Halliburton (NYSE:HAL) and Schlumberger (NYSE:SLB), oil well services and equipment companies, both receive an overall "strong buy" rating on the Street. While I agree that Halliburton trades significantly below intrinsic value, I am much more reserved on Schlumberger. The latter is likely to experience declining margins in North America at the same time that Russia remains very volatile. Although both companies are led by strong managements, the premium at Schlumberger is, in my view, overly high.
From a multiples perspective, Halliburton is the cheaper of the two. It trades at a respective 11.5x an 8.3x past and forward earnings while offering a dividend yield of just 1.1%. Its competitor, on the other hand, trades at a respective 23x and 15x past and forward earnings. At the same time, Schlumberger has gross margins that are 260 basis points higher than Halliburton's at 20.6%.
During the third quarter, Schlumberger's earnings came slightly below expectations whereas Halliburton's CEO, Dave Lesar, noted strong performance for his own firm:
"I'm very pleased with the overall performance of our business in the third quarter. Total revenues of $6.5 billion and operating income of $1.3 billion are both company records, representing sequential growth of 10% and 15%, respectively. We achieved record revenue levels in our North America, Latin America and Middle East/Asia regions. In North America, revenue and operating income grew sequentially by 13% and 14%, respectively, compared to a U.S. rig count growth of only 6%, and we exceeded $1 billion in operating income for the first time ever. Our international revenue and operating income grew 7% and 23%, respectively, compared to a rig count growth of 2%, driven by a 17% revenue growth in Latin America and more modest growth in the Eastern Hemisphere".
Third quarter sequential growth of 4.9% and y-o-y growth of 13.8% in the emerging regions of Middle East and Asia is particularly impressive. And although much has been made about possible margin compression in NAM, I believe this effect will be more than offset by how the company is increasing scale while clearing off net debt. Furthermore, the firm will have strong demand due to activity at the Permian Basin, Eagle Ford, and Bakken. Thanks to having customers of relatively larger size and diversification, Halliburton also is not as vulnerable to commodity volatility as its competitors are.
Consensus estimates for Halliburton's EPS are that it will grow by 62.6% to $3.35 in 2011 and then by 3% and 16.7% more in the following two years. Assuming a multiple of 14x and a conservative 2012 EPS estimate of $4.06, the rough intrinsic value of the stock is $56.84, implying 66.8% upside. Even if the multiple were to decline to 9.5x and 2012 EPS turns out to be 10.2% below the consensus at $3.70, the stock still would not decline.
Schlumberger's catalysts, on the other hand, will mostly come from continued growth in the seismic market and improved pricing globally. Consensus estimates for its EPs are that it will grow by 28% to $3.66 and then by 35% and 23.9% more in the following two years. Assuming a multiple of 18x and a conservative 2012 EPS estimate of $4.85, the rough intrinsic value of the stock is $87.30. This implies an only 17.7% upside. This does not meet the threshold that I consider to indicate a value play. Analysts are, accordingly, more optimistic about Halliburton than they are about its competitor.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.