Schlumberger and Halliburton Shake it Off

 | Apr 28, 2013 | 6:00 PM EDT
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Schlumberger (SLB) and Halliburton (HAL) have rallied over the past week or so, and we believe the stage has been set for higher prices over the next few months.

Previously, investors had been concerned that North American land-drilling services would continue to weigh on the fundamentals of the oil-services industry. In particular, record-low natural gas prices had triggered contractions in demand, pricing and margins throughout 2012 -- and various North American gas producers have dramatically reduced capital-spending plans until a material rebound in prices. This weakness has been a drag on the energy-service providers, and Schlumberger and Halliburton have suffered slipping shares amid their own disappointing fundamentals.

But, to just about everyone's surprise, first-quarter North America fundamentals turned out better than expected. Land-drilling activity was soft, as anticipated -- but offshore Gulf of Mexico drilling has picked up, along with stronger results from the Canadian operations. Additionally, both operators benefited from lower costs, particularly in the price of Guar, a major input expense. Overall, North American margins have improved at both firms.

International activity is also starting to pick up more strongly than expected -- another factor that helped in the recent quarter. Of the two companies, Schlumberger was the bigger beneficiary of a trend toward more overseas drilling, with especially prominent strength in Saudi Arabia and the Middle East as a whole; Africa; and Latin America. Halliburton, on the other hand, reported less-than-stellar results as a result of several new contract signings and start-up costs in Latin America.

As a result of these positive trends, analysts are reaffirming their 2013 targets on the two firms, whereas many had previously expected downward revisions.

For Schlumberger, broad-based growth was seen across Saudi Arabia, Angola and Latin America, as well as in deepwater drilling in the Gulf of Mexico. The company derives 80% of its top and bottom lines from the healthier global market, so it has been a key beneficiary of the international demand uptake. Yet North American margins also came in at 19.1%, much better than expected, and making for a major boost to company confidence.

For all of 2013, Schlumberger earnings are projected to ratchet up to $4.60 per share vs. $4.18 last year, and 2014 should see another jump to $5.85, thanks to the improved industry trends. This equates to a favorable valuation of 16x targets for 2013, and 12.6x expectations for 2014 -- for a company that's at the leading edge of the industry trends toward more international-oriented drilling.

Halliburton also reported much-better-than-expected numbers. A key delta to the upside was a stronger showing out of its North American operations, which account for 52% of its revenue and profit. In that region, drilling demand and sales were down 1%, better than the expected 3% slip, thanks to a mix shift to more technologically sophisticated products. Halliburton was also helped by a large drop in expenses due to a significant retreat in Guar prices, a key input into drilling services. This boosted margins by more than 300 basis points.

Overall, Halliburton is on track toward flat 2013 results -- analysts are expecting $3.05 per share -- but that should set up the company for much better numbers next year, with a $4.21 average target for all of 2014. Halliburton shares also carry a nice valuation, trading at 13.6x and 9.8x earnings for this and next year, respectively.  One word of caution on Halliburton: The company was involved in the 2010 Macondo drilling accident, which has weighed on its numbers.

But, overall, each of these major energy-services firms has put in stronger-than-expected results for the quarter, and shares are now poised for a rebound. The valuations are favorable, and industry fundamentals as a whole are beginning to firm. 

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