HAL - Halliburton: The Recovery Continues

2023-04-22 09:00:00 ET

Summary

• The service industry is now recovering from about 5 years of inadequate profits ending in 2020.
• The current cyclical recovery appears to have a few more years to go.
• The lack of revenue growth shown by Halliburton during the latest cycle is a symptomatic of industry shrinkage.
• Return on Capital employed and cash flow are heading back to reasonable returns.
• Halliburton's balance sheet is one of the best in the industry with a lot of financial flexibility.

(Note: This article is in the newsletter on April 21, 2023.)

Oil and gas service companies like Halliburton (HAL) have had it hard the last few years. These companies are hoping for some relief in the form of a sustained recovery so that the industry can validate its long-term viability. Few parts of the industry have suffered more than service providers after the boom was over in 2015 because of the sizable oil price decline.

Halliburton has outperformed much of the industry because it provides services to all parts of the upstream business from the initial decision to design a well all the way to well abandonment.

Even considering that outperformance, the chart above demonstrates how brutal the last few years have been. Technology has advanced upstream efficiencies at a brisk pace. But that translates into less business for a service provider. The current pricing recovery really has only allowed revenues to approach levels of past cycles.

This has meant a lot of cost cutting and efficiency reorganizations for service providers including this one. These companies now have to make money with effectively less time to make that money as efficiency gains continue to march onward. That is one brutal treadmill for these companies to continuously climb.

Fortunately, this company is able to make acquisitions to complement the low capital budget for new products. Many in the industry just do not have that ability. The future is likely to have forward progress slow as it has in the past. That should provide these service companies with some "breathing room" to establish a long-term profitability strategy that really was lacking the last five or more years since the great oil price decline.

Usually, the time to invest in a company like this is when cash flow and return on capital are at rock-bottom levels. At that point much of the market has a dire outlook for service providers just about the time the cyclical turnaround begins.

However, the industry turnaround that has led to some revenue increases and other improvements shown above appears to have quite a bit of recovery room left. Therefore, this stock may have more room to run to higher levels than was the case in the immediate past.

As long as speculative money does not enter the upstream business to lead to costly (and expensive) over-production from projects that industry insiders would not dream of doing, then the revenue growth along with better profit conditions should continue. Since a lot of speculators were badly hurt in the time period of 2015-2020, it may be a few years before that speculative money signals the end of the current cycle.

This industry ran up losses after the big oil price decline in 2015 and really did not have enough time to reset balance sheets when the aborted recovery of 2018 happened. That led to considerable industry shrinkage due to a lot of losses.

That shrinkage should lead to a period of decent profits for the survivors like this company. Like any cyclical industry, decent profits will eventually attract competitors that go public in large numbers to signal a time to exit for investors. But right now, like upstream, that appears to be a few years out.

Needless to say, the service industry has to maintain very conservative debt ratios. Given the past few years, this requirement is probably more important than is the case in the upstream industry.

Halliburton clearly has given itself adequate capital flexibility. Downturns in the service industry tend to be particularly brutal when bids during the downturn are often made to improve cash flow during those periods. So, reliance on bank lines is really not advised.

The risk of the capital efficiency shown above is that the company's competitive position slides and management either loses business or has to make an expensive acquisition to "keep up". The company has long depended upon a combination of research and development along with some acquisitions to maintain competitive positioning in an industry that is constantly shrinking.

The result is constantly finding new needs to make up for that shrinkage in a way that consistently redefines what it means to be part of the upstream service providing industry. The creativeness needed to keep up is a good deal more extensive (I think) than what I see in the upstream industry and other parts of the industry.

Halliburton, due to its standing in the industry has some flexibility to fall behind. But there is a constant need to monitor a service company, any service company for relative competitive standing.

Halliburton also manages to be a "one stop shopping experience" for many upstream companies. To make this work, every part of that "one stop" experience must remain current. Halliburton has a very good past record for this type of situation. However, there are no promises that the past will repeat in the future.

Key Takeaways

Halliburton is an extensively horizontally diversified company that services all aspects of the "field and production" upstream business when it comes to upstream operations. Management maintains the competitive position of the company through a combination of some research and development as well as occasional acquisitions.

The pace of technology advances the past few years has been brutal in the upstream business. This has led to considerable shrinkage of some more traditional services while creating brand new growth areas that were not visible in the past. So far this company has maintained its competitive position despite the myriad of operational changes and advances in the upstream business.

Finances for the company remain top notch. They have to be to provide room for that occasional acquisition and financial flexibility during the periodic downturns of the service industry.

The current recovery appears to have a few more years to run. That does imply some upside from the current price. But the best time to invest in an industry leader like this is when conditions are so brutal that the market effectively gives up on the stock. Then you just wait for the inevitable industry turnaround knowing that the strong balance sheet will enable the company to make it to that turnaround.

Earnings and revenues should hit new highs. But the low visibility of the upstream industry ensures a bumpy ride. The time to sell is when a lot of speculative money enters the upstream market to bring about another cyclical upstream downturn.

Disclaimer: I am not an investment advisor, and this article is not meant to be a recommendation for the purchase or sale of stock. Investors are advised to review all company documents and press releases to see if the company fits its own investment qualifications

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