Halliburton (HAL) has been making new highs along with all other oil and gas firms this month Recent trends and data suggest that a bottom was made in Q-3, and the company is set to experience increased revenues and margins in Q-4.
We think HAL is attractive at current levels for investors with a moderate risk tolerance. The company is one of the mainstay companies of the oil and gas E&P infrastructure and has the cash reserves and liquidity to go the distance. Simply put, the industry can’t do the work of bringing on new production without them. The catalyst for growth is a rebound in fracking as DUC’s are put into service, and to an extent increased drilling as rigs go back to work domestically and especially internationally as it now accounts for the majority of revenue. What’s clear is the industry collectively has “heaved” a sigh since May and essentially ratified the $40 WTI level as being viable.
The company also is making a modest transition to facilitate “green energy” development and the government subsidies that underpin the green movement will provide an ever-increasing market and substantial margins going forward.
We called the bottom
Halliburton has rallied ~29% from the Mid-October lows when this article was originally published in the Daily Drilling Report Marketplace service, giving members a nice return on capital invested in just a month. It was a bold call at the time. Only Quad-7 joined me with a bullish call on Big Red among a torrent of “Neutrality,” and one bearish with a sell call.
The question now is what do we do with our gains? Is it time to cash out and deploy our “dirty oil money” elsewhere? Or should we stand fast for further gains? I won’t keep you guessing, Halliburton has further running room as the fracking recovery continues. What am I seeing these other guys are missing?
The thesis for Hally going forward
Folks you simply can’t have it both ways. You can’t simultaneously believe that OFS companies will continue to decline and shale production will maintain or slightly accelerate higher from current levels.
Here it is in black and white, blue and yellow. The EIA puts out a number of reports weekly and monthly. For example we are waiting nervously for this week’s WPSR to confirm or rebut yesterday’s API report of a ~4.5 mm BOEPD rise in crude inventories. It matters as crude futures are likely to take their cue from this data over the next few days.
In the left-hand side of the graph above, you can see this agency is forecasting U.S. Daily production of just over ~11 mm BOEPD in 2021. The components of that estimate are ~8.5-9.0 mm from shale, ~1.9 mm from the GoM, and ~.5 mm from Alaska.
As I mentioned the EIA puts out a number of reports, and according to the Drilling Productivity Report of this week, U.S. shale is plugging along at 7.6 mm BOEPD this month and will decline by ~150K BOEPD in December to 7.5 mm BOEPD.
If you are not used to sounding government agencies, it may surprise you there’s a disconnect of ~1.0-1.5 mm BOEPD between those two reports. I’m not here today to say one is more correct and the other more wrong. There’s some time-lag effect and noise in the data and the way it’s collected.
The larger point is in order for the estimate in the STEO to be even close to being right, drilling and fracking must increase. And fast!
Whatever happens with the EIA report today, what’s evident is that inventory levels will have dropped well into the historical five-year moving average as 2021 begins. This will change the mindset of “I can get oil anytime I want it,” to “I am just a little nervous about meeting my commitments.” It’s worth noting that imports could start to fill any gaps that come from U.S. production declines, so it’s not like we are entering an oil famine. But the supply equation will inevitably tighten from here, and that’s good news for Hally!
A Q-3 report out
Pretty much everything that was bad in Q-2 was worse in Q-3. Revenue down 7% to bn, and both sides of the house contributed to the decline with Completions and Production dropping 6% sequentially. Drilling and Evaluation was worse as you might suspect, down at 8 and 17%. No great surprises in any other.
Ready for some good news? Operating income was up 17% at $275 mm QoQ. Higher profits on less income only means one thing. Costs have come down, and that’s exactly what Big Red reported, $1 bn in structural costs-people, equipment, facilities being taken off the books. This is key as you will see shortly.
It gets better. Through the third quarter Hally generated $730 mm of free cash flow and expects for that number to clear $1 bn as we exit 2020. In another bit of encouraging news, the company announced that it’s much less dependent on North America for revenue and margins with 65% of revenue coming from the international side, and both C&P and D&E contributing.
Looking toward a recovery
Hally has established the following strategic priorities as they shift into recovery mode.
- Focus on the strong international business. Now 2/3 of the business this has the potential to be less cyclic than North America.
- A leaner, more profitable North American business. NA will rebound and Hally has chosen to stay and play. They now have 50% less structural headcount and a 50% smaller real estate footprint in North America compared to last year. With costs down and the market consolidating this should spell increased profits as drilling and completions rebound.
Jeff Miller, Hally’s CEO comments on North America-
The supply/demand balance for US fracturing capacity is also improving. We estimate that close to 30% of hydraulic fracturing equipment has been permanently retired this year. We expect more will follow as demand remains structurally lower.
As we predicted, the North America market structure is improving, with both consolidation and rationalization. We’ve seen a steady flow of consolidation announcements from operators as well as service companies. As I see it, the US shale industry will continue to slim down and, as a result, emerge healthier in a relatively more sustainable growth environment in the future. And this plays to Halliburton strength and our disciplined strategy.
- Digital drives everything they do. As digital deployment and integration across the value chain accelerates, they believe that they continue to grow our current businesses, create new revenue opportunities and drive better returns.
- Their capital intensity is structurally lower, with future CapEx expected to be 5% to 6% of revenue. This provides a tailwind to their strong free cash flow generation.
Some high points from the call
Fracturing will continue to be a driver for revenue and profit in North America. 3/4 of domestic production comes from shale fracking and as you’ve heard me say, “no frack – no oil.” Hally intends to tough it out in this sector and is focusing on the high spec end of the business that should drive margins.
Miller comments on SmartFleet-
Before SmartFleet, however, they faced a high level of uncertainty related to fracture placement and performance. SmartFleet changes this. Its intelligent automation integrates real time fracture measurements, live 3D visualization, and real time fracture commands to give operators control over fracture outcomes while pumping. It sets us apart from the rest of the hydraulic fracturing market and solidifies our industry leadership in intelligent fracturing.
SmartFleet and other Halliburton 4.0 digital offerings will continue to address our customers toughest reservoir challenges and improve the efficiency of our service delivery.
This isn’t unique to Hally, but it shows they are high grading their portfolios to hit the top end of the market.
Halliburton Carbon Capture & Storage initiative
In July they announced the formation of Halliburton Labs, a shark-tank environment where entrepreneurs, academics, investors, and industrial labs come together to advance cleaner, affordable energy. Halliburton will receive a minor equity stake in early stage clean energy companies in exchange for their access to our early stage clean energy companies in exchange for their access to their world class facilities, technical expertise, and business network.
We’ve talked about CCS in recent articles. This is a multi trillion-dollar growth story as the world grapples with the challenge of meeting the Paris Climates Accord carbon levels. It’s good to see Hally getting on the bandwagon. There’s money to be made however silly this all is. No one ever said things had to make sense in order for them to be profitable. It doesn’t hurt, but it’s definitely not a requirement.
I like this approach vs. throwing money at a problem through an acquisition that’s barely understood – these often don’t pan out. This way Hally gets an early look at new tech and can weed out what doesn’t fit.
It’s always worth checking on the ability of a stressed company to make it through to better times. Hally has $2.1 bn in cash on the books, up from $2.0 in the second quarter. Long-term debt is ~$9 bn with no maturities due before 2024, and that a manageable $1.3 bn that will probably partially be repaid and the balance shifted down the road. It did some similar with a bond that came due this year. $500 mm was repaid, and a remaining balance of $1 bn shifted to 2030. They also have access to an undrawn revolver of $3.5 bn. In short Hally is solvent and doesn’t present a debt problem for investors.
The news of at least a couple of highly effective vaccines for COVID-19 are the inflection point we’ve needed to make a bottom. Once these begin to be disbursed among our population, demand will surge. We think this will happen faster than anyone realizes at this point.
Hally was trading at an EV/EBITDA multiple of just ~3.5 X currently suggesting there is ample room for margin improvement as general oilfield conditions improve.
The bad news is in. Things get better from here. If an opportunity like Hally interests you, this could be the time to take the plunge. You’ve missed the easy money, but as demand returns drilling and fracking will increase driving better returns and multiples for Hally.
Disclosure: I am/we are long HAL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This is not advice to buy or sell this stock or ETF. I am not an accountant or CPA or CFA. This article is intended to provide information to interested parties and is in no way a recommendation to buy or sell the securities mentioned. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to do their own due diligence before investing their hard-earned cash.