Historically, the energy service industry has been dominated by two companies: Schlumberger Limited. (NYSE:SLB) and Halliburton Company (NYSE:HAL). The former has been handed the “best of breed” mantra for many good reasons, but I suspect that the latter has closed the gap and very well is challenging Schlumberger for the crown.
In this article, I’ll offer some evidence to support my view.
The acid test: stock performance
Let’s start with what matters to most investors: stock performance. Halliburton Company (NYSE:HAL) stock has outperformed Schlumberger Limited. (NYSE:SLB) over the past one, five and ten-year periods. Here’s a graph comparing them over the past year:
Courtesy of google.com/finance
Indeed, the five-year total annualized return (including dividends not reinvested) shows that Halliburton Company (NYSE:HAL) bests Schlumberger Limited. (NYSE:SLB) 23.0% to 17.4%. The ten-year performance record likewise puts Big Red on top 14.7% to 13.4%.
The Balance Sheet
The first place I look when evaluating a company is the balance sheet. In particular, I like to review liquidity, debt, and returns. For Energy Service companies, I check the Asset Utilization ratio.
Here’s a quick comparison between Schlumberger Limited. (NYSE:SLB) and Halliburton Company (NYSE:HAL), using the aforementioned balance sheet metrics:
Summary analysis: Halliburton Company (NYSE:HAL) meets or beats Schlumberger Limited. (NYSE:SLB) in most of these balance sheet metrics. While both companies sport strong balance sheets, Halliburton is somewhat superior on these measures.
Margins and cash flow
For energy service companies, a key operating metric includes trends in operating and net margins. operating margin offers a look into how well the company is performing within its core businesses: operating revenue less operating expenses. Items like corporate overhead and interest expense are excluded. Net Margin are the after-tax earnings that get to the bottom line.
Since we’ve established that Halliburton has provided investors superior stock returns and possesses a balance sheet at least as good or better than the much-larger Schlumberger, we will now concentrate only upon Halliburton’s margins and cash flow.
Margins
Halliburton has experienced improving margin trends over the last several quarters. Here’s a table exhibiting operating and net margins:
Halliburton Margin Analysis
We see that operating margins have been on the upswing, reaching 14.2% in the quarter ending June 30. However, this remains below the level attained in the period a year ago. However, Halliburton management provided investors 2013 guidance that forecast year-end margins climbing back to the mid-teens. If so, more net earnings will get to the bottom line with the expectation that the stock price will follow. Since corporate revenues are likewise projected to continue upward, the combination of higher sales and margins should result in a boost to 2013 earnings per share.
Cash is king. While many Wall Street analysts concentrate on earnings, cash is really where the rubber hits the road. A quick check to determine if a company’s earnings are translating into real cash can be determined by comparing EPS with cash flow per share. If the two are relatively proportionate, it’s a good screen to look at before deciding a deeper dive is required.
For the first six months of the year, Halliburton reported $1.50 operating earnings per share. The corresponding per share operating cash flow has been $1.59. Therefore, the earnings-to-cash conversion ratio has been greater than 1, indicating that the company is actually generating more operating cash than earnings for its investors. That’s a good thing.
Valuation
So far, Halliburton has registered positively on a number of investment measures. However, as equity investors we need to determine not only how the company is performing, but whether or not the stock is a good buy. Even the best business may be a poor stock investment if one overpays for the shares.
While there are a number of valuation methodologies, I prefer to keep it simple. If the company has a good balance sheet, stable or improving revenue and margins, and generates real cash, then a reasonable way to evaluate fair value is to review forward earnings as a function of the historical price-earnings ratio, otherwise known as the PE ratio.
Over the past ten years, Halliburton’s “normalized” PE ratio has been about 17. This means over the period, Mr. Market has placed an average multiple on the stock of seventeen times trailing twelve month earnings. Sometimes it’s higher and sometimes its lower, but the middle ground centers around the normalized figure.
Now then, Halliburton management provides investors with their best assessment of the business and forward earnings “guidance” for the year; updating or commenting upon it each quarter. At the end of the last quarter, I took their guidance and now forecast about 2013 EPS of $3.20. A consensus of 36 Wall Street analysts expect the EPS to be $3.15. We’re close.
Placing a 17 times multiple on those earnings says the fair value of the stock may be about $54 a share. That’s a 20% upside from the stock’s price last night.
While it may take a stock months or even years to reach “fair value,” I believe that over time the price and earnings will harmonize; thereby “reverting to the mean.” If the stock and storyline remain viable, then patient investors can wait.
In other words, if the stock appears beneath fair value today, it may afford the investor an opportunity to buy shares at a discount now, and sell them at a profit: when they approach fair value.
Other investment considerations
All these facts and figures are just part of performing a sound fundamental stock analysis. There’s actually a lot more to it. In addition to other metrics, there’s a key element that is not found in any of the math. It’s the current storyline and ownership thesis.
The current storyline is the news and events around the company that could help or hurt the enterprise.
Here’s a few Halliburton storylines for consideration:
1). Halliburton management has stated that growing international revenues and margins are priorities. The company has been succeeding in this area: over the past year, of all the major energy service companies, Halliburton has demonstrated better international growth than its peers. Revenue increased by 8% year-over-year.
2). The corporate directors recently authorized the company to buy back $5 billion of its shares. This amounts to about 12% of the current shares outstanding. Typically, a company buys back its shares to offset dilution or express confidence in its future prospects.
3). The quarterly cash dividend was increased from $0.09 to $0.125 – a 39% boost. Rarely do directors raise the dividend without expecting the business to support it via future cash generation.
4). On the other hand, Halliburton management was less sanguine about the near-term prospects for settlements related to the BP-Macondo incident. Previously, the company set aside a $1.3 billion reserve to settle litigation associated with the tragedy. Here’s a quote from CFO Mark McCollum upon the second quarter conference call confirming the corporate view:
5). Throughout this quarter, we have continued to pursue in our (inaudible) settlement to resolve a substantial portion of the private claims pending in the Macondo multi-district litigation. However, discussions among the parties to the proposed settlement have recently slowed while BP challenges certain provisions of their previous settlement with the plaintiffs’ Steering Committee including a current appeal in the Fifth Circuit Court.
Finally, why should we invest in this company going forward? What is promising enough about its future for us to consider placing our hard-earned cash down? This is the ownership thesis.
One might entertain the following ownership thesis for Halliburton stock:
Halliburton has demonstrated strong, sustained shareholder returns, a good balance sheet, and the ability to generate cash.
I believe the company’s international growth prospects will continue to add value as energy services’ global demand increases with the world’s appetite for energy.
The North American energy revolution is in its early stages; Halliburton has staked its business defending both onshore and offshore market share. North America sequential revenue was flat, but the trend remains positive.
Corporate directors have expressed confidence in the future by authorizing large boosts in the cash dividend and stock repurchase plans.
While a BP-Macondo settlement is an overhang on the stock, the corporation will ultimately find a reasonable conclusion with respect to its involvement in the tragedy and resulting litigation.
Please conduct your own thorough due diligence before making any investment decision. Good luck with all your 2013 investments.
Raymond Merola is long Halliburton. The Motley Fool recommends Halliburton.
The article Which Energy Service Giant Is Best For Your Portfolio? originally appeared on Fool.com and is written by Raymond Merola.
Raymond is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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