Halliburton (HAL) Stock Analysis: Value, Growth & Governance

Overview and Market Position

As one of the world's leading oilfield services companies, Halliburton Co. (HAL) is naturally reliant on the energy cycle for its profits and revenue. A strong exploration and production environment allowed the company to outperform the broad U.S. stock market over the preceding five years, but more recent comparisons had become relatively difficult. As a result, Halliburton remained relatively undervalued compared to several of its smaller counterparts, yet failed to represent a compelling investment proposition compared to large-cap peers or the market as a whole.

Historical Stock Performance and Revenue Growth

Over the historical five-year period ending March 29, 2010, HAL shares (adjusted for a 2:1 split on July 17, 2006) delivered a compound annual growth rate (CAGR) of 8.45%, compared to a slight loss of 0.1% for the S&P 500 over the same period. While the company participated in the market-wide rout of late 2008 and early 2009, it fell from a higher appreciated base and so remained ahead of the broad market since 2005. However, the company's archrival in the global oilfield services market, Schlumberger Ltd. (SLB), fared even better, logging a CAGR of 13.94% over the same five-year period.

Although the spinout of engineering subsidiary Kellogg Brown & Root (now publicly traded KBR) on November 16, 2006 distorted the company's long-term financial metrics as initially reported, revenue excluding KBR increased substantially from 2005 to 2008. (Because the 2009 recession distorts the overall trend, its results are addressed separately.) Subtracting KBR's results from the as-reported FY 2005 revenue of $20.99 billion and net earnings of $2.35 billion, Halliburton brought in $10.84 billion in gross revenue and reported a net $2.14 billion in profit in 2005. By FY 2008, revenue had expanded to $18.28 billion — a compounded growth rate of approximately 19% per year.

While revenue was surging, net earnings growth slowed to a crawl. In 2005, HAL reported a full-year operating profit of $2.66 billion and net earnings of $2.35 billion, or $4.54 per share. By 2008 — the peak of the company's bullish revenue cycle — full-year operating profit had swelled 50% to $4.01 billion, but net earnings sank 16% to $2.24 billion, or $4.41 per float-adjusted share. Operating margins actually widened from a healthy 12.67% in 2005 to a robust 21.93% in 2008, despite then-prevalent worries that rising contractor and equipment costs during the oil boom would inflate operating expenses.

Earnings, Margins, and Recession Impact

Even in the face of significant operating margin expansion, net margins only edged up from 11.22% in 2005 to 12.16% in 2008, and then receded to 6.65% by year-end 2009. (Compare this to a year-end 2009 net margin of 13.84% for SLB.) Surprisingly, the major drag on operating earnings appears to have been KBR, which HAL continued to claim as a loss from discontinued operations even though that now-theoretically-independent company remained marginally profitable.

Thanks to this lackluster margin expansion, float-adjusted P/E also remained relatively constant over the 2005–2008 period, even though the float-adjusted share price jumped 8.86%. By FY 2009, however, all major performance metrics — revenue, earnings, margins, and P/E — collapsed in the wake of the broader recession. Revenue sank 19.71% on a year-over-year basis while operating and net earnings plunged 50.27% and 48.51%, respectively; margins fell sharply as well, dropping to 13.58% (operating) and 7.85% (net). As the stock price recovered from its recessionary nadir, the trailing P/E ballooned to 23.33 times full-year earnings, versus a compressed 6.34 a year previously.

At a trailing P/E of 23.33, HAL appeared to be a bargain compared to the average oilfield service company, which Wall Street valued at roughly 27.7 times trailing earnings. However, it was still no bargain compared to the typical member of the S&P 500, which traded at a collective trailing P/E of about 22. Given relatively restrained forecasts, the stock was not especially attractive as a growth opportunity either. According to Wall Street consensus, HAL was expected to earn $1.42 per share in 2010 for a forward earnings growth rate of 10.9%. In a less rebound-intensive environment this would not have been bad, but it still represented a PEG ratio of roughly 2.14 — quite high compared to the S&P 500 at large, reflecting a substantial growth premium baked into the stock price. (On a forward P/E basis, HAL was trading at 21.03 times estimated 2010 earnings, versus 15.1 for the S&P 500.)

Valuation and Competitive Comparison

In contrast, SLB presented very similar exposure to a prospective oil industry rebound but was even more richly valued on a growth basis. SLB carried a trailing P/E of 23.98 — a slight premium to HAL — and consensus forward earnings growth of roughly 4.31%, which would deliver a PEG ratio of 5.56. Within its sector, HAL was a relative bargain, but even there, better opportunities existed for the careful investor willing to investigate more obscure small-cap names like WSP Holdings Ltd. (WH) with more immediate growth prospects.

The company's balance sheet appeared relatively strong, although its true condition may have been masked by the shifting tax treatment of the KBR spinout and other factors. The debt ratio roughly tripled over the preceding several years — from 0.124 at year-end 2005 to 0.34 at year-end 2009 — and interest expenses were increasing sharply as a percentage of revenue. While the company's current ratio and large ($2 billion) cash reserves indicated that internal cash flows were more than sufficient to handle near-term debt obligations, the trend was not encouraging, especially since management had expressed a desire to aggressively fund organic growth going forward.

With an enterprise value of approximately $47 billion (counting the 80% stake in KBR at current market value), the company represented a significant opportunity for a buyer who could assemble a reasonable takeover bid along with a compelling strategic rationale for acquiring its ongoing lines of business. However, potential buyers were likely to be few in number: HAL was already the second-largest player in its industry, and the established leader, SLB, had itself been an active consolidator. At its current scale, it was unlikely that HAL would ever attract a meaningful merger-and-acquisition premium.