VIEWS: 47 PAGES: 31 POSTED ON: 4/29/2012
Halliburton 2012: Year of Transition Overview • Oil Services Sector • The Company • Valuation • Making Sense of the Cycle • Managing the Margin Transition • Catalysts • Investment Thesis Oil Services Sector Overcapacity leading up to the Energy bubble of 1980 led to two decades of underinvestment in energy resources in the U.S. Long-term secular bull market began in early 2000’s. Great recession marked ending of first secular phase and beginning of second secular bull market in domestic energy development. 1st phase dominated by fracking and horizontal drilling for natural gas. 2nd phase will employ previously pioneered technology for the more service intensive task of oil extraction. Oil Services Sector Oligopoly: Big Four: Slumberger, Halliburton, Baker Hughes, and Weatherford account for >75% of services market. Big Four added to their portfolios and built market share coming out of the downturn. At beginning of each cycle, stiff pricing competition compresses margins before giving way to margin expansion as cycle progresses and backlog builds. Slumberger and Halliburton are the higher quality names in the sector. Baker Hughes is attempting to implement structural reforms. Oil Services Sector The Case for a Prolonged Secular Bull Market • Every BOE costs more than the last to produce • Evident in both U.S. and International production costs • Entering 4th year of 2nd phase in the secular bull market Oil Services Sector 2007 Today • Concentrated portfolios (only • Balanced portfolios (gas and gas): boom-bust cycle oil): smoother cycle • Constrained capital halted • Access to credit markets with investment record low rates • Customer mix vulnerable to • Aligned with larger customers fluctuations in commodity with more stable activity levels prices • Long-term utilization based • Pricing agreements without contracts volume commitments Oil Services Sector Upstream spending (i.e. exploration & production) is best indicator of oil services revenue. Large cap oil services have captured market share this past cycle as revenues have outgrown upstream spending Oil Services Sector North America: Large Cap Oil Service revenue to benefit from 1. Gaining share in oil and liquid emerging resource plays 2. Increasing presence of international oil companies in U.S. that strongly prefer a single integrated servicer 3. Gulf of Mexico Recovery (only large caps compete) Oil Services Sector International: Large Cap Oil Service revenue to continue recovery: 1. Brazil to overtake Mexico and Venezuela as Latin America’s largest oil producer 2. Egypt never materially affected, while Libya has returned to 1/3 of former capacity 3. Iraq will likely be the most significant growth story in coming decade (CAGR>30% production growth) if infrastructure needs and political stability can be attained (questionable) The Company Halliburton: 2nd by market share in the large-cap oil services space Offers a full package of integrated services (essential for competing for international and deep-water projects) Halliburton Halliburton 2011 Revenue 2011 Operating Income Middle Middle East / East / Asia Asia 17% 18% North America North Europe / 48% Europe / America Africa Africa 52% 21% 17% Latin Latin America America 13% 14% Halliburton Product Line Growth: Halliburton Change in product line market share: Halliburton Change in product line market share: Valuation Valuation Projected Revenue Growth* Projected Operating Margins 70% 35% 60% 30% 50% 25% 40% 20% 30% 15% 20% 10% 10% 0% 5% 0% 2010 2011 2012 2013 North America Latin America Europe/Africa/Asia Middle East/Asia 2011 2012 2013 Total Valuation Valuation Why the discount? • 2012 projected earnings were going to be reduced. No one wants to step in front of earnings estimates that are being revised lower. The stock (and sector) is currently pricing in a severe earnings/margins collapse. • 1Q12 will see margin compression in N.A. from supply chain inefficiencies. • Association with natural gas. Expect supply chain difficulties in the partial transition to oiler fields. HAL will remain with larger clients in natural gas fields. Many of these clients have the lowest cost production and had hedged forward their production. Valuation Why the discount? • Headline risk from the Macondo incident still weighs on the stock. Even though the BP contract indemnifies Halliburton, there's a small probability that the company will have to pay anywhere from several hundred million to two billion dollars. Halliburton has yet to take a contingency charge for the incident (cemented the Macondo well). • Oil Services is a late cyclical play - still no recovery from the 2011 growth scare. The discount has affected the entire sector. Halliburton is not being uniquely punished. Making Sense of the Cycle Equity multiples and Large-Cap Oil Servicers’ earnings growth are not aligned. • Equity multiples rise and fall with LEIs, primarily the ISM index • Oil Servicers’ earnings growth driven by E&P Spending • Sector is trading below normalized P/E multiples, despite similar multi-year growth projections as previous cycles Making Sense of the Cycle Over-reactions to growth scares are not uncommon. The result is that Oil Servicers’ stocks are punished heavily, creating excellent buying opportunities. Conversely, Oil Servicers’ are prone to overshooting on the upside. 65 100% 80% 60 60% 55 40% 50 20% ISM 45 0% -20% 40 -40% 35 -60% 30 -80% 1987 1992 1997 2002 2007 ISM Manufacturing Index Making Sense of the Cycle Outperformance by Early Cyclicals paves way for later outperformance by Late-Stage Cyclicals Early Cyclicals/Late-Stage Cyclicals ratio 180 1.4 160 1.2 140 1 120 100 0.8 SPY 80 0.6 60 Early Cyclicals/Late-Stage 0.4 Cyclicals 40 20 0.2 0 0 2012 2006 2009 1999 2000 2002 2005 2003 2004 2001 2007 2010 2011 2008 Making Sense of the Cycle Relationship can also be understood in reverse. Late stage Cyclicals, notably energy, lag the market. Late-Stage Cyclicals/Early Cyclicals ratio 180 2.5 160 140 2 120 1.5 100 SPY 80 1 60 Late-Stage Cyclicals/Early 40 Cyclicals 0.5 20 0 0 Making Sense of the Cycle Large Cap Oil Services historically lag S&P 500 180 90 160 80 140 70 120 60 100 50 SPY SPY 80 40 Large Cap Oil Services Composite 60 30 40 20 20 10 0 0 2000 2002 2004 2006 2008 2010 2012 Managing the Margin Transition Operating Margins have suffered from transitory headwinds: 1. Inefficiencies from relocating the frac fleet from natural gas to oilier fields. Began in 4Q11 and will likely continue through 2Q12. Mgmt guided N.A. margins down by 100 bp for early 2012.* 2. Idled capacity in GoM during the moratorium has punished D&E margins and supply chain efficiencies are just beginning to recover. 3. Latin America will drive moderate international margin expansion in 2012. 4. HAL kept boots on the ground in Libya, Egypt, and Iraq which punished international margins, but capacity is now coming back online. Iraq has the best growth potential but the farthest to go. This is more likely a late 2012—2013 story. Managing the Margin Transition D&E margins are 510bp lower than last cycle’s average. As HAL rebuilds capacity, GOM margins should begin to provide a tailwind for earnings in 2012. Managing the Margin Transition International margin expansion will likely be driven by Latin America in 2012 and later in the year by MENA operations. Catalysts Turn in investor sentiment. HAL is currently priced at levels not seen since 2009, i.e. fwd P/E = 8.5x Further guidance from Mgmt on the 1Q12 conference call. Mgmt has already emphatically stated that there will not be a collapse in margins in 2012.* Rising energy prices creating a shift in the public dialogue that leads to an increased focus on domestic energy production. Political turmoil in the Middle East (i.e., Iran) shifts national perception of need for domestic energy. Of the four big oil servicers, none stand to benefit more from this shift than HAL. Catalysts Bottoming and recovery in natural gas as many firms exit space stabilizing prices at viable production levels. Quicker than expected recovery in the Gulf of Mexico. A recovery here has the potential to pad NA margins in the first quarter. If all else fails, a continued recovery in the U.S. equity markets could drag the oil services sector up behind it as the widening valuation gap grows increasingly apparent. Investment Thesis Halliburton is the cheapest house in the best neighborhood. The company is currently positioning itself in the sweet spot of long-term secular tailwinds – rising capex intensity, the return of domestic energy production, etc. However, the stock is currently being priced for the end of a secular bull market when only a cyclical restructuring is taking place. In 2012, as operating margins recover in N.A., GoM, MENA, and continue to expand in Latin America and as investor sentiment shifts, HAL will stand to benefit from a significant revaluation of its shares.
"Halliburton (PowerPoint download)"