4 Reasons to Buy this Oil and Gas Company
Sandeep is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Halliburton (NYSE: HAL) has steadily gained market share in key, high-growth product lines such as Drilling Services, Completions, Drilling Fluids, and Drill Bits. The company is relatively evenly split between its North American and International revenues. The company has recently updated its 2012 and 2013 outlook. Now, North American revenue in 3Q12 is expected to be down mid-single digits sequentially versus the prior expectations of relatively flat; NAM margins are expected to decline by 460-510 bps in 3Q12 from 2Q12 due to the high cost of guar inventory (210 bps) and an additional lower activity and pricing (250-300 bps). Despite the current headwinds, I am bullish for the name due to following reasons.
Easing Guar Prices
Guar produces a gel in fracking fluid whose function is to hold open cracks in shale rock when it is fracked. Therefore, it has huge application in the extraction of oil and gas. Thus, the prices of guar is very important for companies like Baker Hughes (NYSE: BHI), Schlumberger (NYSE: SLB) and Halliburton.
I believe that the high guar pricing has led to a significant amount of Halliburton’s margin deterioration in 2Q12. Although very little relief is expected to occur in the 2H12, I believe in 2013 lower guar prices would be a strong margin tailwind. At the same time, the PermStim guar alternative introduced in 2Q12 has offset approximately 5% of guar demand. Its peer Baker Hughes has also developed a substitute called AquaPerm, which has now replaced about 5% of Baker's guar bean requirements. I believe Halliburton's PermStim alternative will continue to gain traction and further reduce the demand of guar. Overall, the company has experienced 600 bps of margin deterioration related to guar. I expect margins to improve as the guar shortage likely abates in 2013.
Few Competitors in Basin Centered Technology
Although Halliburton is facing a challenging situation in North America, I believe through established basin-centered technology teams with an increased focused on subsurface evaluation, the company will be in an advantageous position among its peers in the near term. I am optimistic that land activity will continue to strengthen, led by a growth in unconventional developments in oil basins such as the Bakken. I believe the company is very well aligned with the long-term asset owners in the Bakken. Halliburton is the biggest player with 14 frac spreads in the Bakken as compared to its closest competitor Schlumberger’s 10 frac spreads.
Increasing International Market Share
Latin America has been the fastest growing international region the last few years and I expect the pace of growth to continue for several coming years. Halliburton has won two large contracts with Petrobras (NYSE: PZE) that will vault them into the number 1 position in service revenue in Brazil. Furthermore, despite incurred costs to mobilize for recent award of the wireline package to Brazil in 3Q, I expect Latin America margins to improve not only next quarter, but all through 2013. I believe the market share that the company has captured internationally is longer-term in nature, as it provides a strong incumbent position for many years to come.
Cost Saving through both Fundamentals and Technicals
Roughly 50% of the fleet now has the proprietary Q10 pump with greatly improved efficiency, approaching 100% by 1Q13. This technology is highly likely to gain traction among customers. Also, Halliburton is targeting a 20-25% reduction in costs from several initiatives to decrease the frac spread footprint for equipment and labor, helping to further offset pricing weakness.
The following table summarizes the expected annual growth for next 5 years and forward PE of Schlumberger, Halliburton and Baker Hughes:
|
Company |
Est. Annual Growth (for next 5 years) |
Forward PE
|
|
Schlumberger
|
21.5%
|
14.52
|
|
Halliburton
|
15.3%
|
10.3
|
|
Baker Hughes
|
18.2% |
11.27
|
The company is trading at lower forward PE among its peers. As of now, its discounted valuation seems justified as the company has lowest expected EPS growth. Going forward, I believe that Halliburton will continue to benefit from its strong NAM position which should allow it gain market share during the downturn. Although the company does not have enviable international exposure, I believe it has improved its market share positioning in the past couple of years, particularly in the Eastern Hemisphere. Going forward, I expect the company to be a primary beneficiary from continued activity increases and margin improvements. I believe the long-term outlook and valuation both are compelling today. Thus, I recommend it a buy.
sandeep2gupta has no positions in the stocks mentioned above. The Motley Fool owns shares of Halliburton Company. Motley Fool newsletter services recommend Halliburton Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.
