Halliburton Can Offer A 30% Return Within The Next 2 Years

Summary

• The stock of HAL has nearly doubled in the last 12 months.
• However, the company is only in the early stages of a multi-year recovery.
• HAL is trading at only 10.6 times its expected earnings in 2023.
• As a result, it can offer a 30% return within the next two years.

tdub303/E+ via Getty Images

Thanks to the recovery of the global oil consumption from the pandemic and the discipline of OPEC and Russia, the price of oil has rallied to a fresh 3-year high this year. As a result, the stock of Halliburton (NYSE:HAL) has rallied 83% in the last 12 months. After such a steep rally, the big question is whether the stock has further upside potential or it has become fully valued. In this article, I will analyze why the stock can offer an additional 30% return within the next two years.

Business overview

Global oil consumption is recovering strongly from the pandemic this year. According to the latest report of the Energy Information Administration [EIA], global oil consumption is expected to surge from 92.4 million barrels per day in 2020 to 97.4 million barrels per day in 2021 and the pre-pandemic level of 101.0 million barrels per day in 2022. As a result, drilling activity is likely to increase significantly, in tandem with global oil consumption. This will provide a strong tailwind to the business of Halliburton for the foreseeable future.

Early signs of a recovery have already shown up in the business of Halliburton. In the second quarter, the company grew its revenue 7% sequentially thanks to 12% growth in North America and 4% growth in international markets. The Completion and Production division posted 3-year high margins while Drilling and Evaluation performed better than management expected. As a result, Halliburton grew its earnings per share 37%, from $0.19 in the previous quarter to $0.26, and exceeded the analysts' consensus by $0.03.

Even better, management expects the business momentum to accelerate in the upcoming quarters. More precisely, it expects the drilling activity in international markets to grow at a double-digit rate over last year in the second half of this year. As the price of oil has rallied 13% since management provided its outlook, it is safe to assume that the company will at least meet its guidance.

Halliburton has promising growth prospects, not only for the upcoming quarters, but also for the upcoming years. The global demand for oil did not grow for the first time in more than a decade last year amid the pandemic but it has returned to its long-term growth trajectory this year. At the same time, oil and gas producers have reduced their investment in new growth projects in recent years, especially in the last two years due to the pandemic. As a result, producers will have to boost their investment in new projects significantly in the upcoming years in order to catch up with pent-up demand. They will thus provide a strong tailwind to the business of Halliburton.

Analysts seem to agree on this view, as they expect Halliburton to essentially double its earnings per share over the next two years, from $1.05 this year to $2.04 in 2023. That level is slightly higher than the pre-pandemic 5-year high earnings per share of $1.89, which were posted in 2018. To cut a long story short, after incurring a severe downturn in its business due to the pandemic, Halliburton is ideally positioned to emerge stronger from the crisis thanks to the pent-up demand for new growth projects in the oil and gas industry.

Valuation

Halliburton is currently trading at only 10.6 times its expected earnings in 2023. This is an exceptionally cheap valuation level. The stock has traded at an average price-to-earnings ratio of 17.1 over the last decade. Given the highly cyclical nature of this business and in order to build a wide margin of safety, it is reasonable to assume a fair price-to-earnings ratio of 14.0 for this stock. If Halliburton reaches this valuation level over the next two years, it will offer a 32% return (=14/10.6 - 1), without including its 0.8% dividend. Overall, Halliburton has very good chances of delivering an approximate 30% return within the next two years.

Risks

A potential risk for Halliburton is a significant mutation of the coronavirus, which will be resistant to the existent vaccines. In such a case, many countries may impose another year of lockdowns and thus they will hurt the recovery of the energy market. However, while such a negative scenario cannot be excluded, it is highly unlikely, particularly now that 45% of global population has received at least one dose of a vaccine and hence the pandemic has been put under control in most countries. A significant mutation is likely to show up when the virus propagates completely out of control; not when most people are vaccinated.

The other risk factor is the high cyclicality of the energy sector. However, this sector incurred an unprecedented downturn last year due to the pandemic and has just begun to recover from that crisis. It will be surprising to see the upcycle of the energy market last only one or two years. Such a short upcycle has not occurred in at least three decades. Overall, the odds favor an upcycle of the energy market for the next few years.

Final thoughts

Halliburton seems to be in the early stages of a multi-year recovery. While the stock has nearly doubled in the last 12 months, it can still offer an additional 30% return over the next two years. Nevertheless, due to the cyclical nature of this company, this is not a buy-and-hold-forever stock. Therefore, investors should take their profits as soon as the stock reaches our price target of $29 (=14 * 2.04).

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within 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.