2014 has turned out to be another excellent year for oilfield services companies. Year-to-date, shares of the three major oilfield services companies, Halliburton Company (NYSE:HAL), Schlumberger Limited (NYSE:SLB) and Baker Hughes Incorporated (NYSE:BHI) have posted significant gains. This was after all three stocks outperformed the S&P 500 in 2013. The gains have come as oilfield services companies continue to post strong operating and financial results. The strong performance has been driven this year by growth in the Middle East and Asia. Up until recently though, weakness in North America was a major concern for oilfield services companies. However, the North American market seems to be finally recovering. This is especially good news for Halliburton, which is the most exposed among the three top oilfield services firms to the North American market. In fact, this makes Halliburton the best bet among the three major U.S. oilfield services companies.
Shares continue to surge
In 2013, shares of Halliburton, Schlumberger and Baker Hughes outperformed the S&P 500, gaining 49.21%, 32.59% and 38.39%, respectively. All three stocks have continued to surge this year as well. As of August 4, Halliburton shares have gained more than 39%, Schlumberger shares have gained nearly 23%, and Baker Hughes shares have gained more than 26%. This compares to a gain of just over 5% for the S&P 500.
The rally in shares of oilfield services companies was driven by strong operating and financial performance, which in turn was boosted by higher capital spending from major oil and gas companies in the U.S. and Europe. While oil and gas majors have been reducing capex this year, this has so far not had a negative impact on oilfield services companies. This is because all three major U.S. oilfield services companies have been benefiting from growth in the Middle East and Asia as evidenced by the results in the first half of 2014.
The first quarter of this year saw Halliburton, Schlumberger and Baker Hughes register strong performance in Middle East and Asia. The trend continued in the second quarter as well. Halliburton's revenue from Middle East and Asia rose 11% on a sequential basis. The company's operating income from the region rose 25% on a sequential basis. Baker Hughes's second-quarter revenue from Middle East and Asia was $1.15 billion, compared to $971 million reported for the same period in the previous year. Schlumberger's revenue from Middle East and Asia rose 12% on a year-over-year basis, while the company's margins improved by 323 basis points.
While Middle East and Asia is expected to be a key growth driver going forward as well, up until recently, North America had been a worry. However, North America is finally showing signs of recovery.
North American recovery
Oilfield services firms witnessed weakness in the North American market for two years due to a decline in drilling activity as gas prices weakened. A decline in drilling activity led to an oversupply of equipment, pushing prices lower and hurting margins of oilfield services companies. But after two years, the North American market is getting back on track.
Dave Lesar, CEO of Halliburton, had said in a conference call following the first-quarter results that he was beginning to feel the turn in North America. Following the second-quarter results, Lesar believes that this feeling was dead on target. In the second quarter, Halliburton saw its North American revenue increase 11% on a sequential basis. The company's operating income from North America rose 31% on a sequential basis. More importantly, Halliburton expects North America activity levels to continue to improve, with margins likely to reach 20% in the third quarter. The company is even accelerating additions to its hydraulic fracturing fleet and logistics capabilities in the wake of a recovery.
While Baker Hughes believes that there is still 20% overcapacity in North American markets, the company is seeing increased activity in onshore rigs, wells and horizontal drilling.
Bullish on Halliburton
While the recovery in the North American market has further improved the outlook for all three U.S. oilfield services firms, I am particularly bullish on Halliburton, given that the company is the most exposed to North America.
In the second quarter of 2014, North America accounted for more than 50% of Halliburton's total revenue. On the other hand, Schlumberger generated a third of its revenue from North America. While Baker Hughes depends a little more on North America than Schlumberger, the region accounted for less than 50% of its total revenue in the first half of 2014.
Given this scenario, Halliburton looks like the best bet among the three oilfield services providers although the outlook for the sector overall is bullish.
The major risk faced by Halliburton and the other two companies right now is Russia. Following the tragic MH 17 plane crash in Ukraine, the U.S. and Europe have stepped up pressure on Russia. The U.S. and Europe have also imposed tough sanctions on Russia, which could have some impact on companies in the oil and gas sector. Halliburton noted in its conference call that the Russia sanctions have not had any material impact on its activity levels so far, however, there is some risk related to certain projects that are being tendered later this year.
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