Why Halliburton Company Seems to Have Limited Upside

The company looks expensive from an investor’s perspective, given the headwinds the oilfield services industry is facing in North America.

Jan 27, 2014 at 10:03AM

Following the release of its fourth-quarter and annual earnings last Tuesday, it was surprising to see Halliburton Company's (NYSE:HAL) share price fall. The market's response was puzzling to what had been a solid fourth quarter for the premier oilfield services company. This was unlike the positive responses that fellow peers Schlumberger Limited (NYSE:SLB) and Baker Hughes Incorporated (NYSE:BHI) had received following their earnings releases. In fact, it was actually tempting to brush aside the market's initial reaction as a minor aberration.

Something serious?
Unfortunately, that didn't turn out to be just a insignificant blip on the radar. The last five trading sessions saw Halliburton lose 4.6% of its market value. Now, that certainly looks puzzling to investors. Looking deeper into the company's operations, however, may provide a clue.

On the face of it, Halliburton beat Street expectations of $0.89 with an adjusted EPS of $0.93 for the fourth quarter. Revenue grew to $7.6 billion from $7.4 billion in the year-ago quarter. On an annual basis, the company generated $29.4 billion in 2013, a 3% increase from 2012.

Delving deeper, we notice two contrasting market conditions at play. While international operations seemed to be on overdrive, the sluggish North American market neutralized any advantage gained. Let's dive deeper.

International operations: Mostly good, but with a potential stumbling block
The Houston-based Halliburton reported record revenue growth from its Middle East/Asia and Europe/Africa/CIS regions. In fact, Eastern Hemisphere operations grew an industry leading 17% in 2013. Additionally, operating margins were also attractive, with adjusted operating income growing a solid 23% over 2012.

Elsewhere, however, it wasn't so attractive. The Latin American market was a disappointment given the expectation levels built into this region. The year turned out to be disappointing as deepwater drilling activity was scaled down by Petroleo Brasileiro Petrobras SA (NYSE:PBR). Furthermore, the Brazilian state-owned oil producer announced that 2014 could be even worse in terms of drilling activity. In turn, oilfield services companies have no choice but to scale down operations, since Petrobras is the dominant producer in this region. As a result, Latin American operating margin fell to 13.3% in 2013, from 16.2% in 2012. 

Last month, Halliburton did secure contracts  with Petrobras, beating Baker Hughes. But this could turn out to be a burden for the immediate future as less than expected work volumes could pull down operating margins for Halliburton. In other words, while Latin American capital spending moved north, expected returns from this region might not materialize any time soon. Nevertheless, the company remains optimistic regarding the longer term.

North American operations: In the doldrums for the foreseeable future
Domestically, the market seems over-burdened with competition. Even management has admitted to that. North American revenue tanked 5% to $15.2 billion in 2012, while operating income fell almost 13% to $2.6 billion. Pricing pressures in the pressure pumping market still are a major issue.

Why this should concern investors is that North America generates more than half the company's revenue. Here's a break-up of revenue generated in 2013 by Halliburton and Schlumberger, respectively, by geographic region:

Hal Vs Slb

Source: Author's calculations, earnings press releases, and 8-K filings.

We notice that Halliburton has a comparatively higher exposure to the North American market than the more diversified Schlumberger. With competitive pricing holding tight reins over profit-making opportunities, the company is looking to cut costs in order to boost margins in this region. But this is only a limited measure. At the end of the day, growth has to take place, which, for the moment, looks pretty constrained.

In terms of margins, there is definitely room for growth as Schlumberger has demonstrated last year. Here's a comparison:

Source: Author's calculations, earnings press releases, and 8-K filings.

Foolish bottom line
Given the current scenario, the market's expectations that are built into Halliburton's stock could be a little too high. With a trailing price-to-earnings of 20.7, this is considerably higher than Schlumberger's 17.5. While Baker Hughes has a trailing P/E of 22, its North American and Latin American exposure is considerably lesser.

All in all, while Halliburton remains a solid company, its stock might be offering limited upside.

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Fool contributor Isac Simon has no position in any stocks mentioned. The Motley Fool recommends Halliburton and Petroleo Brasileiro. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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