HAL (IL/A) - Outlook in tact, but near-term momentum likely stronger for SLB + BHI
Goldman-Sachs January 30, 2005
Despite missing 4Q consensus EPS - recurring $0.44 was below our $0.52 estimate + consensus of $0.47 - HAL remains well positioned for the on- going industry upcycle, in our view, w/19% upside to our $49 fair value estimate. E&C margins were disappointing, but higher restructuring savings, less fixed-price contract exposure + pending LNG project awards foreshadow a stronger 2005. Fluids + DFE margins were unexpectedly down sequentially, but several transient costs suggest underlying profitability is better. We are lowering our 2006 EPS estimate to $2.30 from $2.35 due to stock options expense recognition - an issue numerous other oil svs co.s will face as well. We see near-term momentum stronger for SLB + BHI, with $38-39 the valuation point of parity for HAL relative to large cap peers. We maintain our IL/A rating.
VALUATION UPDATE: HAL is currently trading at 21x/17.7x our 2005/2006 EPS estimates = discounts of 6%/6% to BHI + 19%/17% to SLB. Our fair value estimate of $49 is based on 21.5x our 2006 EPS estimate.
4Q04 OILFIELD RESULTS DO NOT SUGGEST HAL IS OUTPERFORMING PEERS A key issue for HAL's relative valuation continues to be oilfield revenue and margin performance versus peers like SII, BHI and SLB. HAL shares outperformed dramatically following 3Q2004 earnings as superior margin performance fueled optimism that new management and restructuring efforts would drive continued improvement in relative valuations.
HAL 4Q2004 oilfield revenue rose 3% sequentially and 21% year-over-year but was 1% below our estimate. In contrast, SII revenue (ex -distribution) rose 7% sequentially and 20% y-y and was 2% above our estimate. SLB 4Q oilfield revenue (ex-seismic) rose 5% sequentially and 18% y- y and was 3% above our estimate. Meanwhile, HAL oilfield operating income (excluding charges) fell 1% sequentially (but rose 54% y-y) with margins -72 bps sequentially and +365 bps y-y. In contrast, SLB oilfield profit (ex-seismic) was +10% sequentially and +15% y-y with margins +78bps sequentially and -49 bps y-y. Smith operating income (ex- distribution) rose 11% sequentially and 30% y-y with margins +43 bps seq and +106bps y-y. HAL oilfield margin was -178 bps vs our estimate while SLB was -32bps and SII was -64bps.
HAL 4Q RESULTS INCLUDED SEVERAL SPECIAL ITEMS. HAL recognized a charge of $33 mln in 4Q2004 for cost overruns on turnkey wells in Mexico that are part of a larger, on-going turnkey package that will not be complete until mid-2006. HAL also recorded an $11 mln charge for an intellectual property lawsuit settlement (related to recently divested Subsea 7), a $22 mln charge for the restructuring of KBR, and about $15 mln higher than expected interest expense related to past activities in Indonesia. A $14 mln gain was also realized from the sale of surface well testing operations.
4Q04 E&C PROFITS WERE ALSO BELOW EXPECTATIONS HAL's E&C revenues were 13% above our estimate due to higher activity in Iraq, but operating profits were 51% below our estimate due to lower Iraq profit recognition and greater project losses on Belanak and US infrastructure projects. CEO Dave Lesar announced that he will recommend separation of KBR to the Halliburton board, though it is likely to be 2H2005 or 1H2006 before ultimate disposition, in our view. Backlog declined $900 mln to $8.4 bln at the end of the qtr, but optimism on several LNG project awards remains high. Mgt is also optimistic about meeting or exceeding the high-end of prior 1-3% E&C operating margin guidance. HAL also remains optimistic about Iraq bonus awards, but timing appears somewhat further off than we expected previously as recognition is contingent on both bonus award board approval and task order definitization.
IMPLICATIONS FOR THE INDUSTRY: (1) HAL is planning only a modest capital spending increase in 2005 of $75mln (to $650mln), with $25-30 mln geared towards E&C. (2) HAL continues to see solid progress in pushing N. America oilfield price increases through and sequential incremental margins in pressure pumping appear to have been a healthy 50% sequentially. This bodes well for the potential for BJ Services to exceed December quarter consensus EPS. (3) HAL sees 2005 raw material cost inflation in percentage terms in the single digits.
I, Terry Darling, hereby certify that all of the views expressed in this report accurately reflect my personal views about the subject company or companies and its or their securities. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report. |
