HAL (OP/A): Upbeat investor day supports our thesis; Reiterate OP/A - Goldman Sachs - June 09, 2006
Halliburton's (HAL) investor day was upbeat and the company presented a bullish outlook that supports our OP/A rating for the stock. Key highlights: (1) Corporate restructuring on track; (2) Market position in Eastern Hemisphere remains strong; (3) Bullish outlook for North America spending and Pressure Pumping; (4) Management is confident the company will be able to keep its above peer average growth/returns/margins and guided 20+ % top line growth through the end of the decade; and (5) Increased focus on acquisitions with a $1-2 bn budget/year. It is unfortunate that HAL's upbeat conference coincided with such strong sell off in the markets. However, we continue to believe that the strength in HAL's operating performance/execution/fundamentals is still not reflected in the stock price and that corporate restructuring will be a catalyst to bridge the large valuation gap between HAL and its peers.
SECTOR TRADING UPDATE - BUY ON WEAKNESS
The past few days have been painful for Oil Services investors with the OSX down 8% in 4 days. As we mentioned in a previous note, we were in Houston last week meeting with senior management of several companies and there seems to be no slowdown in activity/pricing despite volatility in commodity prices (for more details please refer to our June 5th note entitled "Houston trip reinforced our bullish view; Reiterate Attractive coverage view"). Bullish comments made by Halliburton management yesterday were also consistent with what we heard last week. We maintain our Attractive coverage view as sector fundamentals remain solid. And while volatility should continue in the near term, we continue to believe that the risk-return for investors with a 6-12 month horizon is very compelling. Our fair value for the OSX of 269 yields 33% upside.
CORPORATE RESTRUCTURING ON TRACK
As expected, Halliburton did not discuss the business outlook for KBR since it is in a quiet period. However, management stated that corporate restructuring is on track and they reiterated the company's commitment to focus on Oilfield Services.
KHURAIS MEGA PROJECT AWARD HIGHLIGHTS STRONG POSITION IN SAUDI ARABIA
On June 7th Halliburton announced that it had been awarded the Khurais project, which is the largest oil development project in the Arabian Gulf region since the 1950s. This project is a key component of Saudi Aramco's plan to increase production and it should add 1.2 million barrels of oil/day in capacity. The 3-year project will utilize up to 23 rigs to support more than 300 wells. Halliburton should be able to provide services for 100% of the project without the need to outsource parts of it to other companies. The contract does not include Fluids, which will be awarded separately, but the company believes it has good chances to win that piece as well.
The company did not provide specific financial details on this project but made some interesting additional comments.
* First, this project alone will result in 30% revenue growth for Halliburton in Saudi Arabia using 2005 as the base year.
* Second, management comments suggest that the margin on the contract is also healthy. Management indicated that given the size of the project and the attractive economics, Saudi Aramco's decision was based on reliability and technical capability and not on price.
* Finally, the company mentioned how the project will help its market position. For instance, currently Halliburton is in #1 market position in Production Enhancement and #2 in Cementing/Wireline/Drilling Services/Completions. With this project the company estimates it will be in #1 market position in all these areas except for Wireline.
EASTERN HEMISPHERE STRENGTH UNDERAPPRECIATED
We continue to believe that HAL's strength in the Eastern Hemisphere is underappreciated. This is probably in part a function of the size and the strength of the company's North American operations, which has been the best performing region, overshadowing other achievements. Also, HAL does have a smaller exposure to Eastern Hemisphere (39% of revenues) than SLB (46%) and BHI (42%). However, we think that the smaller revenue exposure is widely known and is already priced in, while the strong growth performance is not getting enough credit. For instance, HAL's 1Q06 yoy Eastern Hemisphere growth was 32%, similar to SLB's 31% and above BHI's 22%.
BULLISH OUTLOOK FOR NORTH AMERICA
The company remains very bullish on the fundamentals of the North American market and Pressure Pumping. For instance, management highlighted that since 2002 US gas production is down 1% a year on average, while wells drilled grew at a 16% CAGR and the US stimulation market grew at a 30% CAGR. The company continues to expect strong demand for pressure pumping services due to high decline rates and growth in unconventional gas. Another interesting data point was that HAL estimates that North America will represent 43% of worldwide Drilling and Completions spending in 2010.
We also expect to see continued strength in North America spending, which should be a key driver for growth for HAL. And while North America spending is more sensitive to commodity prices than international spending, we believe this higher cyclicality is currently overdiscounted in HAL/BJS share prices.
The fact that North American results in the 1Q06 were so strong was also reassuring and our meetings in Houston last week suggest that the strength continued into 2Q despite continued commodity price volatility. We continue to believe that E&Ps will not change capex plans due to near term volatility and will "drill through" seasonality as long as strip prices remain resilient.
One interesting incremental data point from our trip last week that supports our view is that so far customer acceptance of BJS' May 1st price increase seems to be either in line or better than the previous round of increases. Even though this time the magnitude of the price book increase was not disclosed, we still think it suggests continued strong demand and solid pricing power. We also heard from different Pressure Pumping companies that there has been no sign of slowdown in activity. This is also a positive read across for HAL's Pressure Pumping business since the company is in the process of raising its price book over the coming months, which should benefit 2H06 results.
MANAGEMENT POSITIVE ABOUT CYCLE STRENGTH/LONGEVITY
Halliburton management expects Oilfield Services revenues to grow at 20% or more annually through the end of the decade indicating confidence in the strength and longevity of this upcycle. This also seems consistent with Schlumberger's statements back in March predicting industry growth in the mid to high teens through then end of the decade. Halliburton also expects EBIT to double in 3 years and EPS to double in less than 3 years.
We think that both SLB's and HAL's comments about growth in the coming years are useful as longer-term guidelines. However, we expect HAL/SLB to grow well above that longer-term rate in 2006. For instance, in 2005 HAL/SLB grew Oilfield Services revenues by 26%/24% and in the 1Q06 yoy growth was 35%/34%. We forecast 28% Oilfield Services top line growth for HAL in 2006 and 26% for SLB. Our growth forecasts for HAL/SLB slowdown to 21%/20% in 2007 and to below 20% in 2008, which we believe is conservative. And while HAL/SLB outlooks suggest longer-term upside to our above-consensus estimates, we believe it is still prudent to be on the conservative side given the lack of visibility into 2008 and beyond at this point. Nevertheless, these statements support our thesis that there is still plenty of room for upwards EPS revisions that are crucial for OSX outperformance and our Attractive coverage view.
MANAGEMENT EXPECTS HAL TO MAINTAIN ABOVE PEER AVERAGE OPERATING PERFORMANCE
Management highlighted the fact that over the past 2 years HAL was able to significantly improve its operating metrics and that currently the company has above peer average growth/margins/returns. Management also sounded very confident in their ability to maintain is superior operating metrics relative to peers over the coming years. We expect HAL to keep posting above peer group average metrics into 2007 and we continue to believe that this is not priced into HAL shares given the current steep discount to peers.
INCREASED FOCUS ON ACQUISITIONS WITH $1-2 BN/YR BUDGET
Halliburton expects to spend $1-2 billion in acquisitions a year. Acquisitions will be focused on 3 key strategies: (1) Leverage distribution system with new products; (2) Additive technologies; and (3) Geographical expansion.
CAPEX INCREASE IN THE 30-40% RANGE
Halliburton expects capex to increase 30-40% annually over the coming years. Oilfield Services capex in '06 should be $800 million, which is in line with our estimates. However, our flat '07 capex of $800 million seems too low and we will have to revise it upwards. Most companies have not provided color yet on '07 capex, but we suspect we are likely to be on the conservative side at this point and our forecasts may need to be revised upwards across the board.
Each of the analysts named below hereby certifies that, with respect to each subject company and its securities for which the analyst is responsible in this report, (1) all of the views expressed in this report accurately reflect his or her personal views about the subject companies and securities, and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report: Daniel Henriques, CFA, and Daniel Boyd, CFA. |
