Halliburton Significantly Undervalued, and 1 Other "Buy"
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For whatever reason - maybe because of the Macondo oil spill or the presumed political connections with Dick Cheney - investors hate Halliburton (NYSE: HAL) and its competing oil & gas service providers. In my view, hate can only last for so long when the fundamentals prove strong. I find that both Halliburton and Schlumberger (NYSE: SLB) are significantly undervalued and offer an equally significant margin of safety. Below, I review the fundamentals of both.
After the Macondo oil spill, matters have never quite been the same. However, this incident was a singular and isolated event that bears no meaning on the future. While it will hurt the firm's credibility in the near-term, in the long-term oil & gas companies look for quality, and Halliburton has the largest economic moat in the service space. With a beta of 1.56, Halliburton's stock can easily swing very high should the sentiment towards the brand change. Transocean (NYSE: RIG) has similarly been deemed culpable for the oil spill and booked $1 billion in related costs. Although the issue has also implicitly hurt the firm's ability to raise credit, Transocean continues to make large acquisitions to increase scale and dilute fixed costs.
As it stands, investors have come nowhere close to factoring in the full growth curve of Halliburton. The stock trades at only a respective 9.7x and 9.2x past and forward earnings with a dividend yield of 1.1%. To put that into perspective, consider that the firm's historical 5-year average PE multiple is 14.8x. Assuming the company meets expectations for 18.1% annual earnings growth over the next five years, 2016 EPS should come out to around $5.91. Using an exit multiple of 15x, the future value of the stock is $88.66. Discounting backwards by 10% yields a present value of $55.05, which is at nearly a 70% premium to the stock's closing value. Analysts, not surprisingly, see the value and rate the stock a 1.8 out of 5, where "1" is a "buy."
In terms of free cash flow, the service firm has been terrific. FCF for the TTM ending 2Q12 was $250 million versus $155 million in 2Q11 - a nice recovery. On average, the firm has had annual FCF of $709 million over the past five years. Baker Hughes (NYSE: BHI), on the other hand, has done well only relative to expectations. 2Q12 performance was nearly 30% better than expectations, but free cash flow was -$1.6 billion over the TTM versus -$880 million in 2Q11.
As undervalued as Halliburton is, it still does not make sense to put all of your eggs in one basket. Schlumberger is a nice way to diversify, since it too is at a substantial discount to intrinsic value. The stock trades at a respective 18.2x and 14.2x past and forward earnings with a dividend yield of 1.5% - much higher than Halliburton's. Even still, the company is expected to achieve slowing annual earnings growth (18%) over the next five years. It still looks cheap when you consider the fundamentals, hence the "buy" rating on the Street. In fact, Goldman Sachs recently upgraded the stock based on the bullish outlook on domestic rigs.
One of the reasons buying now makes sense is that margins are trending upwards for rigging, which will result in greater business offshore. At the same time, Schlumberger is improving its technology for greater cost-effectiveness. Free cash flow is, however, a bit shaky. FCF for the TTM ending 2Q12 was $1.2 billion but $1.7 billion in 2Q11 and $3.3 billion in 2Q10. Thus, it may not be as undervalued as Halliburton, but it still will gain off of the secular trends.
It should therefore not be surprising that its international rig count is up 114 from July 2011 while global floating rigs have only gained by double-digits. The business environment continues to improve, which will create more room for Schlumberger to penetrate as Halliburton recovers from a poor brand image.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Halliburton Company and Transocean. Motley Fool newsletter services recommend Halliburton Company and Schlumberger. 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.