North America accounted for 54 percent of Halliburton’s revenue last year—the highest among the four largest oil-field services companies. And Halliburton is in the process of acquiring Baker Hughes, which generated about 52 percent of its sales in the US and Canada last year.
Both companies have significant exposure to the North American pressure-pumping market and other service lines involved in shale oil and gas production.
Drilling activity in North America tends to exhibit greater sensitivity to commodity prices than in international markets. Whereas the US oil-directed rig count fell more than 60 percent from its October 2014 high to its June 2015 low, the number of active drilling units outside the US and Canada has declined by 20 percent over the same period.
Halliburton’s outsized exposure to North America helps to explain why the stock has given up about 44 percent of its value since June 30, 2014, compared with the less than 29 percent loss posted by Schlumberger’s shares.
The company recorded solid second-quarter results that beat the Bloomberg consensus estimate for revenue and earnings. Like Schlumberger, Halliburton has focused on cutting costs and rolling out sophisticated technologies that aim to improve customers’ returns while preserving the service provider’s margins.
Halliburton’s North American revenue tumbled 25 percent sequentially and its decremental margins came in at 19 percent—an impressive feat.
Schlumberger and Halliburton look well-positioned to win market share from smaller, financially stressed service companies that lack the economies of scale and diversification to compete profitably in the current market.
The combination of Halliburton and Baker Hughes will boast the size and scale to compete with Schlumberger more effectively, especially in international markets.
Halliburton could also generate $5 billion to $6 billion in cash by divesting assets prior to the acquisition’s approval; these proceeds could go toward paying down debt.
Halliburton has ample opportunity to wring efficiencies out of Baker Hughes, which lagged its peers in transitioning to 24-hour pressure-pumping crews and other money-saving process innovations. Management expects the deal to generate $2 billion worth of synergies, regardless of market conditions.
But Halliburton’s North American profit margins came in at 4.9 percent in the second quarter, lagging Schlumberger’s profitability rate of 10 percent. Management asserted that maintaining infrastructure beyond the market’s current need in advance of acquiring Baker Hughes had weighed on Halliburton’s North American profit margins by 300 to 400 basis points.
The bullish case for Halliburton hinges on North American drilling activity bottoming and staging a meaningful recovery at some point in 2016. Our outlook for oil prices contemplates a prolonged period of weakness in North American activity and further pricing pressure in 2016.
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Elliott and Roger on Sep. 27, 2022