Shares of Halliburton Company (HAL) have recovered 36% from their 52-week low of $26.28 touched in June. Market sentiment for the stock is quite bullish. Of the 33 analyst ratings according to Thomson One, there are 10 strong buys, 15 buys, 7 holds, and only 1 underperform. The mean target price of $42.64 represents a 19% upside. However, I am of the view that the market may be overly optimistic, as the stock appears to be reasonably priced and the limited margin of safety would thus not justify the strong-buy sentiment. My opinion is based on the following analysis:
HAL's discounted valuations relative to its peers appear to be justified by the company's financial fundamentals (see table below). Analysts on average forecast HAL's revenue, EBITDA, and EPS 2-year CAGRs to be 9.0%, 1.6%, and -0.7% over the current and next fiscal years. The estimations are substantially below the averages of 13.3%, 18.1%, and 26.9% for a peer group consisting of HAL's competitors, including Schlumberger Limited (SLB) and Baker Hughes Inc. (BHI). HAL's EBITDA margin is predicted to shrink by 3.2% over the same period, compared to the peer average expansion of 1.0%.
On the profit side, HAL's trailing gross margin is below the average, but the EBIT, EBITDA, and net income margins slightly outperforms the group averages. HAL's ROE and ROIC ratios appear to be the firm's bright spot, as they are at the highest level in the peer group. In terms of leverage and liquidity, HAL assumes a low leverage level, as reflected by the company's lower debt to capitalization and debt to EBITDA ratios. Although HAL's free cash flow remains weak, the negative FCF margin is fairly in line with the peer average. Both the firm's current and quick ratios are significantly above the peer averages, reflecting a fairly strong and liquid balance sheet.
In summary of the financial comparisons, the growth potential appears to be HAL's major issue, and the stock should trade at a solid discount to account for the substantially weaker growth prospects. The current stock's valuations at 1.3x EV/Sales, 5.8x EV/EBITDA, 1.2x P/S, and 11.4x P/E (all on a trailing basis) represent an average discount of 31% to the peer-average trading multiples (see table above), suggesting a fair valuation in my opinion.
Despite the fact that both HAL's trailing EV/EBITDA and P/E multiples are trading at 28% and 39%, respectively, discounts to their 3-year historical averages (see charts below), the company's estimated revenue and EPS growth in the current and next two fiscal years are significantly below the actual rates in FY2010 and FY2011 (see chart below).
Comparing the company's current financials to the figures in exactly a year ago (see table below), HAL's revenue, EBITDA, and EPS growth estimates have dropped significantly by an average of 87%. The expected change in EBITDA margin has declined from 3.6% to -3.2%. All of the firm's profitability margin and capital return measures have largely come down, and all of the liquidity metrics have also become worse. Nevertheless, the stock's four valuation multiples have only compressed by an average of 10%, and its PEG ratio has, however, expanded by 61% from 0.37x to 0.59x, indicating the valuation has become more expensive over the past year.
In spite of the 1-year stock price appreciation of 3.4%, HAL's revenue, EBITDA, and EPS estimates has experienced multiple downward revisions over the past 12 months (see tables below), meaning a pricier valuation.
In addition to the unfavorable valuations, I also do not expect the company to raise dividends in the near term. Dividend per share has not changed since FY2008, primarily attributable to the company's lackluster free cash flow generation (see chart below). The annual free cash flow had declined from $1.1B to -$0.8B as of September 2012 on an LTM basis (see chart below). In the recent years, HAL's annual free cash flow was barely able to cover the dividend payments and share repurchase, and as such, I would not anticipate any near-term dividend hike and introduction of a large-scale share repurchase program.
Moreover, following the recent Q3 earnings release, Global Hunter Securities cut its ratings for the stock from buy to neutral, with a lower price target of $38. Although Dahlman Rose reiterated its buy rating, it revised down its target price from $49 to $47 as a result of a lower EPS expectation.
Bottom line, HAL appears fully priced based on the company's relative financial performance to that of its peers and there is almost no visibility into any growth and cash flow improvement down the road. To derive my 1-year target price, I applied a generous 10% premium over the stock's current trailing P/E multiple at 11.4x to account for any potential macro force (i.e. oil price) that would positively impact the stock price. Based on the average FY2013 EPS estimate of $3.14, my target price is then calculated to be $39.50. As such, I recommend a hold rating for the stock.
Comparable analysis table is created by author, all other charts are sourced from Capital IQ, and all financial data is sourced from Morningstar, Thomson One, and Capital IQ.