Transcript Halliburton (HAL)

Halliburton
2012: Year of Transition
Overview
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Oil Services Sector
The Company
Valuation
Making Sense of the Cycle
Managing the Margin Transition
Catalysts
Investment Thesis
Oil Services Sector
Overcapacity leading up to the Energy bubble of 1980 led to two
decades of underinvestment in energy resources in the U.S.
Long-term secular bull market began in early 2000’s.
Great recession marked ending of first secular phase and
beginning of second secular bull market in domestic energy
development.
1st phase dominated by fracking and horizontal drilling for
natural gas. 2nd phase will employ previously pioneered
technology for the more service intensive task of oil extraction.
Oil Services Sector
Oligopoly:
Big Four: Slumberger, Halliburton, Baker Hughes, and Weatherford
account for >75% of services market.
Big Four added to their portfolios and built market share coming out of
the downturn.
At beginning of each cycle, stiff pricing competition compresses
margins before giving way to margin expansion as cycle progresses and
backlog builds.
Slumberger and Halliburton are the higher quality names in the sector.
Baker Hughes is attempting to implement structural reforms.
Oil Services Sector
The Case for a Prolonged Secular Bull Market
• Every BOE costs more than the last to produce
• Evident in both U.S. and International production costs
• Entering 4th year of 2nd phase in the secular bull market
Oil Services Sector
2007
Today
• Concentrated portfolios (only
gas): boom-bust cycle
• Constrained capital halted
investment
• Customer mix vulnerable to
fluctuations in commodity
prices
• Pricing agreements without
volume commitments
• Balanced portfolios (gas and
oil): smoother cycle
• Access to credit markets with
record low rates
• Aligned with larger customers
with more stable activity levels
• Long-term utilization based
contracts
Oil Services Sector
Upstream spending (i.e. exploration & production) is best indicator of
oil services revenue.
Large cap oil services have captured market share this past cycle as
revenues have outgrown upstream spending
Oil Services Sector
North America: Large Cap Oil Service revenue to benefit from
1. Gaining share in oil and liquid emerging resource plays
2. Increasing presence of international oil companies in U.S. that
strongly prefer a single integrated servicer
3. Gulf of Mexico Recovery (only large caps compete)
Oil Services Sector
International: Large Cap Oil Service
revenue to continue recovery:
1. Brazil to overtake Mexico and Venezuela as
Latin America’s largest oil producer
2. Egypt never materially affected, while Libya
has returned to 1/3 of former capacity
3. Iraq will likely be the most significant growth
story in coming decade (CAGR>30% production
growth) if infrastructure needs and political
stability can be attained (questionable)
The Company
Halliburton:
2nd by market share in the large-cap oil services space
Offers a full package of integrated services (essential for competing for
international and deep-water projects)
Halliburton
Halliburton
2011 Revenue
2011 Operating Income
Middle
East /
Asia
18%
Middle
East /
Asia
17%
Europe /
Africa
21%
Latin
America
14%
North
America
48%
Europe /
Africa
17%
Latin
America
13%
North
America
52%
Halliburton
Product Line Growth:
Halliburton
Change in product line market share:
Halliburton
Change in product line market share:
Valuation
Valuation
Projected Revenue Growth*
70%
Projected Operating Margins
35%
60%
30%
50%
25%
40%
20%
30%
15%
20%
10%
10%
0%
5%
0%
2010
2011
2012
2013
2011
2012
North America
Latin America
Europe/Africa/Asia
Middle East/Asia
Total
2013
Valuation
Valuation
Why the discount?
• 2012 projected earnings were going to be reduced. No one wants to
step in front of earnings estimates that are being revised lower. The
stock (and sector) is currently pricing in a severe earnings/margins
collapse.
• 1Q12 will see margin compression in N.A. from supply chain
inefficiencies.
• Association with natural gas. Expect supply chain difficulties in the
partial transition to oiler fields. HAL will remain with larger clients
in natural gas fields. Many of these clients have the lowest cost
production and had hedged forward their production.
Valuation
Why the discount?
• Headline risk from the Macondo incident still weighs on the stock.
Even though the BP contract indemnifies Halliburton, there's a
small probability that the company will have to pay anywhere from
several hundred million to two billion dollars. Halliburton has yet
to take a contingency charge for the incident (cemented the
Macondo well).
• Oil Services is a late cyclical play - still no recovery from the 2011
growth scare. The discount has affected the entire sector.
Halliburton is not being uniquely punished.
Making Sense of the Cycle
Equity multiples and Large-Cap Oil Servicers’ earnings growth are not
aligned.
• Equity multiples rise and fall with LEIs, primarily the ISM index
• Oil Servicers’ earnings growth driven by E&P Spending
• Sector is trading below normalized P/E multiples, despite similar
multi-year growth projections as previous cycles
Making Sense of the Cycle
Over-reactions to growth scares are not uncommon. The result is that
Oil Servicers’ stocks are punished heavily, creating excellent buying
opportunities. Conversely, Oil Servicers’ are prone to overshooting on
the upside.
65
100%
80%
60
60%
55
40%
20%
45
0%
ISM
50
-20%
40
-40%
35
30
1987
-60%
-80%
1992
1997
2002
ISM Manufacturing Index
2007
Making Sense of the Cycle
Outperformance by Early Cyclicals paves way for later outperformance
by Late-Stage Cyclicals
Early Cyclicals/Late-Stage Cyclicals ratio
180
1.4
160
1.2
140
1
120
100
0.8
80
0.6
60
0.4
40
0.2
20
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
0
1999
0
SPY
Early Cyclicals/Late-Stage
Cyclicals
Making Sense of the Cycle
Relationship can also be understood in reverse. Late stage Cyclicals,
notably energy, lag the market.
Late-Stage Cyclicals/Early Cyclicals ratio
180
160
140
120
100
80
60
40
20
0
2.5
2
1.5
1
0.5
0
SPY
Late-Stage Cyclicals/Early
Cyclicals
Making Sense of the Cycle
SPY
Large Cap Oil Services historically lag S&P 500
180
90
160
80
140
70
120
60
100
50
SPY
80
40
60
30
Large Cap Oil Services
Composite
40
20
20
10
0
2000
0
2002
2004
2006
2008
2010
2012
Managing the Margin Transition
Operating Margins have suffered from transitory headwinds:
1. Inefficiencies from relocating the frac fleet from natural gas to
oilier fields. Began in 4Q11 and will likely continue through 2Q12.
Mgmt guided N.A. margins down by 100 bp for early 2012.*
2. Idled capacity in GoM during the moratorium has punished D&E
margins and supply chain efficiencies are just beginning to recover.
3. Latin America will drive moderate international margin expansion
in 2012.
4. HAL kept boots on the ground in Libya, Egypt, and Iraq which
punished international margins, but capacity is now coming back
online. Iraq has the best growth potential but the farthest to go.
This is more likely a late 2012—2013 story.
Managing the Margin Transition
D&E margins are 510bp lower than last cycle’s average. As HAL
rebuilds capacity, GOM margins should begin to provide a tailwind for
earnings in 2012.
Managing the Margin Transition
International margin expansion will likely be driven by Latin America
in 2012 and later in the year by MENA operations.
Catalysts
Turn in investor sentiment. HAL is currently priced at levels not seen
since 2009, i.e. fwd P/E = 8.5x
Further guidance from Mgmt on the 1Q12 conference call. Mgmt has
already emphatically stated that there will not be a collapse in margins
in 2012.*
Rising energy prices creating a shift in the public dialogue that leads to
an increased focus on domestic energy production. Political turmoil in
the Middle East (i.e., Iran) shifts national perception of need for
domestic energy. Of the four big oil servicers, none stand to benefit
more from this shift than HAL.
Catalysts
Bottoming and recovery in natural gas as many firms exit space
stabilizing prices at viable production levels.
Quicker than expected recovery in the Gulf of Mexico. A recovery here
has the potential to pad NA margins in the first quarter.
If all else fails, a continued recovery in the U.S. equity markets could
drag the oil services sector up behind it as the widening valuation gap
grows increasingly apparent.
Investment Thesis
Halliburton is the cheapest house in the best neighborhood. The
company is currently positioning itself in the sweet spot of long-term
secular tailwinds – rising capex intensity, the return of domestic energy
production, etc. However, the stock is currently being priced for the
end of a secular bull market when only a cyclical restructuring is taking
place. In 2012, as operating margins recover in N.A., GoM, MENA, and
continue to expand in Latin America and as investor sentiment shifts,
HAL will stand to benefit from a significant revaluation of its shares.