Halliburton is positioned for crude production growth

March 22, 2018 08:30 AM
Buy

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Halliburton (HAL) is the second largest oil service company in the world with a market cap of $46.53 billion. More importantly, Halliburton is the leader in hydraulic fracturing, the largest oil field service market, with its revenue skewed to the United States. 

The U.S. rig count is poised to grow 16% in 2018, paced by resource plays dependent on fracking. The stock has an upside target of $66 per share over the next 12 months based on its typical 13.5x cash flow multiple on 2018 estimated cash flow of $4.90 per share. That is an increase of close to 40% based off of Feb. 16 levels. 

HAL’s earnings are likely to boom in 2018 assuming current crude oil prices. Its fracturing services are the key component in unlocking enormous unconventional oil and gas resources. It will derive about 60% of its 2018 revenue from North America, a significantly larger exposure than its primary competitors. International revenues tend to lag U.S. revenue by two to three quarters and are expected to grow 5% in 2018. Company-wide margins are expected to improve to about 18% from 11% in 2017 and 6% in 2016.

Its 2017 revenue was up 30% year-over-year to $20.6 billion, following a 33% decline in 2016.

It derived 56% of its revenue from North America, 20% from the Middle East/Asia Pacific region, 13% from its Europe-Africa-Russia segment and 10% from Latin America. Its primary competitor is much more heavily skewed toward international markets.

HAL’s 2018 capital spending will approximate $1.6 billion, up 17% from 2017, funded by cash flow from operations of about $4.2 billion. 

The 40% increase in oil prices since August is likely to stimulate a strong production response, with a typical lag, sufficient to keep oil inventories elevated above the five-year average for all of 2018, despite the extension of OPEC’s production cut to the end of the year. It may even undermine OPEC compliance and negatively impact oil demand.  

The spike provides producers a very attractive opportunity to hedge their 2018 production. The marginal cost of new oil supply is in the $65 to $75 per barrel range, which was well out of reach in each of the last three years. WTI averaged $49 in 2015, $43 in 2016 and $51 in 2017.

WTI is now $62 after peaking to $66, a level not seen since Q4 2014. It averaged $49 for the first nine months in 2017. For 2018, WTI is likely to average about $59. The ability of producers to hedge at current levels ensures strong demand for HAL’s hydraulic fracturing and other oil field services. As the recovery in drilling activity gains momentum in the United States, HAL expects its incremental margins will steadily improve through 2018 with an average of 61% for the year with price improvement. 

HAL’s service lines are reported in two business segments: completion and production, and drilling and evaluation.

Completion and production consist primarily of pressure pumping (hydraulic fracturing), cementing, completion tools and artificial lift. In addition to being the top fracker, HAL is #1 in completion tools with a market share of about 28%. Completion and production is sold out for the first half of 2018 and HAL expects to achieve normal margins around 20% in Q2 2018 and Q3 2018 and for the year. 

Drilling and evaluation has a more diverse mix of products and services, none of which accounts for more than 25% of the segment. They include Sperry directional drilling systems and LWD, Baroid drilling fluids and Security drill bits. The segment also includes digital and consulting solutions (largely Landmark Graphics geophysical data interpretation workstations, which have a market share of more than 33% of the geo-science and software market). HAL ranks second in each of these markets except for drill bits where it ranks third.

Outside North America, drilling activity is expected to increase about 5% in 2018. Pricing is still under pressure and is not expected to improve until 2019 with restoration of normal margins not expected until later. 

Halliburton has a well-diversified mix of products and services and is well-positioned to meet expected growth in demand in the energy services space. It was a solid buy before the early February correction created a very attractive entry point in the stock.   

 

About the Author

Paul Kuklinski is the founder of Boston Energy Research. He also was a partner at Cowen & Co. and a founding partner of Harvard Management Company.