Buying a stock in the energy service sector is a little like buying a ticket to a roller-coaster ride, but one that is already in progress and one where they don't tell you where the car is on the track. When a stock like Halliburton (NYSE:HAL) is near its 52-week lows, it's relatively easy to assume that things will get better, but there may be a further dive yet to come. Likewise, when the stock is riding high you just know that there will be another drop ... but that the stock may have yet to rise before that fall begins.
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With Halliburton's North American business seemingly stabilizing and the international business growing nicely, this may be a time to start thinking about looking at the stock more seriously.
Second Quarter Results a Little Better Than Expected
Although Halliburton gave earlier guidance, the company's final second quarter results ended up being better than feared (as were the earnings at Baker Hughes (NYSE:BHI)).
Overall, revenue rose 5% sequentially as nearly a 15% quarter-on-quarter growth in the international business offset a 1% sequential decline in the North American business. By service, the completion and production segment saw a 4% sequential growth, while the smaller drilling and evaluation business grew 8%.
Margins remain a hot topic with the major service providers. Operating income fell 9% from the first quarter, with North American op inc down 19%. Margin erosion in North America was actually better than feared, though, as the company saw an almost five-point decline. Margins rose over four points in the international business, though OUS margins are only about two-thirds of those in North America.
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North America May Have Found Its Base
Certainly these are tougher times in North America, but Halliburton is holding its own. The average number of working rigs in North America declined about 10% from the start of the second quarter to the end, but Halliburton's revenue dropped only about 1%. Some of this is testament to the company's contract exposure, but it's a solid result nonetheless given that Halliburton has had more than twice the operating leverage to pressure pumping than peers like Schlumberger (NYSE:SLB) and Baker Hughes in recent memory.
Customers have definitely become very price conscious and the large increase in costs for supplies like guar has not helped, but the better-than-feared North American margins this quarter may suggest that expectations and performance have both bottomed out.
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International Can Only Do so Much
Larger service companies ((Halliburton, Schlumberger, Baker Hughes and Weatherford (NYSE:WFT)) clearly have a lot to gain from overseas growth. It still seems to be a commonly under-appreciated fact that while the United States is not in the top 10 in the world in proven oil reserves (though it is No. 5 in natural gas), it is one of the most intense producers in terms of active rigs and service demand. Simply bringing the rest of the world up to the norms of North America is a huge long-term potential growth opportunity.
That potential is not going to materialize overnight, though. Major operators like Petrobras (NYSE:PBR) and PetroChina (NYSE:PTR) face political pressure (if not outright mandates) to build up local service capabilities by directing business to local companies - cutting into the slice of the pie that Halliburton can get. Moreover, there are issues of budgets, accessibility and reserve quality that make easy one-to-one comparisons with North America unreliable. In other words, the international market is big, and growth there definitely is helping Halliburton, but it's not a panacea.
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The Bottom Line
Halliburton continues to look cheap on a forward EBITDA/EV basis, but then it did in April too and still dropped another 15% or so after first quarter earnings. With the economy apparently slowing down, energy prices could still be vulnerable and many of Halliburton's smaller clients simply don't have the capital resources to support drilling at any cost. In other words, although Halliburton's North American results were encouraging and the valuation is low (fair value would seem to be in the mid-$40s on the basis of a six times forward EBITDA multiple), the energy sector roller-coaster has shown over and over again that prices can always go lower before turning back up.
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.