Halliburton And Schlumberger Will Benefit From An Increase In Oil Majors' Capital Expenditures

Includes: HAL, SLB
by: Colin Lokey

Recently, TheStreet.com dubbed Halliburton (NYSE:HAL) 'The Most Mispriced Energy Stock of 2011.' The article blames a "Macondo overhang,...fears of pricing weakness,...and a [projected] BRIC slowdown" in 2012 for the underperformance of Halliburton's shares. These concerns seem largely overblown. As for the Macondo issue, there is certainly a real risk that Halliburton may be forced into a large settlement, but S&P does not believe a ruling on the matter is imminent. Regarding a slowdown in the BRIC countries, the article notes that Argus Research believes a review of big oil's capital expenditure plans should be enough to dispel the notion that an economic slowdown in China or Brazil will derail oilfield service companies in 2012.

This is consistent with S&P's outlook for the oil and gas equipment and services sub-industry. In its stock report on Halliburton, S&P says it expects "higher upstream capex...combined with higher global demand" in the coming year. There are multiple examples of big oil's plan to increase spending in 2012. On December 2, Conoco Phillips (NYSE:COP) announced it was increasing 2012 planned capex to $15.5 billion from a previous estimate of around $14.5 billion. The new estimate represents a 15% increase from 2011. In a sign of how the industry is recovering since oil prices crashed to around $30 in the wake of 2008's financial crisis, Conoco's 2012 spending plan "mark[s] a return to the level of investment the company had before 2009, when it slashed its spending plans by 40%" according to the Wall Street Journal.

Also, Conoco said "the bulk of [its] exploration and production capital program will be spent in North America," where Halliburton maintains a leadership position. Chevron (NYSE:CVX) also plans to increase capex in 2012. The second-largest U.S. oil company said it expects to increase spending by 17% next year to $32.7 billion, a record for the company, while Exxon (NYSE:XOM), the largest U.S. oil company, is expected to increase spending by 5% next year according to MarketWatch.

Going forward, the European situation poses a significant risk for oil companies. Should the ECB's Long Term Refinancing Operations fail to spur investment in distressed sovereign debt, Italy and Spain could find themselves unable to access the bond market, causing them to seek a bailout from the IMF. This would likely spark a recession in Europe that could be deep enough to cause significant demand destruction for oil, thus putting downward pressure on prices. Thus far, Europe has navigated the crisis reasonably well--to date, the region's leaders have managed to avert a 'Lehman event'. The likely scenario is that Europe will manage to limp through the crisis without anything going disastrously wrong.

Additionally, geopolitical factors, such as Iran's threat to close the Strait of Hormuz, should counterbalance recessionary fears in Europe. Furthermore, Forbes notes that JP Morgan's commodities research team is predicting that "as a result of producers rebalancing supply and demand," oil prices should remain resilient in 2012, while "past recessions and the price movement of oil [indicate] the floor [for Brent] seems to be in the $80 to $95 a barrel range." The aforementioned Forbes article cites JP Morgan as predicting a 2012 average of $115 for Brent. This bodes well for oil field services companies as "oil and gas companies in aggregate [are] basing 2012 capital spending budgets on an average oil price of $87 WTI and $98 Brent," according to Barclays. This means prices have some leeway to drop before the capex budgets of the oil majors would be affected.

Given that increased capex expenditures should support oilfield service companies in 2012, the question remains: Why Halliburton and not Schlumberger (NYSE:SLB)? For starters, Halliburton maintains a leadership position in North America. This is good in the current environment given that, according to Barclays, "supermajors will increase spending by 25% in North America [and only] 10% internationally"--Schlumberger derives nearly 73% of its income outside North America. Additionally, Schlumberger is more expensive in both absolute terms and in terms of its earnings multiple. Schlumberger trades for around 14 times forward earnings--shares of Halliburton trade hands for around 8.14 times analysts' consensus estimate of $4.15 for 2012.

Also, Halliburton's trailing twelve month price-to-sales and price-to-cash flow are well below Schlumberger's, and the two companies' trailing twelve month gross margins, operating margins and net profit margins are very similar. All-in-all then, both Schlumberger and Halliburton are poised to benefit from increased capex by oil and gas companies in 2012, but Halliburton seems to be a better value from a valuation perspective. Now seems like a good time to buy, with HAL shares trading around $34.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in HAL, SLB over the next 72 hours.