HAL - Halliburton: Macro Above All Else
2023-05-03 16:17:43 ET
Summary
- While Halliburton's current financial performance is strong, the company's near-term prospects are becoming increasingly cloudy.
- Leading economic indicators are pointing towards a recession and this is being reflected in oil markets.
- Halliburton's stock price could remain volatile and range bound until the labor market cracks or economic conditions begin to rebound.
Halliburton’s ( HAL ) first quarter earnings were relatively strong, on the back of increased activity and higher pricing. Deteriorating macro conditions continue to dictate the share price though, as the prospect of a recession and a decline in profitability rises.
Management continues to believe that structural underinvestment has created a tight market for oil and gas and oilfield services which will last years. Customers currently expect their spending to grow in 2023 and beyond, but this will be dependent on economic activity remaining resilient. Operator CapEx growth in the US is expected to be around 17% in 2023 , but this is likely to be revised downward as the year progresses. International spending is expected to increase by a high teens percentage in 2023, with the Middle East, Asia and Latin America driving this growth.
The impact of tighter monetary policy is still working its way through the economy, but is already causing problems. Leading economic indicators continue to show weakness and this is beginning to impact labor markets. Banking issues in the US are likely to be an ongoing problem and this will impact credit availability.
Figure 1: Small Business Expectation of Future Business Conditions (source: Created by author using data from NFIB)
Halliburton expects investment to be directed towards development activity, which would be a positive as it would drive outsized demand for products and services. Given weakness in Halliburton’s D&E segment relative to C&P, this doesn’t currently appear to be the case. The frac market in the US is also currently more resilient than the drilling market.
Halliburton’s CEO expects that natural gas market softness in the US will be resolved by the additional 6 BCF per day of LNG export capacity that is expected to come online over the next two years. While this will be supportive of the natural gas market, production capacity far exceeds domestic demand and export capacity, meaning that any improvement is likely to only prove temporary before an oversupply occurs again. In response to natural gas weakness, Halliburton recently moved three frac fleets from gas basin to oil basins and retired a diesel fleet. These moves reportedly reduced Halliburton’s natural gas market exposure by roughly 30%, indicating how little activity is required to meet current demand.
Revenue increased by 33% YoY in the first quarter, with North America and international markets both performing well. International revenue grew 23% YoY and North America revenue by 44%. Halliburton’s exposure to the offshore market is increasing, contributing nearly 45% of international revenue in the first quarter. Completion and Production revenue increased 45% YoY in the first quarter, compared to 17% growth for the Drilling and Evaluation segment.
While this growth looks impressive, Halliburton is about to begin lapping far more difficult comparable periods, leading to significantly lower growth. Activity also appears to have peaked, with growth now being driven by price increases. Pricing continues to increase across product lines and regions, and this is creating extremely strong margins for service companies, but it is not clear that this situation is sustainable. At some point supply is likely to increase or demand decrease, lowering prices and profitability.
Figure 2: Global Rig Count (source: Created by author using data from Baker Hughes)
Halliburton’s operating profit margin was 17% in the first quarter. The C&P division delivered an operating profit margin of 20%, while the D&E division achieved a 16% operating profit margin. While margins remain at current levels, Halliburton is able to generate large free cash flows, but the situation is unlikely to be sustained for an extended period of time.
Figure 3: Halliburton Operating Profit Margins (source: Created by author using data from Halliburton)
Oil markets are tight, but it should be kept in mind where oil and gas prices would likely be if it weren’t for the war in Ukraine and OPEC production cuts. There has likely been a period of underinvestment but this is difficult to assess and the importance of any underinvestment has likely been greatly over estimated. I wrote about the underinvestment in 2019 and why I thought it would eventually result in a period of higher oil prices. While aspects of this thesis may have been right, absent supply shocks it is unlikely that returns in the oil and gas sector would have been strong in recent years.
Halliburton’s management is intent on returning capital to shareholders, with a minimum target of 50% of free cash flow. On the first quarter earnings call, CEO Jeff Miller suggested that current conditions are supportive of returning more capital to shareholders in the form of buybacks. Halliburton repurchased approximately 100 million USD of common stock during the first quarter. Unless current margins can be maintained, Halliburton’s stock is not particularly cheap at the moment and these repurchases have a high risk of appearing ill-timed if the economy continues to weaken.
My interest in Halliburton at this point doesn’t really extend beyond the insight it provides into oil markets and the macro economy. In the event of a recession Halliburton could provide an attractive trading opportunity if the stock price falls below 20 USD.
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Halliburton: Macro Above All Else