Halliburton (HAL) is one of the largest providers of oil services. The company provides a variety of oil field services, from pressure pumping to drilling, across North America and about 80 countries around the world. Over time, Halliburton has integrated its services into a single solution. Thanks to this policy, customers can obtain increased well performance, and reduce nonproductive time, by standardizing with Halliburton's services rather than combining services from several service providers. In the past two years, the company has shown remarkable revenue growth. However, the growth in revenues was not reflected in the stock price. The stock significantly lagged its peers in terms of market performance.
According to my valuation model, the stock of the company is trading at a considerable discount. Here, I explain why Halliburton is deeply undervalued. Let's start with basic assumptions. Like any other financial model, there are certain assumptions about the revenue growth, cost structure and capital structure of the company.
Model Assumptions:
The company has recorded growth in revenues of over 20% for the current year. However, in my ProForma earnings estimate, I have taken a conservative and cautious approach. I have assumed 11% growth in revenues for 2012, which will decline to a stable 4% in the terminal year. My revenue growth estimates are in agreement with Morningstar, which uses 11% growth rate for Halliburton revenues. Currently, Halliburton's cost of sales is 81% of sales. In my model, I have assumed a constant 81% cost of sales for the forecasted period. In addition, I have assumed a growth rate of 10% for general and administrative expenses. Halliburton has a tax rate of 32%. The company has significant stock options outstanding, which are generally exercised as the price of the stock moves up.
ProForma Earnings:
Reported Earnings | Projected Earnings | |||||||
2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | 2017 | |
Revenues: | ||||||||
Services | $13,779 | $19,692 | $21,858 | $24,044 | $26,208 | $28,305 | $30,286 | $31,497 |
Product sales | $4,194 | $5,137 | $5,702 | $6,272 | $6,837 | $7,384 | $7,901 | $8,217 |
Total Revenues | $17,973 | $24,829 | $27,560 | $30,316 | $33,045 | $35,688 | $38,186 | $39,714 |
Operating costs and expenses: | ||||||||
cost of services | $11,227 | $15,432 | $17,130 | $18,842 | $20,538 | $22,181 | $23,734 | $24,683 |
cost of sales | $3,508 | $4,379 | $4,861 | $5,347 | $5,828 | $6,294 | $6,735 | $7,004 |
General and Administrative | $229 | $281 | $309 | $340 | $374 | $411 | $453 | $498 |
Gross Expenses | 83% | 81% | 81% | 81% | 81% | 81% | 81% | 81% |
Total Operating costs and expenses | $14,964 | $20,092 | $22,299 | $24,529 | $26,740 | $28,887 | $30,921 | $32,185 |
Operating Income | $3,009 | $4,737 | $5,261 | $5,787 | $6,304 | $6,801 | $7,265 | $7,528 |
Operating margin | 17% | 19% | 19% | 19% | 19% | 19% | 19% | 19% |
Interest Expense | $297 | $263 | $271 | $279 | $287 | $296 | $305 | $314 |
Other, net | $57 | $25 | $26 | $27 | $27 | $28 | $29 | $30 |
Income from continuing operations | $2,655 | $4,449 | $4,964 | $5,481 | $5,990 | $6,477 | $6,931 | $7,185 |
Provision for Income Taxes | $853 | $1,439 | $1,589 | $1,754 | $1,917 | $2,073 | $2,218 | $2,299 |
Tax Rate | 32% | 32% | 32% | 32% | 32% | 32% | 32% | 32% |
Net Income | $1,802 | $3,010 | $3,376 | $3,727 | $4,073 | $4,404 | $4,713 | $4,886 |
Non-Controlling interest in net income of subsidiaries | -$7 | -$5 | -$9 | -$8 | -$9 | -$11 | -$7 | -$9 |
Net Income attributable to the company | $1,795 | $3,005 | $3,367 | $3,719 | $4,064 | $4,393 | $4,706 | $4,877 |
Shares outstanding | 908 | 918 | 923 | 928 | 932 | 937 | 942 | 946 |
Diluted shares outstanding | 911 | 922 | 926 | 931 | 935 | 940 | 945 | 949 |
EPS | $1.98 | $3.27 | $3.65 | $4.01 | $4.36 | $4.69 | $5.00 | $5.15 |
Diluted EPS | $1.97 | $3.26 | $3.64 | $4.00 | $4.35 | $4.67 | $4.98 | $5.14 |
According to my earnings estimate, Halliburton should be able to maintain healthy margins. I expect the company to post EPS of $5.15 by the end of 2017. Halliburton should be able to maintain healthy growth after the valuation period.
Valuation:
For the valuation purposes, I have assumed a discount rate of 10%. Halliburton has a strong history of revenue growth, healthy cash reserves and immensely strong business model. Taking into account the strong position of the company, I believe a discount rate of 10% is justified.
Valuation | 2012 | 2013 | 2014 | 2015 | 2016 | 2017 |
Earnings | $3.65 | $4.01 | $4.36 | $4.69 | $5.00 | $5.15 |
Discount rate | 10.00% | 10.00% | 10.00% | 10.00% | 10.00% | 10.00% |
Present Value Factors | 0.95 | 0.91 | 0.83 | 0.75 | 0.68 | 0.62 |
Discounted Earnings | $3.47 | $3.65 | $3.62 | $3.52 | $3.40 | $3.19 |
Terminal year Value @4% constant growth | $89.32 | |||||
Discounted Terminal Value | $55.38 | |||||
True Value | $76.22 |
There are two conventional methods to calculate the terminal year value; multiple of terminal year earnings and a constant growth model. I have used the latter, and assumed a 4% constant growth rate after the declining growth period of five years. Furthermore, the terminal year earnings of $5.15 are discounted using the single stage growth model, where the earnings are first adjusted for constant growth and then discounted by the discount rate of 10%. The single stage growth model also adjusts discount rate for growth by deducting the terminal growth rate from the discount rate. Once the terminal year value is calculated; it is then discounted to reach at the present value.
On the other hand, earnings before the terminal year are simply discounted to reach at the present value. Finally, the discounted earnings are added to the discounted terminal value to reach at the true value/fair value of the stock. According to my valuation model, Halliburton should trade at $76.22. The stock is currently trading at a significant discount to its fair value.
Peer Comparison:
Baker Hughes (BHI) and Schlumberger Limited (SLB) are the biggest competitors for Halliburton.
Halliburton | Schlumberger | Baker Hughes | |
P/E | 10.60 | 18.70 | 11.20 |
P/B | 2.30 | 3.00 | 1.20 |
P/S | 1.20 | 2.40 | 1.00 |
EPS Growth | 3.90% | -7.40% | -9.20% |
Operating Margin | 18.00% | 16.70% | 12.30% |
Net Margin | 10.70% | 12.60% | 8.70% |
ROE TTM | 22.60% | 16.80% | 11.70% |
Debt to Equity | 0.30 | 0.20 | 0.20 |
Source: Morningstar.com
It is evident from the table that the firm beats its competition on almost all the metrics. Halliburton is trading at a lower P/E ratio, while the firm has shown positive EPS growth when the competition recorded negative EPS growth numbers. In addition, the firm has higher margins, ROE and a lower debt to equity ratio as compared to its competitors. Baker Hughes looks relatively cheaper based on the P/B ratio.
Summary:
Halliburton stock is currently trading at a discounted price. As the valuation model shows, the stock should be trading near to $75 mark. The company has impressive revenue growth and attractive market multiples. At the current price, Halliburton provides an immense opportunity to make healthy returns.
The only negatives for the company could be the potential exposure from its role as a contractor on the Macondo well project that led to the catastrophic oil spill in the Gulf of Mexico. The oil spill is the subject of quite a few continuing government investigations, which keeps the stock at the current depressed prices. In addition, the company has been named in about 400 civil suits. However, the firm has estimated contingencies of $300 million, and I do not expect the total amount to be significantly higher than the estimated amount. Even after adjusting for these costs, the stock has almost 100% upside potential.
Disclaimer: EfsInvestment is a team of analysts. This article was written by Ahmed Ishtiaq, one of our writers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
