Halliburton's (HAL) a great company. There, I said it. The EPA may find the firm partially culpable for the Macondo oil spill (a disaster that is overblown in more ways than one) and the public may scorn their work, but Halliburton is substantially undervalued. Oil well service peers Schlumberger (SLB), National-Oilwell Varco (NOV), and Baker Hughes (BHI) are also definitely worth a look.
What makes Halliburton so attractive right now? Aside from the fact that the firm has beaten expectations for the last four quarters by an average of 4.8% despite an out-of-touch stock decline of 38.7% over the last 12 months, Halliburton is cheap on a multiples basis. It trades at just a respective 8.7x and 7.9x past and forward earnings - multiples the Street appears to think are cheap given the $44.42 price target and "buy" consensus. Halliburton's PE multiple is just three-fifths of its 5-year average PE multiple and 35% of its sector's current PE multiple.
Source: Internal research. Note: Halliburton's EPS over the past 5 years.
If you take a logarithmic regression of the oil well service firm's EPS over the last decade, you extrapolate 2016 EPS to be $4.60. This figure is actually highly bearish given that the Street anticipates 22.6% average annual growth over the next five years. Nevertheless, multiplying my 2016 EPS projection by the 5-year average PE multiple of 15.2x, the future stock value of Halliburton is $69.90. Discounting backwards by a WACC of 10% yields a target price of $43.40 - in-line with consensus and at a more than 50% premium to the current market value.
But the story gets even better. Halliburton is one of those rare firms that is actually generating positive free cash flow in the high-capex oil & gas sector. If you project 26.5% growth over the next six years and 3% into perpetuity, consistent operating metrics, and a discount rate of 10%, you arrive at an intrinsic value of $38.40, which provides a 30.4% margin of safety. This comes on top of a 1.2% dividend yield and excellent management.
Schlumberger, NOV, and Baker Hughes are also cheap at a respective 12.7x, 9.9x, and 8.9x forward earnings. They are also recommended on the Street and have delivered impressive momentum. Baker Hughes is only valued for less than one-half of its 52-week high, a total absurdity given better-than-expected results in the first quarter. Shareholders still seem to be on the fence after the 2.5% and 8.3% respective miss in 3Q11 and 4Q11. The fundamentals of the company are still strong: if the firm annually grows EPS at roughly one-half of what it is expected to (ie. 10%) over the next five years and trades at a 15x multiple (the 5-year average is 18.6x), the current stock price is justified at $59.55 (a roughly 50% premium to what it is valued at now) when discounting back by 10%. The market seems to be absurdly factoring in a WACC of 20% on a historically low PE multiple and operating projections that already assume a 50% and growing miss over 5 years.
NOV is currently rated an impressive 8 out of 10 on MSN Money's StockScouter Report. The last four quarters have also beat expectations by an average of 7.4%, although the Street has gotten closer and closer to actual results over the time period. The firm still has a PE multiple that is one-half of it's sector. In terms of solvency, NOV is also solid at a current ratio of 2.2. Operations have further yielded an impressive 5-year average ROIC of 12%.
Schlumberger adds yet another layer to my bullish oil well service thesis. The company trades at just 83% of its historical 5-year average PE multiple despite solid double-digit growth over the last four quarters. Performance may have a been a bit off in 1Q11 and 3Q11, but the fundamentals are well positioned to exploit growing demand for a scarce resource. EPA regulations have been overblown and are likely to be curtailed in the event of Romney victory. Oil spills have similarly given the industry a bad name despite their value creating role in the economy. But if investors are willing to put production and shareholder value ahead of reputation, the stock price has nowhere to go but up.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: 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.
