Halliburton 2Q Preview: Weakness In US Drilling Activity Will Continue To Be A Drag On Revenue

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Halliburton (NYSE:HAL), the second largest oilfield services company, is expected to release its second quarter results on Monday, 20th July 2015. Similar to the last quarter, the company is likely to experience a sharp decline in its earnings as the oil companies continue to limit their exploration and production activities on the back of plummeting crude oil prices. We expect the impact of last quarter’s lower drilling activity and service cost deflation to be visible in this quarter’s performance. Here’s a quick look at the major trends that will impact Halliburton’s 2Q results.

We currently have a price estimate of $50 per share for Halliburton, which is 14% ahead of its current market price. We will be updating our valuation model and price estimate for the company after the company’s earnings release next week.

See Our Complete Analysis For Halliburton here

 

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Large Exposure To The Weak US Drilling Markets Likely To Pull Down Revenues

The North American oilfield services market is dominated by tight oil activity, which has a higher marginal cost of production, and shorter planning horizons that allow operators to respond to the commodity cycle more quickly. Thus, in the wake of falling crude oil prices, the North American upstream capital expenditure has declined drastically over the last one year. While the global crude prices (Brent) showed signs of recovery in the last three months, the oil companies continued to restrict their exploration budgets due to the uncertainty about the Iranian nuclear deal. Consequently, the US oil rig count, one of the closely watched metric in the industry, stood at 645 units [1] at the end of the June quarter, almost 50% lower on an annual basis, marking the lowest levels since July 2011. Since Halliburton derives more than 50% of its revenues from the North American markets, the oilfield giant is expected to witness a steep decline in its revenues due to the downturn in drilling and completion activity in the US.

However, the international markets have been much more resilient as they are driven by conventional land and offshore drilling with lower break-even prices. The International oil rig count dropped by around 13% [1] on a year-on-year basis, as opposed to a more than 50% fall in US oil rig count. Accordingly, we expect Halliburton’s international exposure to soften the blow on its top line, though it might not be substantial enough to match its closest competitor Schlumberger (NYSE: SLB).

Oil rig count

Further, the weak crude oil prices have also hampered the pricing power of the oilfield services companies. With the lower bargaining power, Halliburton has been able to negotiate its new contracts at much lower prices. As a result, we expect the company’s earnings to remain depressed in this quarter as well.

Inability To Manage Variable Costs Will Weigh On Halliburton’s Margins

In order to control its operating costs, Halliburton has cut about 9,000 jobs, or roughly 10% of its workforce. Though the company has been making efforts to manage its costs, they might not be sufficient to overcome a downturn of this magnitude. For example, its major rival, Schlumberger, initiated its cost cutting program in the third quarter of last year and has reduced its head count by over 20,000. Unlike Schlumberger, Halliburton did not realize the need to manage its input costs early on, and began its cost reduction measures only in the last quarter when things became worse. Consequently, the company’s margins are expected to remain weak in this quarter. However, as these cost reduction measures pace up in the later half of the year, the company would be able to bring down its variable costs for the full year.

Additionally, Halliburton has decided to keep its logistics network and underlying service delivery platform intact to capitalize on its pending merger with its smaller rival Baker Hughes (NYSE:BHI) [2]. Although this decision is likely to weigh heavily on the company’s operating margins, it should provide a long-term upside through cost synergies and potential market share gains after the deal closes in the second half of 2015. [3].

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Notes:
  1. Baker Hughes Rig Count [] []
  2. Lower cost cuts at Halliburton may give Schlumberger near-term edge, Reuters, April 2015 []
  3. Halliburton (HAL) Q1 2015 Results – Earnings Call Transcript, Seeking Alpha, April 2015 []