As the BP plc (BP) - Halliburton (HAL) oil fiasco nears its resolution, oil well service investors are in a good position to gain from the global recovery. Greater industrial activity and the subsequent rise in transportation will yield a rightward-shift in energy demand (see here).
In this article, I will run you through my DCF model on Baker Hughes (BHI) and then triangulate the result with an exit multiple calculation and a review of the fundamentals compared to Halliburton, Schlumberger (SLB) and National-Oilwell Varco (NOV). I find considerable upside for Halliburton and Baker Hughes. In fact, I would not be surprised if either one turns out to be a top stock of 2012.
First, let's begin with an assumption about the top-line. Baker Hughes finished FY2011 with $19.6B in revenue, which represented a 37.6% gain off of the preceding year - deceleration. I conservatively model growth trending from 25% to 5% over the next half decade or so.
Moving onto the cost-side of the equation, there are several items to consider: Operating expenses, capital expenditures and taxes. I model cost of goods sold as 76.8% of revenue versus 7% for SG&A, 2.7% for R&D, and 11.1% for capex. Taxes are estimated at 31% of adjusted EBIT (ie. excluding non-cash depreciation charges to keep this a pure operating model.)
We then need to subtract out net increases in working capital. I model this hovering around 3% of revenue over the explicitly projected time period.
Free cash flow is estimated to be in the red at -$778M in 2012. In FY2011, Baker Hughes had -$954M in free cash flow. In light of these capital losses, the stock is actually being overly discounted .. it is cheap by a multiples standpoint.
Baker Hughes trades at just a respective 10.2x and 8.5x past and forward earnings. Corresponding figures for Halliburton are 9.8x and 8.2x; 16.5x and 11.3x for NOV; and 18.9x and 13.1x for Schlumberger. If Baker Hughes can hit a multiple of 13x and produce 2013 EPS of just $4.68, the stock would soar by 38.8%. This is well worth the concern over currently negative free cash flow.
Meanwhile, Halliburton has failed to appreciate despite strong momentum:
"I'm very pleased to report the following results that were achieved in the first quarter. Total revenue of $6.9 billion and operating income of $1.3 billion represents growth over the first quarter of 2011 of 30% and 63%, respectively, which I believe demonstrates how well we have executed against our targeted investment strategies. These are very strong results, especially considering the industry disruptions in North America related to rig movements and the harsh weather we experienced in the Eastern Hemisphere in Q1. Despite these challenges, we achieved record revenue during the first quarter in our North America region. Globally, both our cementing and Baroid product lines achieved record revenues in the first quarter, with cementing also setting a record for operating income."
Despite excellent first quarter results, the stock has been down a bit for the year to date. I think the stock is healthy and, with a beta of 1.6, the opportunity for high risk-adjusted returns is substantial. A multiple of just 12x and a conservative 2013 EPS of $4 would send the shares soaring 44.2%.
My optimism is less bullish for NOV and Schlumberger. Consensus estimates for NOV's EPS forecast are that it will grow by 24.9% to $5.96 in 2012 and then by 15.4% and 12.8% in the following two years. Assuming a multiple of 13x and a conservative 2013 EPS of $6.79, the stock would rise by only 13.6%. At a beta of 1.7, this is simply not worth the risk right now.
Ditto for Schlumberger. Consensus estimates for Schlumberger's EPS forecast are that it will grow by 21% to $4.43 in 2012 and then by 23.3% and 22.5%. Assuming a multiple of 13x and a conservative 2013 EPS of $5.42, the stock is roughly at fair value. With that said, analysts are still incredibly bullish about Schlumberger and NOV. In fact, according to Nasdaq, the consensus is a "strong buy" for both. I think this points to more of a bullish outlook on the industry in general, which supports my "strong buy" recommendations for Baker Hughes and Halliburton.