High Oil Should Make For A Healthy Halliburton

By Stephen D. Simpson, CFA | April 17, 2011 AAA

Building models and calculating price targets for energy service companies like Halliburton (NYSE:HAL) almost feels like an exercise in futility. Not only is the business maddeningly inconsistent, but there is only scant evidence that investors pay much attention to valuation. More often, energy services are simply a trading vehicle for attitudes about near-term exploration and production in oil and gas.

That said, Halliburton is seeing stronger business conditions and with oil prices as high as they are, the near-term outlook for exploration and production should be quite healthy. (For more, see Unearth Profits In Oil Exploration And Production.)

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North America Drives the Quarter
Halliburton delivered strong revenue performance to start the year, driven in large part by momentum in the North American business. Overall revenue jumped 40% from last year and rose more than 2% on a sequential basis. Completion and production saw better than 6% growth (and made up about 60% of total revenue), while the drilling and evaluation segment saw a 3% contraction. North American revenue jumped 13% sequentially, while business in regions like Africa, Europe, Russia, Asia and the Mideast dropped by double-digit amounts.

Profitability was not as impressive, as operating income fell almost 11% sequentially (though nearly doubling from last year). Costs seemed to be generally higher across the board, but margins were notably stronger in North American than in the OUS markets. It will be interesting to see, then, whether investors choose to focus on the above-expectation revenue (as the sector seems to be strong) or the below-expectation profitability, though management does seem to believe margins will pick up as the year progresses. (For more, see Oil Services Sector Powered By North America.)

Plenty of Projects on the Way
Halliburton does not appear to be lacking in new business prospects. Companies like Continental Resources (NYSE:CLR), Whiting (NYSE:WLL) and Hess (NYSE:HES) are moving quickly to exploit resources in the Bakken formation, and the Eagle Ford in Texas is likewise very active right now.

Looking abroad, major oil giants like Statoil (NYSE:STO), Chevron (NYSE:CVX) and Exxon Mobil (NYSE:XOM) have all tapped Halliburton for major projects. What's more, with Saudi Aramco surprising the market recently with an increase in rig demand, there is definitely a lot of activity coming on around the world.

Will Halliburton Match R&D with Deals?
Not much is made of R&D in the energy services space, but it has long been a major differentiating factor companies like Halliburton and Schlumberger (NYSE:SLB). Some of these new products and procedures can increase well and reservoir productivity by 20% or more, and that is no minor consideration for energy companies under pressure to maximize their production and earnings potential. While it is true that dollars of R&D spending do not automatically translate into new products, the sheer scale of Halliburton and Schlumberger give them advantages over smaller companies like Weatherford (NYSE:WFT).

Along similar lines, it is worth wondering whether large energy services companies will look to boost their growth potential and scale through further acquisitions. Companies like Superior Energy Services (NYSE:SPN) and Weatherford could get a bid if that were to be the case, though its unclear whether Halliburton would run into some antitrust issues.

The Bottom Line
Cash flow modeling for energy service companies like Halliburton is almost a lost cause. That leaves less rigorous methods like EV/EBTIDA as common ways to assign price targets and value these companies. To that end, Halliburton seems to be trading at a bit of a premium. That is not unexpected or unusual when investors are bullish about the sector's prospects, and there are plenty of reasons to be optimistic about energy services today. Halliburton isn't a bad play on the sector, but investors have to make their peace with volatile results and dodgy valuation methodologies. (For more, see The Value Investor's Handbook.)

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