Halliburton (HAL) is one of the oldest oil companies in the U.S.. Established in 1919, the Houston-based Halliburton is a truly global energy company, providing various services and products to the oil and gas companies in more than 80 countries. This year has not been a good one for the basic material companies, but it has been an exceptionally bad one for Halliburton. The company lost near 18% of its market cap in 2011.
As of the time of writing, Halliburton stock was trading at $33.55 with a 52-week range of $27 - $58. It has a market cap of $31 billion. Trailing twelve month P/E ratio is 11.2, and forward P/E ratio is 8.2. P/B, P/S, and P/CF ratios stand at 2.5, 1.3, and 9.6, respectively. Operating margin is 18.7%, and net profit margin is 11.1%. The company has some debt issues. Debt/equity ratio is 0.3. It pays a yield of 1.08% with a payout ratio of 12%.
Halliburton has a 5-star rating from Morningstar. Out of 27 analysts covering the company, 22 have buy, 3 have outperform, and 2 have hold ratings. Wall Street has diverse opinions on Halliburton's future. Top line growth estimate is 45%, and the bottom line growth estimate is 2% for the next year. Average five-year annualized growth forecast estimate is 18%.
What is the fair value of Halliburton given the forecast estimates? We can estimate Halliburton's fair value using discounted earnings plus equity model as follows.
Discounted Earnings Plus Equity Model
This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:
V = E0 + E1 /(1+r) + E2 /(1+r)2 + E3/(1+r)3 + E4/(1+r)4 + E5/(1+r)5 + Disposal Value
V = E0 + E0 (1+g)/(1+r) + E0(1+g)2/(1+r)2 + … + E0(1+g)5/(1+r)5 + E0(1+g)5/[r(1+r)5]
The earnings after the last period act as a perpetuity that creates regular earnings:
Disposal Value = D = E0(1+g)5/[r(1+r)5] = E5 / r
While this formula might look scary for many of us, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate, and the discount rate. To be as objective as possible, I use Morningstar data for my growth estimates. You can set these parameters as you wish, according to your own diligence.
Valuation
Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate. In order to smooth the results, I will also take the average of ttm EPS along with the mean EPS estimate for the next year.
E0 = EPS = ($2.96 + $4.15) / 2 = $3.56
Wall Street holds diversified opinions on the company's future. While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average five-year growth forecast is 18%. Book value per share is $13.43.
The rest is as follows:
Fair Value Estimator | ||
V (t=0) | E0 | $3.56 |
V (t=1) | E0 (1+g)/(1+r) | $3.78 |
V (t=2) | E0((1+g)/(1+r))2 | $4.02 |
V (t=3) | E0((1+g)/(1+r))3 | $4.27 |
V (t=4) | E0((1+g)/(1+r))4 | $4.54 |
V (t=5) | E0((1+g)/(1+r))5 | $4.83 |
Disposal Value | E0(1+g)5/[r(1+r)5] | $43.88 |
Book Value | BV | $13.43 |
Fair Value Range | Lower Boundary | $69 |
Upper Boundary | $82 | |
Minimum Potential | 107% | |
Maximum Potential | 148% | |
You can download FED+ Fair Value Estimator here.
I decided to add the book value per share so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5-year discounted-earnings-plus-book-value model, the fair-value range for Halliburton is between $69 and $82 per share. At a price of $33.5, Halliburton is at least 100% undervalued.
Summary
Halliburton did not perform well this year, and the stock is trading at more than 40% below its 52-week high. Analysts are pretty bullish on the company, dominantly suggesting 'buy' ratings.
Compared to its industry peers, Halliburton is significantly undervalued. The industry leader, Schlumberger (SLB), is trading at P/S ratio of 2.4 and P/E ratio of 20.8. This is a huge premium compared to Halliburton's valuation. If Halliburton was valued at this P/E ratio, the stock could be trading around $64.
Analysts also agree with me. While not bullish as my model suggests, their mean target price of $53 imply significant upside potential for the company. Barclays has an overweight rating with a target price of $67, which is near the lower end of my fair value range estimate. The stock was subject to massive sale between August and October, loosing near 50% of its market cap. Sell-off seems to be over, and the shares are stabilized above $30. Therefore, I think it can be a good contrarian pick for 2012.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
