With BP plc (BP) estimating settlements costs of $7.8B and floating partial blame on its contractors, Halliburton (HAL) and Transocean's (RIG) fates are still uncertain. As an investor relations consultant, I believe that this negative press has had an irrational impact on limiting value creation for strong brands like Recon Technology (RCON) and Tesco Corporation (TESO). I strongly recommend these two smaller oil well & equipment service firms (which I will elaborate on in later articles) and not letting the BP debacle cloud your perspective.
In this article, I will run you through my DCF analysis on Halliburton and then will triangulate the result with an exit multiple calculation and a review of the fundamentals compared to Transocean and Schlumberger (SLB).
First, let's begin with an assumption about revenues. Halliburton finished FY2011 with $24.8B in revenue, which represented a 38.2% gain off of the preceding year. Analysts model 26.5% over the next five years.
Moving onto the cost-side of the equation, there are several items to consider: Operating expenses, capital expenditures, and taxes. I expect cost of goods sold to eat 84% of revenue versus 1.3% for SG&A and 32% for taxes. Capex is around 12% of revenue, but we will exclude it from the model since - like many firms in the sector - it renders free cash flow negative. Instead, we will look at adjusted cash flow from operations.
We then need to subtract out net increases in working capital. I model accounts receivable as 21% of revenue, inventories as 13% of COGS, accounts payable as 8% of OPEX, and accrued expenses as 290% of SG&A.
This means that the company will generate $7.7B worth of adjusted operating cash flow by 2017. If this projection is discounted backwards by a WACC of 10% at a perpetual growth rate of 2%, the contribution to equity is $72B. Of course, we have yet to add in capex.
All of this falls under the context of strong performance:
I'm very proud to say that this was a record year for our company, with revenues of $24.8 billion, operating income of $4.7 billion and with growth, margins and returns that led our peer group. To put this in perspective, our business has nearly doubled in size over the last 5 years, primarily from organic growth.
From a division perspective, we achieved record revenues in both our Completion and Production and Drilling and Evaluation divisions, and I want to thank all our employees for their help in making it happen. The cornerstones of our strategy remain unchanged and include maintaining leadership in unconventional plays, participating in the deepwater expansion and impacting the decline curve in mature fields.
From a multiples perspective, Halliburton is fairly attractive. It trades at a respective 10.6x and 7.7x past and forward earnings versus 21.9x and 13.4x for Schlumberger, and 12.2x forward earnings for Transocean. Assuming a multiple of 13x and a conservative 2013 EPS of $4.51, the rough intrinsic value of the stock is $58.63, implying 70% upside.
Consensus estimates for Transocean's EPS forecast that it will grow by 94.8% to $3 in 2012 and then by 59.3% and 18.6% in the following two years. Assuming a multiple of 13x and a conservative 2013 EPS of $4.70, the rough intrinsic value of the stock is $61.10, implying 4.1% upside. At the BAML 2011 Global Energy Conference, Transocean's CEO Steven Newman claimed indemnity indemnity and argued that "[i]f BP fails to honor its promises, it doesn't live up to its obligations". In a play of brinkmanship, Newman continued that "the service community [may] no longer rely on the contract" and that this will cause "[t]he cost structure [to] increase dramatically". Transocean, itself, is in strong financial shape and has excellent geographical diversification to hedge against instability in any one region.
Schlumberger is similarly proving its strong fundamentals. The company delivered impressive results in the most recent quarter, beating analyst expectations. Rig count decline will, however, put pressure on margins, while free cash flow yield remains low. Utilization rates of around 80% will make Haynesville and Fayetteville the ares to watch as dry-to-wet switching increases. I expect the company to outperform.
Disclaimer: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.