Why The Bears Are Wrong About Big Hal & Other "Buys"
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
If you are bearish about eroding margins in North American oilfield services, consider the current prices. Has this already been factored into stock prices? Many of the top oilfield service firms trade at historically low multiples and have exceptional growth opportunities ahead in penetrating international and, particularly, deepwater markets. The focus on efficiency in energy drilling is also a major opportunity. Below, I review 3 oil well suppliers with these factors in mind.
Don't Let North American Headwinds Mislead You…
Halliburton (NYSE: HAL) has seen free cash flow decline from a peak of $3.1 billion in December 2006 (ttm) to -$77 million today. But the 10.8x PE multiple is now well below the 14.8x historical 5-year average and the 18.3x industry average. Moreover, Big Hal is still forecasted for a 3-5 year EPS growth rate of 7.4%, which is 510 bps greater than the oil equipment & services industry average. But there is nothing better than growing and creating value at the same time--Halliburton does just that with a return on invested capital ("ROIC") of 18.7%, which is 843 bps greater than the industry average.
It has top exposure to domestic markets relative to peers. This has been by and large viewed as a headwind, since margins are eroding as a result of the crowding in oil basins and the associated overcapacity. However, there are several other ways of looking at this… (1) First, with energy companies slowing domestic well development, they are focused on maximizing the returns of existing wells. Halliburton would be the prime beneficiary of this.
Halliburton is focused on greater on efficiency that is becoming increasingly important with the race for scarce resources. Their "Frack the Future" initiative, for example, targets Q10 pumps use 25-40% less horsepower than traditional technology. Particularly in this conservative spending environment, oil & gas companies are becoming more interested in greater efficiency than in just increasing scale. Baker Hughes (NYSE: BHI), a similarly North American-focused producer, has increased wells per rig by 15% y-o-y and expects a 10% gain next year. So, both are supplying their clients with superior cost structures and efficiency.
Second, (2) you could argue this current North American concentration just implies upside, since it means Halliburton has greater room for penetrating international markets. Indeed, Halliburton has forecasted for upwards of 60% of new production to come from deepwater in around the next half decade period, and a huge deepwater market is Brazil. 90 rigs are located in this emerging market and currently Baker Hughes is the number 1 supplier. Based on the number of awards it has seen, Halliburton, however, believes it can take the lead. On the other hand, North America's Gulf of Mexico is also huge and believed to experience the greatest deepwater activity growth. In any event, Halliburton believes its deepwater service business can rise 25% faster than peers at an annual rate of around 18%. If that's the case, these comparatively low multiples won't stay this low.
Baker Hughes tries considerably higher at 13.5x past earnings. But it still has a PEG ratio of 1x and is forecasted for 13.9% annual EPS growth over the next 5 years. Moreover, the consensus price target of $51.08 is at a 20% premium to the current market assessment.
Why You Should Buy Schlumberger (NYSE: SLB)
Schlumberger is nearly twice as big as Halliburton and Schlumberger combined. Moreover, it has greater international exposure and thus commands a strong barrier to its smaller peers finding drilling clients that are willing to go for a less experienced supplier. But this comes at a cost for new investors: Schlumberger trades at a premium 17.6x PE multiple. Even still, analysts are incredibly bullish on the company's future. No analyst recommends selling the stock, but 27 of 29 reporting analysts rate it a "buy" or better--11 of which say "strong buy". This is a huge bet of confidence for the top oilfield service, which generates a 12.9% ROIC.
In regard to the deepwater market, the company formed a "game changing" JV agreement with Cameron International to target this market. It has also been praised by Wall Street for good reason. In the deal, Schlumberger will contribute its pump products division and pay $600 million to Camera for contributing its subsea division. This market is dominated by smaller producers and will see a much needed efficiency boost from the partnership. Moreover, the decline in crude oil prices has masked the company's strong earnings power, which is largely a result of its industry leading offshore and deepwater drilling technology.
Barclays is forecasting for a 7% rise in global exploration & production spending in 2013 outside North America, so Schlumberger has some obvious tailwinds. But has this been factored into the stock price already? Analysts forecast 16.5% annual EPS growth over the next 5 years. Assuming expectations are met, 2016 EPS will come out to $7.75. At a multiple of 15x, this translates to a future stock value of $116.25. Discounting backwards by 10% yields a present value of $72.18--roughly in-line with the current market price. So, while Schlumberger is not undervalued, its growth curve will still drive outperformance and is complemented by a 1.5% dividend yield.
TakeoverAnalyst 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!