A Look at Two Oilfield Service Stocks: Why to Buy, Why to Sell
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While the media loves to talk about energy prices, since they speak directly to consumers' pockets (how much do I pay at the pump?), not enough attention is given to the industry's suppliers: oilfield service firms. These companies look tremendously discounted against the shale gas boom and Asia's growing interest in harvesting its shale reserves. In my view, this slice of the energy industry looks particularly beaten down and has upward potential from here. I review several of them below.
Big Hal (NYSE: HAL): Several Reasons to Be Optimistic
Halliburton in one of the world’s largest oilfield services company; it operates in more than 70 countries and employs over 60,000 workers. Their services, such as locating reserves, drilling, well completion, and production optimization, are provided to E&P companies the entire reservoir life-cycle. Their unconventional approach to drilling is becoming more and more popular. While many regard Schlumberger (NYSE: SLB) as the oilfield service leader (which it is by revenue), not enough credit Halliburton for its lead in hydraulic fracturing. This leading position gives Halliburton strong forward exposure to the shale gas boom, which is expected to make up 50% of North American production in the next decade compared to 23% in recent years.
Shale gas, which is "fracked," contains one-fifth of the world’s natural gas production, and China is believed to hold the most reserves. The emerging market has been unable to produce from its rich plays due to poor infrastructure and geological data. Ultimately, it will be a race between Schlumberger and Halliburton to win over Asian upstream producers. While Schlumberger is ideal for its experience in international business, Halliburton still understands fracking the best and has its fingers in every accessible play right now. Ultimately, the largest oil well equipment firm is likely to focus more on its core business, which is offshore and deepwater drilling. Schlumberger's new deal with Cameron, for example, reinforces this focus. So, I believe Halliburton can win over these Asian customers and attract a large slice of future energy production from this high-growth economy.
But, alas, most of the company’s revenues come from North America (58%). The result has been an investor focus on margin erosion resulting from overcapacity. This issue is of course being exacerbated by a slowdown in natural gas drilling and oil basin crowding. The CEO and Chairman David Lesar, admitted that he "expect[s] the next couple of quarters to be pretty bumpy" and that they’re looking for improved efficiency as a way of hedging.
Halliburton is trying to add more efficiency by improving equipment, labor productivity, and new technologies. Fortunately, investors can see that the company has succeeded in this end: Revenue per rig has climbed from $5.6 million in 2010 to $6.3 million in 2011 and $7 million today. Guar gum volatility may be a "headwind" alongside macro uncertainty, but the upside more than offsets. Deepwater exploration may have high startup costs, but the long-term free cash flow trajectory will drive an increase in the return on invested capital.
Again, however, with a potential of tapping into China, investor sentiment is likely to become more optimistic. From a $1.2 billion deal with Malaysia-based Dialog Group to the increasing scarcity of resources abroad, Halliburton is positioned for multiples expansion. I encourage buying sooner rather than later.
Baker Hughes (NYSE: BHI), or Why North America Looks Bad
Perhaps Baker Hughes is the reason why the market is against everything North American in the oilfield service market. Baker Hughes, which is exposed to this region, has announced that margins and their top-line will be below their expectations. This deterioration has been a function of decreased land drilling and rising costs in pressure pumping..
The company's number of natural gas drilling rigs fell three times during the week of Dec. 14, 2012. Pressure pumping, the equipment used to extract resources from shale rock formations, continues to have a weak outlook. This is because this activity has seen business fall even faster than rig count. This indicates that upstream producers are not targeting more locations but are rather focusing on present wells. Some argue that this this pumping and drilling will "equilibrate over time." Barclays, for example, believes that rig count will increase in 2013 from an inflow of new capital despite a 17% sequential decline in the recent quarter.
But at 13.4x past earnings, Baker Hughes's headwinds appear a tad overdone by the market. Assuming expectations are met, 2016 EPS will come out to $4.43. At a multiple of 15x, this translates to a future stock value of $66.50. Analysts are currently on the fence with a rating of 2.5 out of 5, but I expect that this will start to move more towards the bullish side when natural gas prices improve from the lows. For now, it may be safer to back much larger peers Schlumberger and Halliburton.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Halliburton Company. Motley Fool newsletter services recommend Halliburton Company. 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. Is this post wrong? Click here. This article was written by the staff of TakeoverAnalyst, which does not intend on opening a position in the next 48 hours.