Expectations, Not Operations, Weighing On Halliburton

Going into this quarter, I had wondered whether expectations for Halliburton (NYSE:HAL) were running a little hot and whether that might set the company and stock up for a tough post-quarter reaction. I don't know whether it was the lack of major upside to second quarter numbers or management's comments that the pace of oil spill settlements has slowed, but the shares were a little soft in early trading Monday morning. Although Halliburton is not really my favorite company in the energy service space, it's hard for me to ignore the value and I believe this remains a good candidate for investors looking to play the rebound in North America and the future growth in offshore and international unconventional development.

A Decent Result In A Tough Stretch
On both a relative and absolute basis, I'd say that Halliburton did pretty well. What's more, investors and analysts may regard the company's $5 billion share buyback announcement as further evidence that the company has moved past the worst of the down-cycle in North America.

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Revenue rose 1% this quarter, which was actually the worst of the Big Three (including Baker Hughes (NYSE:BHI) and Schlumberger (NYSE:SLB). On a sequential basis, though (and that's the comparison most investors follow in this sector), revenue rose by the same 5% as everybody else. North American revenue fell 8%/rose 3%, which again was identical on the sequential side. For international revenue, Halliburton saw 14%/8% growth – the best of the three, though not be a lot (Schlumberger was up 6%, Baker Hughes was up 7%). As has been the case, a tough Canadian breakup pressured North American results, while a field closure ahead of new contract awards in Mexico slowed LatAm performance.

On the margin side, Halliburton's performance was a little more mixed. Gross margin did improve sequentially, and operating income was up almost 15% from the first quarter. That was good for better than one point of margin improvement, and Halliburton sits basically midway between Schlumberger and Baker Hughes in terms of its operating margin (Schlumberger being the top of the heap).

Is Pressure Pumping Going Higher From Here?
The future of the fracking/pressure pumping market is a big question for Halliburton as it is the market leader. Pricing seems to be stabilizing (or turning slightly higher), though, and Halliburton has about 75% of its fleet working 24 hours a day. As rivals (including smaller C & J Energy Services (Nasdaq: CJES)) have backed off some on capacity additions, it looks like the market could turn relatively quickly if demand comes back.

Of course, E&P companies have their own agendas and one of those is to reduce well costs. Moving to pad drilling and holding off on more iffy acreage helps, but there's still a fundamental tradeoff that companies like EOG (NYSE:EOG) face in their prime operating areas – skimp on fracking stages and proppant use and see less production, or pay up and generate better flow through the well. While exploring for oil is still a very worthwhile endeavor, the state of the gas drilling market is still a challenge for companies like Halliburton.

Go Offshore And Overseas
Like Schlumberger, Halliburton is looking to benefit from expanding activity overseas and offshore. Australia and China haven't even begun to develop their unconventional reservoirs in a meaningful way, and expectations are that these major service companies should benefit when they do (though IP issues in China are still a concern). Likewise, Halliburton is looking to leverage its strong position in offshore tools/production enhancement, even in the face of Schlumberger's OneSubsea joint venture.

The Bottom Line
In terms of quality, it's hard to beat Schlumberger as a top pick in the services space. Likewise, there are other stocks like Core Labs (NYSE:CLB) that offer more particular leverage to trends like declining fields. But I wouldn't just skip over Halliburton. The company's leverage in fracking/pressure pumping is a threat and the company does have some gaps in its service offerings, but it is a global player with the scale to be competitive – and who's to say that a deal or two couldn't plug some gaps, and/or that new products (like the Q10 pumps developed with Apache (NYSE:APA) and Caterpillar (NYSE:CAT)) don't have some upside.

At a 7.5x multiple to future EBITDA, Halliburton would trade at roughly $50, and that seems like a fair price today. Baker Hughes may hold more upside if its can put its execution issues behind it, but Halliburton looks like a less risky way to take advantage of the next leg up in oil and gas exploration activity.