The phrase “temporary efficiency drags will create headwinds for additional upward pricing in the third quarter” may cause your eyes to glaze over. For shareholders of Halliburton Co. — whose CEO uttered those unfortunate words on Monday — it induced sudden nausea. The stock collapsed 8 percent, its biggest one-day drop since November 2014, when OPEC’s surprise decision to keep pumping sent oil into a tailspin.
That’s the first clue the reaction is overdone. This isn’t the start of an oil crash. Nor is there a major deal hanging over Halliburton’s head, as was the case back then (it had just announced its ultimately doomed bid for Baker Hughes).
As it happens, Halliburton announced earnings on Monday that met expectations. What hurt it was weaker third-quarter guidance, essentially confirming fears that pipeline constraints are forcing a slowdown in the beating heartland of American oil, the Permian shale basin. Since Halliburton’s story is defined by its leading position in the fracking boom — especially in contrast to the more international flavor of rival Schlumberger Ltd. — this hits it hard.
But the market is overreacting. As I wrote here, the Permian basin’s constraints are temporary, with new pipelines due to solve the problem by late 2019, little more than a year away. Its transient problems are a result of its consistent success; namely, raising production with greater efficiency in the teeth of the worst downturn in oil in a generation. On a medium-term view, the Permian basin remains one of the most dynamic development regions in the world.
Yet Halliburton is now priced as if the party is over. At 7.7 times 2019 Ebitda, the stock trades at a 35 percent discount to Schlumberger, the widest since the summer of 2016, when oil was still in the doldrums, U.S. production was falling, and the Baker Hughes deal had just collapsed.
Meanwhile, despite the Permian basin’s logistical difficulties — as well as rising cost inflation as activity has picked up over the past 18 months — margins in Halliburton’s completion and production business (most exposed to fracking) are back to levels seen before the crash:
And while Schlumberger has more to gain from what appears to be, at last, a meaningful recovery in international exploration and production activity, Halliburton isn’t a complete homebody: Roughly 40 percent of its revenue is generated outside North America.
The next month or so will likely be rough on Halliburton as Permian-exposed E&P companies report earnings and, similarly, reinforce their immediate challenges as they try to reset investors’ near-term expectations. Even so, Halliburton now looks priced for the end, rather than an intermission.