I have mentioned Halliburton (NYSE:HAL) in several articles this year as a great momentum selection, risk-adjusted, to climb in price with the advent of an oil industry upcycle. It remains a solid choice based on my proprietary Victory Formation momentum models. The company is the second largest oil field services company globally by sales, next to Schlumberger (NYSE:SLB).
Consolidation in the oil services sector has been a headline for several years after the biggest oil bust since the mid-1980s, during 2014-16. With crude oil falling from over $100 a barrel to under $30, investment in exploration and drilling worldwide has dried up significantly. Huge 30%-50% revenue declines at the largest companies have led to employee layoffs, restructurings, cost cutting and the merging of failing business structures with stronger industry leaders like Halliburton, Schlumberger, and Baker Hughes (BHI).
Halliburton attempted to combine its business with Baker Hughes in 2015-16. However, U.S. anti-trust concerns eventually forced the proposal to be suspended. Halliburton had to pay $3.5 billion in break-up fees to Baker Hughes when the merger failed. Baker Hughes quickly switched gears and agreed to combine with the General Electric (NYSE:GE) oil & gas services unit. The BHI/GE deal is facing anti-trust scrutiny also, and will likely require some divestiture of overlapping businesses where a 40% to 50% market position would prove anti-competitive.
For Halliburton, an overall sales decline from $33 billion in 2014 to $16 billion last year proved challenging, as the company aggressively reduced costs to fit market demand. HAL has written off some $7 billion in accounting equity and restructuring costs since 2014. At the same time, weak oil investment activity is forcing the company to refocus and rebrand its unique technologies and integrated solutions for the industry. Halliburton is today well capitalized and positioned in the marketplace to grow revenues and profits strongly as oil drilling activity increases over time.
Oil price outlook is improving
Investors with a long-term horizon are quite worried a meaningful oil price spike will be reality over the next 2-3 years, as slow exploration and drilling activity outside the U.S. could curtail global oil production dramatically. The IEA organization is warning ultra-low oil prices in 2015-17, well below the sustainable cost of production worldwide, may translate into a shortage of product a few years out. Specifically, the International Energy Agency is predicting slowly growing overall demand will outpace supply by 2020, using current estimates of production from planned well development and older field depletion rates. Even in the U.S. where light tight oil (LTO) shale production has risen during 2017, the IEA is anticipating subdued growth in production the next five years at sub-$55 oil prices.
According to Dr. Fatih Birol, the IEA's executive director in March,
We are witnessing the start of a second wave of US supply growth, and its size will depend on where prices go. But this is no time for complacency. We don't see a peak in oil demand any time soon. And unless investments globally rebound sharply, a new period of price volatility looms on the horizon.
OPEC announced Thursday, production restraints started in early 2017 will continue throughout the year. The OPEC effort is credited with keeping worldwide inventories from growing in 2017, and the feeling among market participants is OPEC cuts lasting a few more quarters will allow above ground stocks to begin a long-term cycle decline.
In addition to overseas oil exporters desperately wanting higher prices to fund government spending and keep oil workers employed, the kingdom of Saudi Arabia is preparing the largest Initial Public Offering of a single stock in history during 2018. The nation is attempting to initially sell hundreds of billions of dollars in underlying oil company value to help raise money to diversify its economy away from energy. This ambitious effort roughly equates to putting half the country's assets in a publicly traded equity. The background idea is Saudi rulers can easily raise cash in the future, as they sell shares from their majority stake to fund investments in their economy. The formerly state owned monopoly, Aramco market capitalization is expected to be in the $2-3 trillion range at $50 to $60 crude oil. Of course, it will be worth considerably more if oil prices jump the next 12 months. You can see the incentive Saudi Arabia has to cut production today and juice the international oil price for the IPO next year.
Overall, as long as global demand continues to expand, a price rise in crude oil back above the sustainable long-term cost of production in the $65 to $70 a barrel range is inevitable. The longer it takes for the current price to climb above $50 in 2017-18, the more likely a shortage spike above $100 becomes from a lack of investment in new oil fields.
The biggest "worry" for inflation-rate watchers of all stripes, consumers, businesses and investors alike remains the negative economic effect from an oil supply shock. For example, any new Middle East war with an associated and currently unexpected supply shock could deplete bloated oil inventories quickly and generate a spike in oil to $80+ almost overnight.
I strongly believe calls for sub-$50 oil epitomize wishful thinking and simple trend following at this stage of the oil price/production cycle. My view is only a sizable drop in demand from a global recession can keep the oil price below the cost of production much longer. In conclusion, either prices rise now or rise later in the decade. The point is prices long-term will climb from $50 a barrel, and new well exploration, drilling and development activity is bound to increase from the 2016-17 low point.
Halliburton's leading position in oil services
The company is one of the best positioned to benefit from rising U.S. shale production specifically and a coming pick-up in oil services demand globally. It invented hydraulic well fracking in the 1940s. Halliburton is the leading expert in the refracturing technologies fueling American oil production growth of late. Perhaps the lowest cost avenue to pump more oil from underperforming wells and older shale varieties left for dead, refracturing expands extraction rates and extends the existing life of oil deposits, especially in America. It is estimated just 5% of U.S. wells have used refracturing techniques to date. So, there exists oversized potential for Halliburton sales growth if oil prices start rising.
Below is information on the customer value proposition, Halliburton's Activate Refracturing Service provides:
Business in 2017 is already accelerating at such a brisk pace, Halliburton's new CEO last week announced price hikes of 10%-20% are coming to pay for bringing older equipment back into service and hiring new employees at higher wage rates than a few years ago. Wall Street analyst consensus projects a jump in 2017 revenues to $20 billion from $16 billion last year, and $25 billion in 2018, or 25% annual growth each year. The significant bump higher in sales is also being formulated under the assumption of a low oil price environment. You can imagine the outcome will be even brighter for many years into the future, if oil prices climb meaningfully into 2018, and overseas producers increasingly adopt and demand Halliburton's refracturing technology solutions.
Halliburton may also represent one of the bigger investment opportunities of a Trump presidency and Republican majority in Congress. With Halliburton's greater than typical political connections, including former Republican Vice-President Cheney as CEO, Trump's less strict EPA standards (deregulation) and jobs first focus could improve the company's business outlook tremendously without any uptick in oil & gas prices.
Putting the fundamental pieces of the puzzle together, Halliburton could be on the cusp of a multi-year surge in operating business profitability. Wall Street consensus forecasts earnings per share rising smartly from breakeven in 2016, to $0.96 in 2017 and $2.70 next year. Plus, this forecast was made before last week's price increase notice to customers. The 2018 sales estimate of $25 billion is still 25% below the 2014 peak number. I fully expect a better drilling activity situation globally in a few years could support new records for sales and profits by 2019-2020. An optimistic forecast would place sales at $35 to $40 billion by 2020, with earnings per share in the $4.00 to $5.00 range, using past margins on sales as a predictor. However, it is entirely possible Halliburton products will entertain great demand in North America; profit margins will be higher than the last cycle; and, results for shareholders will be equally impressive.
Strong financials and liquidity near a cycle bottom
Halliburton appears to be well positioned financially to grow its business, after a successful restructuring period in 2015-16. The company intelligently prepared for a prolonged industry downturn a few years ago. It took advantage of ultra-low interest rates in the U.S. economy by issuing $7.5 billion of debt during 2015, with annual interest costs ranging between 2.7% and 5.0%, plus long-term maturity dates of 2020-45.
For the March quarter reporting period, the company held $10 billion in current assets vs. $4 billion in current liabilities and $16 billion in total liabilities. Since the majority of Halliburton liabilities are low cost, long-term varieties not due for many years, the company can use its $6 billion working capital position and $3 billion in 2017 estimated operating cash generation to expand the business organically. Financial liquidity remains excellent if oil prices rebound, bringing new business orders for the firm.
The equity market capitalization is $40 billion at a $47 stock price, against $4 billion in tangible book value. I would prefer a higher tangible book value number, but the whole oil and gas industry has undergone a decimation of balance sheet accounting worth in the latest oil bust. Holding $4 billion in tangible book value against $6 billion in net liabilities beyond current assets is only slightly leveraged from my perspective.
Halliburton's common equity is priced at a premium 13x annual cash flow estimated for 2017 by Wall Street analysts, against a 10-year average around 10x. The premium may be deserved if business trends continue to improve and Wall Street investors discount future growth. Price to 2017 sales projections stand at 2.0x today vs. a 10-year trailing average around 2x sales.
Momentum considerations for the stock
You can view Halliburton's progress vs. competitors and peers on charts drawn the past few years of trading. The relative strength in Halliburton is a testament to its strong balance sheet position and better than typical demand for its oil well products/services. I have pictured below comparisons of relative industry outperformance during periods from one month to two years. I am contrasting HAL vs. the overall U.S. market S&P 500 index [^GSPC], the VanEck Vectors Oil Services ETF (NYSEARCA:OIH) peer group, and competitors Schlumberger, Baker Hughes, National Oilwell Varco (NYSE:NOV) and Weatherford International (NYSE:WFT).
The upside for Halliburton shareholders is the potential for high rates of renewed business growth from another U.S. oil boom. If refracturing activity explodes in the U.S. incentivized by improving oil profits at drillers and explorers, HAL could be a top name to own in the sector. With leading fracking and refracturing technologies and services, global Halliburton sales are primed to grow substantially the next 2-3 years from an ultra-depressed level in 2016.
I mentioned Halliburton as a strong buy on weakness choice during January in this Seeking Alpha article. I outlined the mid-$40s price point as an area I would purchase Halliburton shares in another article from March. We have been bouncing around this buy zone for a few weeks. I expect it to hold, barring a large bear move in the U.S. stock market generally. Basically, the HAL stock price is projected by my momentum system to outperform the S&P 500 over the next year.
Please continue to research Halliburton's prospects for investment on your own, if interested in purchasing shares for your portfolio. Carefully weigh the pros and cons of a rise or fall in crude oil prices on the business valuation, and don't be shy about consulting an experienced financial adviser before entering any security position.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in HAL over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.