Halliburton at a Discount - Despite Continuously Meeting Expectations

Energy servicing giant Halliburton Company (NYSE: HAL) is down over 25% from its summer peak of $55, tracing the performance line of crude oil. This is to be expected in a market with little in the way of broad direction or leadership, but with oil becoming so volatile on YoY levels, price movements have lost some of their longer-term perspective.

Nearly all the “picks & shovels” leaders in the energy sector are still clocking record results, with most of those gains made from customer decisions back when crude was $20 to $30 cheaper than today’s $106 and change for NYMEX Light Sweet Crude.

Forest Level View

Consider that Halliburton grew non-U.S. revenues by 26% in the second quarter while sequentially increasing operating margins from the first quarter of 2008 (see earnings call transcript). They are forecasting roughly 20% top-line growth for the year, order backlogs are strong, and the company is positioned well for horizontal drilling in the newly-fashionable shale sites in the U.S.

I conducted a breakup value analysis of the company last year and calculated a value of $59 per share, based mainly on 2006 revenues and crude oil at about $55. Given that margins have compressed about 300 basis points from when I did the study, I will keep the value steady at $59 even though crude is twice as high today. The study was done back when private equity seemed to be eying anything with good cash flows, but estimating what operating segments would be valued at independently is a great way to supplement ongoing due diligence.

Halliburton’s decision to move headquarters to Dubai may not make friends in the U.S. but has positioned them to clean up on Middle East contracts. They are in a favorable position to get solid bookings from a $10 billion sour crude project in Abu Dhabi, and have already signed a multi-year deal with Saudi Aramco for an offshore field that could produce up to 900,000 bpd.

Which Side Do You Want to Be On?

With oil still well above the zero-barrier line for profitable drilling at darn near any point on the planet, is the 5-year EPS growth estimate of 15% for HAL too low? I’ve got to go with a “yes” here; I just don’t have the gumption to bet against secular global growth trends, peak oil fears, supply disruptions, and freakish global weather, all at the same time. I can think of just two major hypothetical situations that would impede 5 year EPS growth - industrywide -of 20%+ :

1. Commodity prices rise so high and across the board that global inflation spikes, killing demand for crude and derivatives;
2. A major alternative energy source emerges that is both cost effective and easy to distribute on legacy grid systems.

The greenie in me will celebrate when #2 happens, but I will likely be 15 or 20 years older by then. #1 has been taken care of quite efficiently by global markets in the past month; commodities across the board, hard and soft, have taken a beating. This should be enough to curb inflation fears while still allowing emerging economies to grow their coffers.

Project and capital allocation decisions are being made by sovereignties and the multinationals on crude prices much lower than we’re seeing here; I would need to see sub $80 prices before I’d be concerned about the cancellation of a major supply or service contract.

Parting Thoughts

Despite continually hitting or exceeding numbers, Halliburton is still getting a valuation discount to its peers. Shares are going for less than 12x forward estimates against a secular backdrop that is really hard to discount. I would be dipping my toes into the proverbial well at these levels, as I believe crude will settle in above $100 before steadily moving higher. If Hurricane Ike continues to retrace the path of 1992’s Hurricane Andrew, that price stabilization could happen much sooner, and at a level more like $120-plus.

Disclosure: Author does not hold any positions in the stocks mentioned.

Comments

[ajhough:]

I bought HAL at a much lower price and continue to hold it. It is contracting as the does the market. We will be drilling for many years and HAL will be a very busy company.

2008 Sep 07 08:58 AM

[sharksm:]

HAL is a great company and I own a lot of it. Lousy P.R., but a good business!

2008 Sep 07 09:51 AM

[tipalia:]

great company indeed but as a retiree I would like to see a juicier dividend
Do they have an habit of raising their dividend every year?

2008 Sep 07 12:04 PM

[Ryan Barnes:]

HAL did increase their dividend by about 20% in 2007, to $.09/share quarterly. But the annual dividend is at the board's discretion, and there isn't the same commitment to increasing it annually per se that you might find at other companies. Dividend growth will likely occur (given management's discussion in annual reports and CCs) so long as cash flow remains solid. Judging by the fundamentals, they could support a larger dividend, but they also work in a pretty capital-intensive business.

2008 Sep 07 11:34 PM

[RDG:]

How is HAL positioned to compete for a place at the table, if and when offshore drilling begins in the U.S., and given HAL's overseas commitments and headquarters location?

2008 Sep 09 02:22 AM

[Ryan Barnes:]

HAL should compete just fine for any increased business in U.S. offshore drilling. They would be better-prepared had they been able to acquire Expro group earlier this year, but they lost out to private equity. Nonetheless, they have strong partnership with PBR who has the largest offshore reserves (known) in the Western hemisphere...

2008 Sep 09 04:59 AM

[VintonCounty:]

P/E is 12.5 for HAL and 19 for SLB. Tax may explain the difference. The effective income tax rates are 25% for HAL and 20% for SLB. The difference is likely due to domicile; HAL is incorporated in the U.S. (Delaware), and SLB is incorporated in Netherlands Antilles. U.S. tax rate of about 40% (35% fed. + state taxes) is the world's highest. For HAL to have 25% effective tax rate, it must divide itself into domestic Halliburton and foreign Halliburton; and the foreign funds must not come to the U.S. That restricts management's freedom of action. So the shadow of the IRS may be the reason for the lower P/E for HAL.

2008 Sep 11 02:47 AM

[tinman:]

I don't trust HAL management to stay out of the news. Won't touch it.

2008 Sep 13 05:06 PM

[User 263331:]

International revenues will be the highlight of the Q3 show and tell in October. What a lot of people forget is that over the last year +, the dramatic revenue increases HAL has seen from the int'l side have actually been heavily tempered by the weak US$. Although much of HAL business is conducted in US$ regardless of location there is still a fair proportion in local currencies, and expenses are alway in the local currency too. So.....

Now that the $ has started regain some ground, you will find that those revenue increases are going to look exceptional and will be complimented by large drops in operating expenses.

2008 Sep 16 08:26 AM