With the Western world's tension with Russia unlikely to be resolved in the near future, we have no other choice to believe that energy supply constraints will remain. What this suggests is that in order to offset the loss of oil and energy exports from Russia, investments in global drilling activity will need to increase. We want to diversify our energy exposure by adding an oil services company that benefits from the expected and necessary increase in drilling activity. That company is Halliburton.
Our bullish HAL thesis is mainly predicated on:
A supportive macro environment for increased drilling activity, with oil prices globally well above $100 per barrel.
On the fourth quarter earnings call, Halliburton CEO Jeffrey Miller said, “I believe 2022 will be a strong year for our industry and especially for Halliburton. While global energy demand and economic growth demonstrated resilience, global energy supply has shown its fragility. The impact of several years of underinvestment in new production is now apparent, and the structural requirement to invest around the wellbore is crystal clear.”
Halliburton is the largest oilfield services provider in North America and has the most revenue exposure to North America among the big three large cap oilfield services companies.
Forty percent of HAL’s revenues comes from North America, compared to 25% for Baker Hughes and 20% for Schlumberger.
Domestic exposure is important to us right now and want little to do with Russia due to the sanctions on Russian crude. Analysts at Barclays recently estimated that Halliburton may have less than 3% to 4% revenue exposure to Russia, compared to an estimated 5% to 8% for Schlumberger.
North America customer spending in 2022 is expected to grow more than 25% year over year, according to management, mostly from increased investment in private operators as the public E&Ps continue to express discipline and the prioritization of cash returns to shareholders. However, we think the possibility of upside to these numbers is possible with crude significantly elevated Tuesday. But like the U.S. based E&P companies, Halliburton is focusing on maximizing cash flow too.
Management recently completed what they called “the most aggressive set of structural cost reductions” in company history, and made changes to their process that drive higher contribution margin. The key point to of this is that Halliburton will have meaningful operating leverage as North American activity accelerates. And more and more customers are choosing Halliburton in the low-emissions equipment segment because they provide more environmentally friendly solution.
We should also note that digitization and automation has become increasingly important to oilfield services companies, and Halliburton understands this. The benefits are twofold:
Digitization creates higher margin opportunities through the use of software, smarter tools and ancillary products, and also cost savings.
Meanwhile, automation helps reduce health and safety concerns, accelerates service delivery improvements, and decreases the environmental footprint of the total operation.
Focus on capital efficiency is strengthening cash flow generation, leading to improving balance sheet and increasing cash returns.
Halliburton currently targets capital expenditures at 5% to 6% of revenue This is down from 11.4% in 2009-2014 and 7.2% in 2015-2019.
As a sign of confidence in the future, Halliburton recently increased its quarterly dividend to $0.12 per share from $0.045.
Management also recently redeemed $600 million of its $1 billion of debt maturing in 2025.
While there may be little here in terms of dividend yield and share repurchases are still on hold, we are encouraged by the confident message Halliburton sent to the markets by showing they can increase cash returns and reduce debt at the same time.
We know we are not early to the Halliburton story with the stock up more than 50% this year, but even in an uncertain economic environment this is a company who we feel quite certain that the earnings estimates will prove to be too low. But at the same time, we understand the run HAL has been on over the past few weeks and that’s why we are starting off with a smaller than usually position size.
We are have price target of $53 for the stock, representing 20x estimated 2023 earnings of $2.66/share.