Halliburton’s Valuation Nears Tipping Point

Halliburton (HAL) reported Q1 results on Monday morning that exceeded consensus analysts’ estimates. The world’s second largest oil field services firm reported profits of $252 million or $.28 per share ex-items, which was three cents better than Wall Street expected. The company saw improving activity in North America, particularly related to drilling for natural gas, which helped offset weakness in other parts of the world. Halliburton’s revenue was $3.8B or right about where analysts expected declining by 3.7% from a year ago. North America was the only region that showed any growth at all and that was only at a rate of 1.2%. The stock closed down fractionally despite the earnings beat most likely because of declines in the price of crude oil, which applied pressure to the entire sector.

The company’s results suffered from pricing concessions made on long term contracts last year, at that time drilling activity had slowed considerably and Halliburton and its competitors were bidding for few contracts available. CEO David Lesar commented that he believes there will be a steady resurgence in international activity in the second half of the year and into 2011. The company is starting to show optimism in more tangible ways as well; they hired 1,200 employees in the year or about 20% as many as were laid off last year. It marked the first quarterly report with net hiring that the Houston-based company has had since 2008. In addition, the company is currently dealing with 4 different small acquisitions, the most recent being their April 10th announcement to buy Boots & Coots, Inc (WEL). The oil field services sector is no stranger to M&A activity as both BJ Services (BJS) and Smith Int. (SII) have been snapped up by Halliburton’s competitors.

The operating environment has certainly improved for Halliburton, as higher crude oil prices and new shale gas drilling projects have brought new opportunities for oil services firms. For Halliburton specifically though, the stock is nearing the high end of our expected price range, which means the Ockham methodology sees little room for price appreciation given the current fundamentals. For instance, historically the market has been willing to pay between 6.6x and 14.7x times cash earnings per share for Halliburton, but the stock currently trades uncomfortably close to the high end of that range at price-to-cash earnings of 13.8x. Similarly, the current price-to-sales of 1.95x is fairly high compared to the historically normal range of .95x to 2.00x. Based on our analysis of how the market has historically valued HAL, we think the stock will trade in the range of $25 to $33 per share given current fundamentals.

We believe that margins should expand later in the year, and revenue growth will indeed return likely even in the next quarter. However, based on our analysis, there is not a lot of upside for investors in this stock despite improving fundamentals. We currently have a neutral or Fairly Valued rating on HAL but it is at risk of a downgrade in the coming weeks’ reports. Halliburton has easily outperformed its closest competitors over the last twelve months rising 68% compared to 43% for BHI and 41% for SLB, thus value investors may want to look elsewhere for a buying opportunity.

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

We utilize this straightforward approach to value over 5500 securities, with key emphasis given to the study of individual securities' price-to-sales, price-to-cash earnings and other historical valuation ranges. Our long term value investing methodology is powered by the teachings of Ben Graham and it has proven to be very adept at identifying stock prices that are out of line with fundamental factors.

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