Summary
- Halliburton has enjoyed an impressive rally off its bottom in March.
- While the price of oil has rallied to a 4-month high, the recovery of shale oil production is not expected until the second half of next year.
- Halliburton has limited upside and significant downside risk in the short run.
About three months ago, I wrote an article in which I stated that Halliburton (HAL) had plunged to the extreme and thus it would greatly reward investors if the pandemic did not last longer than expected. Since my article, the stock has rallied 55% and hence the big question is what investors should do at the current stock price.
Business overview
The steep rally of Halliburton has been fueled by the rally of the price of oil, which has climbed to a 4-month high. The coronavirus crisis has caused a slump in the demand for jet fuel and gasoline and thus the global demand for oil products is on track for a record slump this year. However, the pandemic is expected to subside the latest from next year. As a result, the demand for oil products is likely to recover strongly from next year.
The International Energy Agency ("IEA") agrees on this view, as it recently issued a markedly positive outlook for the energy market. According to the report, the global demand for oil products is expected to surge at the fastest pace in history next year, by 5.7 million barrels per day. If this forecast materializes, the demand for oil products next year will be only 2.4 million barrels per day lower (2.4%) than it was last year, before the onset of the pandemic.
However, the recovery of U.S. shale oil production is expected to be slow. The active U.S. rig count has decreased for 13 consecutive weeks at a fast pace and thus it has slumped 71% over last year, to an 11-year low level. Even worse, according to the CEO of Precision Drilling (PDS), a major onshore oilfield services provider, shale oil producers will not return to production mode until the second half of next year even if the economy continues to recover. This slow recovery will provide a strong headwind to the business of Halliburton for at least the next two years.
Analysts seem to agree on this outlook. They expect Halliburton to incur losses this and next year and earn only $0.19 per share in 2022 and $0.28 per share in 2023. Even in 2024, Halliburton is expected to post earnings per share of only $0.78, much lower than the earnings per share of $1.24 reported last year. This means that Halliburton is currently trading at 16.0 times its expected earnings in 2024. Moreover, the stock has traded at an average price-to-earnings ratio of 16.2 over the last decade. It is thus safe to conclude that the fair earnings multiple of the stock is around this value. Therefore, it is evident that the market has already priced most of the growth expected from Halliburton over the next four years in its current stock price.
It is also important to note that Halliburton was struggling even before the pandemic. Since the previous downturn of the energy sector, which was caused by the collapse of the oil price from $100 in mid-2014 to $26 in 2016, oil producers have become remarkably conservative in their budgets and thus they have exerted a strong headwind to the oilfield service providers. In addition, thanks to technological advances in the production of oil, oil producers are now able to extract more oil from a given number of wells and thus Halliburton generates lower revenues at a given rate of production.
This helps explain its lackluster performance in recent years. To provide a perspective, the U.S. oil production and the global oil production kept posting new all-time highs every year between 2014 and 2019 but the adjusted earnings per share of Halliburton slumped 69% during that period, from $4.03 to $1.24.
