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Halliburton – Continuing To Grow Despite The Headwinds - $HAL $BHI

By Jack Ryan

As those of you who read my posts know, I am a big fan of Halliburton (HAL). I’ve been a believer and investor in the company for over a year, and even though the stock price may be down currently, I wanted to discuss why I’m reiterating my long position. Let me preface my case with this; the worst of the oil decline ended in January 2015 after oil prices seemingly bottomed out at $45 from a peak of $115 in June 2014. Currently, oil prices are trading in the $65 range, which validates the Fed’s view that the oil price decline is transitory and should be looked past in monetary decision making.

Halliburton is the leading oil services company based in Texas, with global operations. It provides services and equipment for upstream oil rig and natural gas production facilities. Naturally, it had been badly affected by the reduction in oil rigs after oil prices plunged. Based on its earnings call of Q1 2015, HAL confirmed that global oil rig count dropped by 19% in Q1 2015 compared to Q1 2014. US oil rig count was badly affected with a 50% drop, but the fall in Asia’s rig count was milder at 9%. In the face of this drop, global demand continued to increase at 1 million barrels per month. This means that the pie has shrunk for oil services companies across the world. Less oil rigs mean less work and less revenue. Period.

Now before I go into the details of HAL’s strategy, I would like to start with a summary of its strategy as glimpsed from its Q1 2015 earnings call. It would be to outlast the competition, and emerge as a leaner and keener oil services company of choice after this downturn.

Size matters and economies of scale allows for more competitive advantage. A downturn is a cruel process where weaker competitors are eliminated and you will have to find ways to stay competitive. One way in which HAL is trying to stay competitive is by acquiring Baker Hughes (BHI). This acquisition, which is expected to enlarge HAL’s menu of services to its clients, is expected to close by the end of 2015. Obviously there are regulatory hurdles to be cleared with the Department of Justice and other relevant authorities worldwide in terms of compliance with competition laws for the merger and divestiture of assets. This merger is expected to provide $2 billion in cost synergies and HAL is working hard to ensure that those synergies stick as quoted from Chief Integration Officer Mark McCollum:

“What happens to those costs, in order for the synergy case to be ultimately captured, we’ve got to make process changes, procedural changes, changes in the way that we do business between the two companies that ultimately captures those synergies, so that when the business does come back, the cost associated with those activities does not.”

The other strategy would be to cut costs as its clients are demanding pricing concessions in response to lower energy prices. This means that HAL is forced to look at innovative manners to cut costs. One way in which HAL is doing this is by squeezing its suppliers and cutting out the weaker suppliers. This allows HAL to offer them higher volumes and allows its remaining suppliers to offer better prices. After squeezing its suppliers, HAL moved to squeezing its own employees and its assets. This resulted in a $1.2 billion restructuring charge and it wrote off its investments in Libya and Yemen.

While it is common sense to cut costs in a downturn, especially one as severe as this, HAL continued to keep its eye on the quality of its service delivery. HAL chose to cut less for its acquisition of Baker. This quote from HAL President Jeff Miller underlines the company’s long-term commitment despite the short-term costs involved:

“This means that we’re not cutting as deep as we might have done so otherwise. And consequently we’re carrying an elevated cost structure. While this decision burdens current margins it is clearly the right thing to do in the long run.”

Lastly, HAL upgraded its oil equipment to provide better quality services to its clients. Some of the cutting edge technologies provided by HAL include Frac of the Future for drilling, CoreVault system for subsurface sample collection, and CYPHER for stimulation service. Jeff Miller described the benefits of HAL’s cutting edge Frac of Future service:

“In terms of efficiency, this is where innovations like our Frac of the Future with its increased reliability and lower-cost profile become important differentiators. Our Q-10 pumps support our surface efficiency strategy which will enable us to lower operators’ costs while at the same time protect our margins against deteriorating industry conditions. This is also where we leverage the scale of our global logistics network and supply chain.”

On this last point about upgrading its capability, it is HAL’s cutting edge technology which allows it to seize clients from other competitors in this difficult operating environment.

Unless technology allows the world to reduce its dependence on oil and gas in a cost effective manner, we will continue to require them in the long run. It is clear that the global economy has started on its mild recovery as seen in the relatively strong European GDP growth of 0.4% and Japanese GDP growth of 2.4% in Q1 2015. These 2 major economies emerged economically after generous dosages of QE to make credit cheaper and with sensible fiscal policies. The US is expected to grow strongly after it thawed out of its harsh winter in Q1 2015. Still, despite the harsh winter, the US grew by 0.2% in Q1 2015.

While it is uncertain if upstream companies can find new oil reserves, they will require oil services companies like HAL if they are to try their luck. So as the economy recovers, oil demand would increase and bring along more demand for oil services companies. That said, the recovery would not be immediate and would take at least 9-12 months.

In reiterating my long position, I’m essentially placing my bet on the company that only lost 4% of revenue when the global oil rig count dropped by 19% worldwide. This showed that it has a competitive advantage to grab a bigger piece of the pie from its competitors who are also struggling. The difference is that HAL struggles less. HAL is also not complacent. It’s proactively cutting costs to keep itself lean and expanding its economies of scale with the Baker Hughes acquisition. Therefore, it is likely that HAL would play a leading role in the market once the economic recovery gains further traction.

HAL has a market capitalization of approximately $38 billion based on current prices. This chart shows that HAL’s share price is making a steady recovery, as oil prices recover and the company grabs market share. It is the time to get some exposure while HAL is still relatively cheap at around 17 times earnings (trailing 12 months), and it is notable that the recent announcement of the Baker acquisition did not pressure HAL’s price significantly in the short term.

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