Halliburton (IL/A): Raising estimates + fair value to $99 - Goldman Sachs - January 29, 2006
We are raising our 2006-07 EPS estimates for Halliburton to $4.00/ $5.10 from $3.70/ $4.25 primarily due to higher E&P spending/ oil service revenue growth assumptions of +25%/ +15% for 2006-07 vs +20%/ +10% previously. We expect to be making similar changes for other oil service companies through 4Q earnings season. Higher oilfield + E&C margins for HAL and lower net interest expense also contribute to our changes. We are also raising our fair value for HAL to $99 (19.5x 2007 PE) from $79, or ~25% upside potential. We see HAL's relative outperformance continuing near-term given recent underperformance, sharply improved EPS outlook + upcoming catalysts - i.e. the IPO of its E&C unit (see our sum-of-the-parts discussion below) and likely stock repurchase. However, we prefer to see extent of estimate revisions for the balance of our coverage before revisiting our sector relative ratings. Maintain IL/A rating.
E&C IPO LIKELY TO FOCUS INVESTOR ATTENTION ON SUM-0F-THE-PARTS HAL announced on its 4Q conference call that it will proceed with a partial IPO of its E&C business - KBR - following the filing of its 10K. As a result, we have revisited our sum-of-the-parts analysis to discern what impact this action might have on investors sense of relative value near-term. Bottom line, we think the analysis points to 9% upside potential on a relative basis, but we prefer to wait for 4Q earnings reports from the balance of our coverage and KBR's E&C peers before revisiting our rating.
HIGHER E&C MULTIPLES DO NOT APPEAR REFLECTED IN HAL'S VALUATION
Currently, HAL is trading at 20.7x 2006 P-E and 16.3x on 2006 EV/EBITDA = discounts of 3%/ 10% to its oil service peers. Historically, HAL has traded at a discount to oil service peers due in part, we believe, to the lower multiples investors have assigned to its (and others') E&C business. This has been justified by lower + less predictable levels of profitability and growth historically. However, E&C valuations are currently above those of oil service companies given, we think, the emerging visibility on strong growth in infrastructure spending and the fact that this business is earlier in its cyclical recovery.
SUM-OF-THE-PARTS ANALYSIS SUGGESTS 9% RELATIVE UPSIDE
Specifically, the E&C stocks' 2006-07E EV/ EBITDA multiples are in the 13x/ 11x range vs 12.2x/ 10.4x for oil service stocks. Our conclusion is that HAL's valuation does not fully reflect the higher multiples for E&C earnings on a sum-of-the-parts basis and that KBR's IPO could be the catalyst to prompt the market to begin recognizing its strong position in this business. Specifically, our analysis suggests 9% relative upside in HAL shares to its oil service peer group. We make the following assumptions in our sum of the parts model (Exhibit 1):
(1) HAL's oilfield business should trade in-line with a peer group of SLB, BHI, SII, and WFT. On 2006 estimates, this implies enterprise value for this business of $40.5 bln assuming all of HAL's current net debt remains with the oilfield business, or $77 per share.
(2) For KBR, we assume that the Energy & Chemicals unit trades in-line with FLR, JEC and TKP. On 2006 estimates, this implies value of $4 bln, or $7.50/ HAL share. However, we believe the argument for KBR to garner up to a 10-15% premium to its peers is very strong based on its proprietary technology and dominant franchise in gas monetization, which is clearly in the early stages of a generational cyclical sweet spot. Whether this premium is achievable at the outset of the company's public existence is likely a function of the ability of KBR's new CEO to articulate the company's competitive advantage, though improved financial performance of late certainly provides a solid platform. KBR's new CEO has not yet been announced, but is expected to be announced shortly and come from outside Halliburton.
(3) KBR's Gov't Services unit is a lower multiple business, in our view, based on the lack of predictability of earnings and ever-present headline and headache risk inherent in the nature of its business. HAL has indicated that it may sell a piece of KBR before the IPO and we suspect they may be examining options for the Gov't Services unit to be sold to the defense contractor community. Currently, the defense contractors trade around 9.1x/8.6x 2006-07 EV/ EBITDA. We suspect they would be willing to pay ~5x "normalized" EBITDA, which excludes earnings from KBR's operations in Iraq, which are expected to be winding down over the next 1-2 years. KBR's Gov't Svs unit had revenue in 4Q2005 of $2.1 bln w/ Iraq accounting for $1.3 bln and the more recurring/ normalized revenue component at $830 mln. Annualizing this number and assuming 3-5% trend-line growth as well as a 2.5-3% EBIT margins yields a normalized EBITDA estimate for Gov't Svs of $110 mln. At 5x, this implies total value for HAL's Gov't Svs unit of $550 mln. We also think a buyer would pay 1x 2006-2007 cash flow from KBR's Iraq operations, or another ~$110 mln. This boosts the total value for Gov't Services to $660 mln, or $1.25 per share.
Adding the pieces yields a sum of the parts value of $86 per share, or 9% upside from current levels. Please note that this is a relative value estimate based on current market multiples for oil service and E&C peers, and differs from our longer term $99 fair value estimate that is based on 2007 estimates (19.5x EPS).
Each of the analysts named below hereby certify 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 their 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: Terry Darling, Jerry Revich. |
