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Over the next couple of years Nat Gas prices within North America are expected to increase. The increase in price is in turn expected to increase E&P onshore capex spending. As onshore capex spending within N.A. is expected to increase in 2014, Halliburton (NYSE:HAL) is an undervalued, large-cap, oil and gas service company that will greatly benefit from this trend.

Company Description

Founded in 1919, Halliburton is one of the world's largest providers of products and services to the energy industry. With more than 75,000 employees, representing 140 nationalities in approximately 80 countries, the company serves the upstream oil and gas industry throughout the lifecycle of the reservoir - from locating hydrocarbons and managing geological data, to drilling and formation evaluation, well construction and completion, and optimizing production through the life of the field.

In the section below, I will analyze aspects of Halliburton's past performance. From this evaluation, we will be able to see how Halliburton has fared over the past five years regarding their profitability, debt and capital, and operating efficiency. Based on this information, we will look for strengths and weaknesses in the company's fundamentals. This should give us an understanding of how the company has fared over the past few years and will give us an idea of what to expect in the future.

Profitability

Profitability is a class of financial metrics used to assess a business's ability to generate earnings compared with expenses and other relevant costs incurred during a specific period of time. In this section, we will look at four tests of profitability. They are: net income, operating cash flow, return on assets and quality of earnings. From these four metrics, we will establish if the company is making money and gauge the quality of the reported profits.

  • Net income 2010 = $1.835 billion
  • Net income 2011 = $2.839 billion
  • Net income 2012 = $2.635 billion
  • Net income 2013 = $2.125 billion

Over the past three years Halliburton's net profits have increased from $1.835 billion in 2010, to $2.125 million in 2013. This represents a 15.80% increase.

  • Operating income 2010 = $3.009 billion
  • Operating income 2011 = $4.737 billion
  • Operating income 2012 = $4.159 billion
  • Operating income 2013 = $3.138 billion

Operating income is the cash generated from the operations of a company, generally defined as revenue less all operating expenses, but calculated through a series of adjustments to net income.

Over the past three years Halliburton's operating income has increased from $3.009 billion to $3.138 billion in 2013. This represents an increase of 4.29%.

ROA - Return On Assets = Net Income/Total Assets

ROA is an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage.

  • Net income growth

    • Net income 2010 = $1.835 billion
    • Net income 2011 = $2.839 billion
    • Net income 2012 = $2.635 billion
    • Net income 2013 = $2.125 billion
  • Total asset growth

    • Total assets 2010 = $18.297 billion
    • Total assets 2011 = $23.677 billion
    • Total assets 2012 = $27.410 billion
    • Total assets 2013 = $29.223 billion
  • ROA - Return on assets

    • Return on assets 2010 = 10.02%
    • Return on assets 2011 = 11.99%
    • Return on assets 2012 = 9.61%
    • Return on assets 2013 = 7.27%

Over the past four years Halliburton's ROA has decreased from 10.02% in 2010 to 7.27% in 2013. This indicates that the company is generating less income off its assets than it did in 2010.

Debt And Capital

The Debt and Capital section establishes if the company is sinking into debt or digging its way out. It will also determine if the company is growing organically or raising cash by selling off stock.

Total Liabilities To Total Assets, Or TL/A ratio

TL/A ratio is a metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt.

  • Total assets

    • Total assets 2010 = $18.297 billion
    • Total assets 2011 = $23.677 billion
    • Total assets 2012 = $27.410 billion
    • Total assets 2013 = $29.223 billion
    • Equals an increase of $10.926 billion
  • Total liabilities

    • Total liabilities 2010 = $7.924 billion
    • Total liabilities 2011 = $10.479 billion
    • Total liabilities 2012 = $11.645 billion
    • Total liabilities 2013 = $15.642 billion
    • Equals an increase of $7.718 billion

Over the past four years, Halliburton's total assets have increased by $10.926 billion, while the total liabilities have increased by $7.718 billion. This indicates that the company's assets have increased more than the liabilities thus adding shareholder value.

Working Capital

Working Capital is a general and quick measure of liquidity of a firm. It represents the margin of safety or cushion available to the creditors. It is an index of the firm's financial stability. It is also an index of technical solvency and an index of the strength of working capital.

Current Ratio = Current assets / Current liabilities

  • Current assets

    • Current assets 2010 = $8.886 billion
    • Current assets 2011 = $11.577 billion
    • Current assets 2012 = $13.086 billion
    • Current assets 2013 = $13.704 billion
  • Current liabilities

    • Current liabilities 2010 = $2.757 billion
    • Current liabilities 2011 = $4.121 billion
    • Current liabilities 2012 = $4.752 billion
    • Current liabilities 2013 = $5.026 billion
  • Current ratio 2010 = 3.22
  • Current ratio 2011 = 2.81
  • Current ratio 2012 = 2.75
  • Current ratio 2013 = 2.73

Over the past four years, Halliburton's current ratio has decreased. As the current ratio is well above 1, this indicates that Halliburton would be able to pay off its obligations if they came due at this point.

Common Shares Outstanding

  • 2010 shares outstanding = 908 million
  • 2011 shares outstanding = 918 million
  • 2012 shares outstanding = 928 million
  • 2013 shares outstanding = 851 million

HAL Shares Outstanding Chart

HAL Shares Outstanding data by YCharts

Over the past three and a half years, the number of company shares has decreased from 908 million to 851 million.

Operating Efficiency

Operating Efficiency is a market condition that exists when participants can execute transactions and receive services at a price that equates fairly to the actual costs required to provide them. An operationally efficient market allows investors to make transactions that move the market further toward the overall goal of prudent capital allocation without being chiseled down by excessive frictional costs, which would reduce the risk/reward profile of the transaction.

Gross Margin: Gross Income/Sales

The Gross Profit Margin is a measurement of a company's manufacturing and distribution efficiency during the production process. The gross profit tells an investor the percentage of revenue/sales left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors and industry is more efficient. Investors tend to pay more for businesses that have higher efficiency ratings than their competitors, as these businesses should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).

  • Gross margin 2010 = $3.228 billion / $17.973 billion = 17.96%
  • Gross margin 2011 = $5.018 billion / $24.829 billion = 20.21%
  • Gross margin 2012 = $4.434 billion / $28.503 billion = 15.56%
  • Gross margin 2013 = $4.471 billion / $29.402 billion = 15.21%

Over the past four years, Halliburton's gross margin has dropped slightly. The ratio has decreased from 17.96% in 2010 to 15.21% in 2013.

Asset Turnover

The formula for the asset turnover ratio evaluates how well a company is utilizing its assets to produce revenue. The numerator of the asset turnover ratio formula shows revenue found on a company's income statement and the denominator shows total assets, which are found on a company's balance sheet. Total assets should be averaged over the period of time that is being evaluated.

  • Revenue growth

    • Revenue 2010 = $17.973 billion
    • Revenue 2011 = $24.829 billion
    • Revenue 2012 = $28.503 billion
    • Revenue 2013 = $29.402 billion
    • Equals an increase of 63.59%
  • Total Asset growth

    • Total assets 2010 = $18.297 billion
    • Total assets 2011 = $23.677 billion
    • Total assets 2012 = $27.410 billion
    • Total assets 2013 = $29.223 billion
    • Equals an increase of 59.71%

Over the past four years the revenue growth has increased by 63.59% while the assets have increased by 59.71%. This is an indication that the company from a percentage point of view has been more efficient at generating revenue.

Based on the information above we can see that Halliburton has produced mixed results from a fundamental point of view. Revenues over the past four years have increased by 63.59% outpacing the asset growth indicating an increase in shareholder value. The company has been very aggressive in share buybacks over the past six months. On the negative side Halliburton's gross margin has decreased, along with the ROA. Based on the results above we can see that Halliburton has shown many strengths but some weakness.

Driving Growth in 2014

Halliburton, which earns ~52% of its revenue within North America, is expecting a strong year in 2014. To support this statement Barclays is forecasting an increase of more than 7% in E&P spending within the continent this year. As this increase is being driven by the expectation that Natural Gas prices are on the increase, it is becoming more economical for E&P companies to focus on the onshore drilling market.

E&P spending is expected to be significantly higher than last year as in 2013 E&P spending increased by ~2%. As Halliburton is one of the largest oil and gas service companies in the business and has the most exposure to N.A. compared to Baker Hughes (NYSE:BHI) which earns ~50% of its revenues within N.A. and Schlumberger Limited (NYSE:SLB) which earns ~30% of its revenue within N.A., the increase in spending should have a positive effect on Halliburton's fundamentals moving forward.

Valuation

EV/EBITDA = Enterprise Value/Earnings Before Interest, Taxes, Depreciation and Amortization

In the next section, I will use the EBITDA to calculate the EV/EBITDA. The adjusted EBITDA takes into account foreign exchange and share-based payment expenses. The EV/EBITDA ratio is one of the most commonly used valuation metrics, as EBITDA is commonly used as a proxy for cash flow available to the firm. Oil and Gas service stocks typically have an EV/EBITDA ratio that trades in the 8.0x to 9.0x trading range.

Enterprise Value or EV = Market Capitalization + Total Debt - Cash and Cash Equivalents.

  • EV - $44.04 billion+ $7.816 billion - $2.356 billion = $42.161 billion
  • EV = $49.5 billion
  • EBITDA = $6.31 billion
  • EV/EBITDA = 7.84

As the Oil and Gas service sector often trades in the 8.63 trading range, an EV/EBITDA ratio of 7.84 indicates at current levels the stock is trading just fair value compared to other companies in its sector.

Other metrics that indicate the stock is undervalued are: Halliburton has a P/S of 1.59, which is below the industry average of 1.66 and a P/FCF of 10.53, which is above the industry average of 11.19.

Forward P/E to create a target

To create a target price for Halliburton. I will use Apache Energy's forward P/E ratios with estimated earnings to find a target. Currently, Halliburton has a forward P/E of 10.35 and FY 2017 high earnings projected at $6.46. These two metrics lead to a target price of $66.86.

As of February 11th, Halliburton was trading at $51.87. Using the forward P/E model, this indicates that the stock has a 28.89% potential upside from this point.

Conclusion

Based on improving nat gas prices increasing onshore drilling activity within North America, Halliburton's fundamentals will benefit from this trend. As the earnings are expected to increase, this will drive the stock price. Currently based on the information presented above, Halliburton is undervalued compared to the industry average with a price target in the mid $60's for 2014.

Source: Halliburton: Look For 25% Upside In 2014