Key Takeaways From Halliburton’s Q1 Earnings And What Lies Ahead

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Halliburton (NYSE:HAL), the second largest oilfield services company, published its Q1 2015 earnings on April 20, reporting a sharp decline in earnings as customers in North America and some international markets curtailed exploration and production activity and pushed for price cuts amid weak crude oil prices. However, the numbers still managed to beat market expectations, owing partly to better-than-expected results in overseas markets such as the Middle East and Latin America. While quarterly revenues declined by about 3% year-over-year to about $7.1 billion, adjusted income from continuing operations fell by about 33% to $418 million. On a GAAP basis, the firm posted a loss from continuing operation of about $639 million as it recorded approximately $823 million in after-tax charges relating to job cuts and write-downs. [1] The near-to-medium term outlook for the company remains challenging, as oil and gas firms have meaningfully dialed back on their upstream spending plans (average cuts of about 20% and upwards) and we believe that the full impact will only factor into earnings in the quarters to come as higher-priced contracts end and as new contracts are negotiated at lower rates. Here’s a brief overview of Halliburton’s earnings and what to expect going forward.

Trefis has a $48 price estimate for Halliburton, which is about in line with the current market price. We are currently updating our valuation model and price estimate for the company to account for the earnings release.

See Our Full Analysis For Oilfield Service Companies HalliburtonSchlumberger |Baker Hughes

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North American Revenues Decline, Margins Collapse

Halliburton’s North American revenues fell by about 9% year-over-year to about $3.54 billion on the back of activity declines and pricing pressure. Operating margins plummeted to about 8% from around 19% a year ago as reductions in the company’s operating cost structure failed to keep pace with the price declines. The North American oilfield services market is primarily driven by tight oil activity, which has higher marginal costs of production and shorter planning horizons that allow operators to respond to the commodity cycle more quickly. North American upstream capital spending is expected to fall by about 30% in 2015 and the U.S. oil rig count is already down by about 50% since the beginning of the year, leading to a broad-based decline in drilling and completions activity.  Halliburton is facing the brunt of this downturn, since over half its revenues are exposed to the North American markets, with focus on unconventional activity. There are some specific trends in the land drilling market that are likely to impact services firms as well. For instance, the inventory of drilled but uncompleted wells has been rising in the United States, potentially reducing future demand for drilling services and resulting in a delay in the completions and stimulation cycle. Halliburton estimates that there are currently about 4,000 drilled but uncompleted wells against a total of about 55,000 wells drilled last year. Additionally, the trend of re-fracking has been gaining steam and this could reduce the demand for drilling services, although it could help to bolster demand for pressure pumping services.

International Results Hold Up On Strong Activity In The Middle East

Halliburton’s international business helped to soften the blow from the North American markets, with revenues declining by just about 2% year-over-year to $3.45 billion while operating margins actually saw a slight  uptick, rising to about 14% by our estimates. On average, international rig activity has been much more resilient given that it is driven by conventional land and offshore drilling that has lower break-even prices. Additionally, unlike the North American market, which has seen growth driven by highly-leveraged independent drillers, participants in the international upstream space are typically larger and better capitalized. The international rig count has declined by just about 9% from its 2014 peak.

The Middle East has emerged one of the strongest geomarkets in the current environment and Halliburton indicated that its recent project awards in Saudi Arabia, Iraq, UAE and Kuwait are expected to move forward as planned. Per-barrel production costs in the region are among the lowest in the world, and the near-term outlook remains positive as core OPEC producers continue to pursue market share at the expense of non-OPEC part of the international supply base. However, most of the company’s other international markets will witness headwinds. For instance, the Europe/Africa/CIS region has been seeing significant cuts in spending, with offshore exploration in the North Sea and Angola facing increasingly challenging project economics. The company also expects to see lower activity Latin America, owing to budget constraints in Mexico and reduced activity in Brazil and Colombia. Asian markets including Australia and Malaysia are also likely to see reduced customer spending and delayed projects.

Cost Structure Remains High On Baker Hughes Merger, Delay In Variable Cost Reductions

While Halliburton has been reducing its operating cost structure by cutting about 9,000 jobs, or roughly 10% of its workforce, the company noted that these cuts were smaller than it would have typically undertaken in a downturn of this magnitude. For example, chief rival Schlumberger (NYSE:SLB) has outlined headcount reductions of about  20,000 or roughly 15% of its Q3 2014 employee base. This is largely attributable to the fact that Halliburton has decided to keep its logistics network and underlying service delivery platform intact in order to capitalize on its pending merger with smaller rival Baker Hughes (NYSE:BHI). [2] Although this decision is likely to burden operating margins by a few percentage points in the near term and potentially make the company less competitive in an increasingly price conscious market, it should provide long-term upside through cost synergies and potential market share gains after the deal closes. Separately, Halliburton said that there was a slight delay in realizing input cost reductions from its supplier base, noting that cost reductions for items like sand and logistics only began during Q1. ((Halliburton (HAL) Q1 2015 Results – Earnings Call Transcript, Seeking Alpha, April 2015)) These reductions should ramp up through the year, helping the company improve its variable costs.

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Notes:
  1. Halliburton Q1 2015 Earnings Press Release []
  2. Lower cost cuts at Halliburton may give Schlumberger near-term edge, Reuters, April 2015 []