Halliburton, Schlumberger, Baker Hughes: Buy, Buy, Buy

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 |  Includes: BHI, HAL, SLB
by: Takeover Analyst

In a previous article on Seeking Alpha, I argued that "notorious" oil well service provider Halliburton (HAL) was 50% undervalued after the overblown, and singular, Macondo incident erased billions in value. My price target of $43.30 is backed by the company's earnings power and impressive fundamentals. It is also backed by my bullish take on the entire industry, which includes Baker Hughes (BHI) and Schlumberger (SLB). I thus recommend investors open a large stake in the sector and diversify.

Halliburton

Halliburton is forecasted for solid growth in the years ahead. Earnings may dip to $3.22 in 2012, but they are expected to rise to $4.32 in 2014. The firm is having their 2Q12 earnings call, and this is what I believe investors should expect: NAM margins should be in the 20% territory after the June 6th pre-announcement of as much as a 550 bps sequential decline. International results are unlikely to be the tipping factor since two-thirds of operating income comes from NAM. Sequential top-line revenue growth is forecasted to be around 4% off of a seasonally weak first quarter.

Moving onto the second half of 2012, guar costs will start to peak after Halliburton stockpiled during 2Q12 and pricing pressure won't be meaningful outside of frac. Most importantly, international penetration should continue as (1) gas opportunities are explored in Australia and Saudi, and (2) Eastern Hemisphere margins pass the upper-teens. In addition, international growth will be more volume-driven than price-driven, so risk is lower and more predictable. The company has moved up in analyst rankings of the S&P 500 to #48, or the top decile. It is rated a "strong buy" on the Street according to FINVIZ.com.

Schlumberger

Schlumberger has similar upside to Halliburton but less of an economic moat and brand value to sustain as much predictable growth right now. NAM margins are expected to experience greater pressure than peers, especially in the Permian and Bakken basins. On the other hand, the firm has shown to have strong pricing power in small scale projects while large open-tender contracts remain competitive. In the offshore business, margins have started to normalize to pre-Macondo levels, and I anticipate activity returning to pre-Macondo levels in the latter part of 2H12.

Like Halliburton, Schlumberger also has opportunity in the gas markets of Saudi Arabia. The Middle East region is attempting to lower decency on oil, and the companies that lay the infrastructure down now will see particularly strong appreciation when energy demands in fact--not just in intention--change.

Schlumberger is currently worth around 83% of its historical 5-year average PE multiple but has grown in the solid double-digits over the past four quarters. Generally, performance has been better-than-expected. If Mitt Romney wins the presidency, oil & gas at large will rise from the loosening of EPA regulations.

Baker Hughes

This oil well service provide has struggled of late in the U.S. pressure pumping market, but there is likely to be a turnaround in the U.S. Golf of Mexico (GoM) and international markets. As mentioned above, EPA regulations and North American profit margins have all put pressure on the industry's ability to create value; international remains the main catalyst going forward.

Due to its chief focus on smaller customers, Baker Hughes has less sustainable streams of revenue and, accordingly, more challenges on the U.S. pressure pumping front. Logistics and supply chain issues have both exacerbated the issue. But outside of pressure pumping, Baker Hughes is doing just fie. Frac completion has held up well in terms of both demand and supply while GoM has normalized to pre-Macondo volume. Moreover, oil & gas operations are transitioning from exploration to development, which Baker Hughes has a core advantage in.

Baker Hughes is rated around a "hold" on the Street, despite trading at just a respective 10x and 9.2x past and forward earnings. Moreover, the PEG ratio is 40% below 1, which indicates that future growth expectations are being underappreciated by the market. 16.6% annual EPS growth is expected in the years ahead, which will put 2016 EPS at $6.79. A 13x multiple would yield a future stock value of $88.27, which, at a 10% discount rate, translates to a present value of $54.81 - in-line with consensus. This means that Baker Hughes has around a 40% margin of safety and highly undervalued even under analyst expectations.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.