Slipping oil prices have definitely taken the steam out of what had been a strong seasonal move in many oil service and equipment stocks. Even so, many in the oil and gas industry seem to think that rig counts have bottomed and that exploration and production activity will start picking up again in 2013 barring a major economic downturn. While the timing and magnitude of that recovery does present some risk to Halliburton (NYSE:HAL) investors, today's valuation looks like a pretty attractive entry point to play an eventual recovery in the services and equipment sector.
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Decent First Quarter Results Relative To Expectations
On an absolute basis, Halliburton's first quarter results weren't all that good, but then there has been a significant decline in North American activity and increased price pressure overseas. Even so, Halliburton did pretty well on a relative basis.
Revenue rose less than 2% for the quarter, while falling 4% from the fourth quarter. Revenue in North America slid about 1% sequentially, which was inferior to Baker Hughes (NYSE:BHI), but better than both the performance of Schlumberger (NYSE:SLB) and North American rig counts (down 4% and 3%, respectively). International business remains mixed, as revenue slipped 8% sequentially but rose 21% on double-digit growth across all geographies.
Margins came in surprisingly strong for Halliburton, led by North America. Operating income in North America increased 30% sequentially, with the margin up almost four points on lower guar costs and better service intensity. International margins weakened almost five points, but this was roughly in line with expectations. All told, Halliburton delivered about four to five cents per share of earnings upside on an operating basis.
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Is North America Back?
Energy service investors have been waiting for a rebound in the North American market, and that certainly is true for Halliburton. Of the major four service companies, Halliburton has the largest exposure to North America and definitely could use a recovery in pressure pumping and overall completion activities. Halliburton has the largest share of the pressure pumping market (27%, versus 21% for Schlumberger and 15% for Baker Hughes), but capacity expansion from rivals and cost-containment activities from clients still represent threats.
Even still, rig counts seem to have bottomed, and Halliburton management is optimistic about 2013 being a year of recovery in North America. It certainly doesn't hurt that the company continues to innovate in the pressure pumping space, with products like the Q10 pumps, SandCastle proppant silos, and new dual-fuel frac fleets in partnership with Apache (NYSE:APA) and Caterpillar (NYSE:CAT).
Time To Expand, Both Geographically And Operationally
I believe one of the big drivers for Halliburton will be expansion. It is pretty much accepted as fact that there are significant opportunities outside of North America, ranging from deepwater activities off Brazil and Africa to unconventional shale in China. Now the race is on to see who will grab the share. Schlumberger has an excellent global reputation already, but Halliburton has made it clear that they fully intend to fight hard for share.
I also expect Halliburton to at least consider expanding its range of services and products. In particular, I think Halliburton could stand to get stronger in areas like artificial lift, tubing/casing, and downhole tools. With General Electric (NYSE:GE) recently buying Lufkin (Nasdaq:LUFK) to become the #2 artificial lift player, I have to wonder if Halliburton might consider making a bid for Weatherford (NYSE:WFT).
SEE: GE Pays Up To Get Into Another Attractive Energy Business
Weatherford has had a number of struggles and problems over the years, but they do have an international presence, and they would complement Halliburton nicely – Weatherford is strong in areas like artificial lift, tubing, and downhole tools (where Halliburton is weak), while not really overlapping much in pressure pumping, fluids, and drilling (where Halliburton is strong). Of course, Weatherford isn't the only fish in the sea – Dover (NYSE:DOV) could also be a candidate if the company is willing to sell its artificial business, and there are a number of smaller overseas companies that could make sense as targets as well.
The Bottom Line
Although Schlumberger usually gets all the praise for its culture of innovation and operational execution, Halliburton is actually quite strong in metrics like return on invested capital (ROIC). The company's above-average exposure to North America and pressure pumping are both risk factors, but I expect both markets to recover and I believe Halliburton will look to diversify through M&A.
Even if Halliburton doesn't deserve the same multiple as Schlumberger, it looks significantly cheaper today. Giving Halliburton a one-point EV/EBITDA discount (7.5x versus 8.5x), fair value would be in the high $40s today, making this an interesting pick at these levels. While there are certainly risks that energy prices fall further, and take oilfield activity with them, the stock does seem to offer rewards for that risk.
At the time of writing, Stephen D. Simpson owned shares of Weatherford.
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