revenue so far in 2013.
The Drilling and Evaluation segment provides field and reservoir modeling, drilling, evaluation, and wellbore placement solutions. They provide drill bits, seismic services, analysis of dynamic reservoir information, drilling fluids, performance additives, testing equipment, and waste management for oil and natural gas drilling. This segment also offers directional and horizontal drilling services, drilling and production software, and does consulting and project management.
In 2012, 53% of Halliburton's revenue came from the United States. Outside of the U.S., no other country accounted for more than 10% of the company's revenue.
Cash and Cash Equivalents
The first line in the Assets column of the balance sheet is for the amount of cash and cash equivalents that the company has in its possession. Generally speaking, the more cash the better, as a company with a lot of cash can invest more in acquisitions, repurchase stock, pay down debt, and pay out dividends. Some people also value stocks according to their cash positions. Some of the larger and more mature companies tend not to carry a lot of cash on their balance sheets, as they might be more inclined to buy back stock with it, or pay out dividends.
Halliburton is one such company. As of Sept. 30, 2013, Halliburton had $1.49B in cash and cash equivalents, which can be easily converted into cash. Over the last 12 months, Halliburton repurchased $4.29B worth of stock, and paid out $420M in dividends. The dividends are well supported by the company's 12-month free cash flow of $1.16B.
As of Sept. 30, 2013, the company had $1.7B remaining on its authorization to buy back stock. Halliburton recently announced a 20% increase to its dividend. This marks the second time that the company has increased its dividend payout within the last 12 months.
Receivables constitute money that is owed to a company for products or services that have already been provided. Of course, the risk with having a lot of receivables is that some of your customers might end up not paying. For this reason, you usually like to see net receivables making up a relatively small percentage of the company's sales.
Halliburton had a total of $6.63B in net receivables on its balance sheet, which represents 22.8% of its trailing 12-month sales of $29.1B. For fiscal 2012, 20.3% of its sales were booked as receivables, while that percentage was at 20.5% for fiscal 2011.
While this figure is high in absolute terms, it has been fairly consistent, and is more than likely reflective of the nature of the company's business. I don't see anything to be alarmed about here.
With manufacturing and service companies like Halliburton, I like to keep an eye on inventory levels. I usually like to see inventory levels stable or slightly rising from one year to the next. If I see inventory levels rising, then I want to see revenues rising as well, to indicate higher demand for the company's products. I don't like to see rapidly fluctuating inventory levels that are indicative of boom and bust cycles. In some instances, if inventory ramps up without increases in volumes or revenues, then it may indicate that some of the company's products are going obsolete.
As of Sept. 30, 2013, Halliburton had $3.40B worth of inventory, which amounts to 11.7% of the company's sales over the last 12 months. At the end of fiscal 2012, this level was at 11.2% of sales, while at the end of fiscal 2011, it was at 10.4% of sales. This shows that the company's inventory levels are steady relative to the revenues. I don't see anything here that would indicate boom and bust cycles or the possibility of a large number of their products going obsolete. So, I see nothing to worry about here at this time.
Another factor that I like to look at is the current ratio. This helps to provide an idea as to whether or not the company can meet its short-term financial obligations in the event of a disruption of its operations. To calculate this ratio, you need the amount of current assets and the amount of current liabilities. Current assets are the assets of a company that are either cash or assets that can be converted into cash within the fiscal year. In addition to cash and short-term investments, some of these assets include inventory, accounts receivable, and prepaid expenses. Current liabilities are expenses that the company will have to pay within the fiscal year. These might include short-term debt and long-term debt that is maturing within the year, as well as accounts payable (money owed to suppliers and others in the normal course of business). Once you have these two figures, simply divide the amount of current assets by the amount of current liabilities to get your current ratio.
If a company's operations are disrupted due to a labor strike or a natural disaster, then the current assets will need to be used to pay for the current liabilities until the company's operations can get going again. For this reason, you generally like to see a current ratio of at least 1.0, although some like to see it as high as 1.5.
The current ratio of Halliburton is 2.71, which is excellent. If you strip the company's inventory levels out of the calculation, then the ratio (also known as the quick ratio) comes in at 2.00, which is very good. This means that even if the company's inventory was worthless, there would still be enough current assets available to cover the company's short-term financial obligations in the event of an unlikely disruption.
Property, Plant and Equipment
Every company, regardless of the industry in which it operates, requires a certain amount of capital expenditure. Land has to be bought, factories have to be built, machinery has to be purchased, and so on. However, less may be more when it comes to outlays for property, plant and equipment, as companies that constantly have to upgrade and change their facilities to keep up with competition may be at a bit of a disadvantage.
However, another way of looking at it is that large amounts of money invested in this area may present a large barrier-to-entry for competitors. Right now, Halliburton has $10.9B worth of property, plant, and equipment on its balance sheet. This figure is inline with the $10.3B that the company reported at the end of fiscal 2012. Of these assets, 89% is tied up in machinery and equipment, while 10% is in buildings and improvements.
Goodwill is the price paid for an acquisition that's in excess of the acquired company's book value. The problem with a lot of goodwill on the balance sheet is that if the acquisition doesn't produce the value that was originally expected, then some of that goodwill might come off of the balance sheet, which could, in turn lead to the stock going downhill. Then again, acquisitions have to be judged on a case-by-case basis, as good companies are rarely purchased at or below book value.
Halliburton has $2.13B worth of goodwill on its most recent balance sheet, which is inline with the $2.14B worth of goodwill that it reported 9 months prior.
Usually, I don't like to see goodwill account for more than 20% of a company's total assets for the reason that I discussed at the beginning of this section. Since goodwill only accounts for 7.6% of the assets at Halliburton, I don't see much to be concerned about here, going forward.
Return on Assets
The return on assets is simply a measure of the efficiency in which management is using the company's assets. It tells you how much earnings management is generating for every dollar of assets at its disposal. For the most part, the higher, the better, although lower returns due to large asset totals can serve as effective barriers to entry for would-be competitors. The formula for calculating return on assets looks like this:
Return on Assets = (Net Income) / (Total Assets).
For Halliburton, the return on assets would be $2.64B in core earnings over the last 12 months, divided by $27.9B in total assets. This gives a return on assets for the trailing twelve months of 9.46%, which is decent. I also calculated Halliburton's returns on assets over fiscal years 2012, 2011 and 2010 for comparative purposes. This can be seen in the table below.
Table 1: Decent Returns On Assets At Halliburton
The numbers shown in the above table are decent returns on assets, and they show that management is doing a good job at making efficient use of what it has at its disposal.
We see a rise during 2011, which was due to increased activity in oil and natural gas basins in North America. Then, in 2012, the return on assets dropped back to where it was in 2010 due to higher costs and pricing pressures for production enhancement services in North America. Higher costs stemmed from 900%-1000% increases in the price of guar gum, which is used as a controlling agent in oil wells to facilitate easy drilling and prevent fluid loss. These price increases were caused by Halliburton and Schlumberger building up their inventories in guar gum in fear of any shortages that might result from droughts that were occurring in India during that time.
Short-Term Debt Versus Long-Term Debt
In general, you don't want to invest in a company that has a large amount of short-term debt when compared to the company's long-term debt. If the company in question has an exorbitant amount of debt due in the coming year, then there may be questions as to whether the company is prepared to handle it.
At present, this is not a concern for Halliburton, as they don't have any short-term debt on their balance sheet.
Long-term debt is debt that is due more than a year from now. An excessive amount of it can be crippling in some cases. For this reason, the less of it, the better. Companies that have sustainable competitive advantages in their fields usually don't need much debt in order to finance their operations. Their earnings are usually enough to take care of that. A company should generally be able to pay off its long-term debt with 3-4 years' worth of earnings.
Right now, Halliburton carries $7.82B of long-term debt. This figure is well above the $4.82B that was reported just 9 months prior, as well as the $4.82B that was reported at the end of fiscal 2011. This increase was brought on by the company issuing $3B in senior notes in four tranches this past August. One tranche is $600M financed at 1.0% with a maturity of 2016. $400M was financed at 2.0% with a maturity of 2018. $1.1B was financed at 3.5% with a maturity of 2023, while $900M was financed at 4.75% with a maturity of 2043. The proceeds from this $3B debt issue were used to buy back stock.
Maturities on the company's long-term debt range from 2016 to 2096, with rates ranging from 1.0% to 8.75%.
In determining how many years' worth of earnings it will take to pay off the long-term debt, I use the average of the company's core earnings over the last 3 fiscal years. The average core earnings of Halliburton over this period is $2.46B. When you divide the long-term debt by the average earnings of the company, here is what we find.
Years of Earnings to Pay off LT Debt = LT Debt / Average Earnings
For Halliburton, here is how it looks: $7.82B / $2.46B = 3.18 years
This is pretty good for Halliburton, in that the company can pay off its long-term debt with an amount that is just over three years' worth of earnings. To me, this shows that the company's debt position is manageable when considering the company's earnings power. It should be mentioned that of the $7.82B in long-term debt, only $1.4B comes due within the next 5 years.
In the equity portion of the balance sheet, you will find the treasury stock. This figure represents the shares that the company in question has repurchased over the years, but has yet to cancel, giving the company the opportunity to re-issue them later on if the need arises. Even though treasury stock appears as a negative on the balance sheet, you generally want to see a lot of treasury stock, as strong, fundamentally-sound companies will often use their huge cash flows to buy back their stock. For this reason, I will often exclude treasury stock from my calculations of return on equity and the debt-to-equity ratio in the case of historically-strong companies, as the negative effect of the treasury stock on the equity will make the company in question appear to be mediocre, or even severely distressed, when doing the debt-to-equity calculation, when in reality, it might be a very strong company. In this case, I will try to calculate the debt-to-equity ratio and the return on equity both ways to help give the reader an idea as to how much effect the treasury stock really has.
Halliburton has $8.17B in treasury stock.
The debt-to-equity ratio, as normally calculated, is simply the total liabilities divided by the amount of shareholder equity. The lower this number, the better. Companies with sustainable competitive advantages can finance most of their operations with their earnings power rather than by debt, giving many of them a lower debt-to-equity ratio. I usually like to see companies with this ratio below 1.0, although some raise the bar (or lower the bar if you're playing limbo) with a maximum of 0.8. Let's see how Halliburton stacks up here.
Debt-To-Equity Ratio = Total Liabilities / Shareholder Equity
For Halliburton, the debt-to-equity ratio is calculated by dividing its total liabilities of $15.1B by its shareholder equity of $12.8B. This yields a debt-to-equity ratio of 1.18.
This figure is just a little bit higher than ideal. However, when you cancel out the negative effects that the treasury stock has on the equity, it gets better.
In these instances, I calculate what I like to call the adjusted debt-to-equity ratio. It is calculated as follows.
Adjusted Debt-To-Equity Ratio = Total Liabilities / (Shareholder Equity + Treasury Stock)
Using the data from the most recent balance sheet of Halliburton, this figure is calculated as: $15.1B / $21.0B = 0.72. The tables below show how both the normal and adjusted debt-to-equity ratios have changed over the last few years.
Table 2: Debt-To-Equity Ratios Of Halliburton
Table 3: Adjusted Debt-To-Equity Ratios Of Halliburton
From these two tables, we can see that Halliburton's debt is very manageable when compared to its equity position. The main reason why we see an increase in the 2013 figures is the $3B debt issue that was mentioned earlier. Before then, the ratios were very consistent.
Return On Equity
Like the return on assets, the return on equity helps to give you an idea as to how efficient management is with the assets that it has at its disposal. It is calculated by using this formula.
Return On Equity = Net Income / Shareholders' Equity
Generally speaking, the higher this figure, the better. However, it can be misleading, as management can juice this figure by taking on lots of debt, reducing the equity. This is why the return on equity should be used in conjunction with other metrics when determining whether a stock makes a good investment. Also, it should be mentioned that some companies are so profitable that they don't need to retain their earnings, so they buy back stock, reducing the equity, making the return on equity higher than it really should be. Some of these companies even have negative equity on account of buybacks. However, Halliburton is not one of these companies.
So, the return on equity for Halliburton is as follows:
$2.64B / $12.8B = 20.6%
This appears to be a pretty solid return on equity. In the table below, you can see how the return on equity has fared over the past three years.
Table 4: Returns On Equity At Halliburton
This table shows that there was some variation in this figure over the last 3-4 years. The jump in 2011 was due to a 67% increase in core earnings that came from increased oil and gas activity in North America. The subsequent drop in 2012 was due to lower earnings mentioned earlier, coupled with a 20% increase in the company's equity position over the same period. It then rebounded, but this was due more than anything else to the $3B debt issue, which reduced the company's equity position, making the return on equity higher.
Adjusted Return On Equity = Net Income / (Shareholders' Equity + Treasury Stock)
When I strip out the negative effects of the treasury stock, here is what I come up with when using the data from the most recent balance sheet.
Adjusted Return On Equity = $2.64B / $21.0B = 12.6%.
This appears to be a pretty solid return on equity, although it's not much to write home about either. In the table below, you can see how the adjusted return on equity has fared over the past three years.
Table 5: Adjusted Returns On Equity At Halliburton
For the most part, the adjusted returns on equity showed the same behavior over the last few years as the normal return on equity.
Retained earnings are earnings that management chooses to reinvest into the company as opposed to paying it out to shareholders through dividends or buybacks. It is simply calculated as:
Retained Earnings = Net Income - Dividend Payments - Stock Buybacks
On the balance sheet, retained earnings is an accumulated number, as it adds up the retained earnings from every year. Growth in this area means that the net worth of the company is growing. You generally want to see a strong growth rate in this area, especially if you're dealing with a growth stock that doesn't pay much in dividends or buybacks. More mature companies, however, tend to have lower growth rates in this area, as they are more likely to pay out higher dividends.
Halliburton currently has a retained earnings figure of $18.2B. Below, you can see how the retained earnings have fared at Halliburton at the end of each of the last four fiscal years.
Table 6: Retained Earnings At Halliburton
From the above table, you can see that Halliburton has been steadily growing its retained earnings since the end of fiscal 2009, at a cumulative rate of 67%. This has been happening as the company has been buying back stock and paying dividends. These impressive figures are a testament to the strong earnings power of Halliburton.
After reviewing the most recent balance sheet, it can be concluded that there are a lot of things to like about the financial condition of Halliburton. For starters, Halliburton has very good current and quick ratios, which show that the company has enough current assets on hand in order to meet its short-term obligations in the event that its operations encounter an unlikely disruption. Halliburton has solid returns on assets and equity. The company's debt is also quite manageable, as can be seen by its adjusted debt-to-equity ratio and the fact that less than four years worth of earnings could cover its long-term debt. Retained earnings growth has also been very good, leaving Halliburton with plenty of money to reinvest back into the company for more growth.
While this is not a comprehensive review as to whether Halliburton should be bought or sold, I think that the company is in very good financial condition at this point in time.
More information on how I analyze financial statements can be found at my website here.
Thanks for reading and I look forward to your comments!