The coronavirus caused business activity to come to a standstill and caused oil prices to plummet. It also led to a lack of demand for oil, making it difficult for shale oil plays to make money. Supply cuts by OPEC and Russia have driven oil into the $40 range, but that may not spur E&P. Drilling activity could remain depressed for the rest of the year. This sounds foreboding for Halliburton (HAL), which reported Q2 revenue of $3.2 billion, down 37% sequentially and 46% Y/Y.
Halliburton (HAL), Schlumberger (SLB) and Baker Hughes (BKR) dominate the North America land drilling market.
Revenue from North America fell 57% sequentially and fell over 65% Y/Y. E&P in the region went through fits and starts for much of 2019. Pricing power for oil services companies also waned. The North America rig count fell 61% compared to the second quarter of 2019. It was no surprise that revenue in the region fell hard. The pandemic caused a disruption in the North American oil market. Drilling activity may not rebound anytime soon.
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International revenue was $2.1 billion, down 17% sequentially. The international rig count fell in the double-digit percentage range during the quarter. A falling rig count connotes lower E&P and lower completion activity. Drilling and completion activity could remain stagnant until global economies fully reopen. Customers have been delaying projects, particularly in the offshore sector. Halliburton may not have the offshore/subsea exposure of Schlumberger or Baker Hughes. That could be a blessing for now, as offshore projects may not be economical at current oil prices.
Halliburton and Schlumberger have been cutting costs early and often to help offset their stagnant top line growth. No one could have envisioned a pandemic that would nearly shut down the economy. Halliburton incurred restructuring costs in Q1 and Q2 of $1.1 billion and $2.2 billion, respectively. About $1.5 million of restructuring costs in Q2 were related to severance pay and asset impairment charges:
As reflected in these results, our aggressive cost actions are an important part of our earnings power reset. As you recall, we removed $300 million in costs over the prior two quarters. In April, we announced an additional $1 billion in annualized cost reductions. I’m pleased to report today that these actions, which are largely permanent changes to our business, are 75% done. I expect the remaining cost reductions, which are mostly aimed at our international business and real estate rationalization, to be completed by the end of the third quarter.
Operating costs of $2.7 billion fell 35% Q/Q, which was less than the 37% decline in revenue. As a result, EBITDA of $487 million fell 43% Q/Q. EBITDA margin was 15%, down 200 basis points versus Q1. Cost cuts could pay dividends down the road. For now, Halliburton appears to be treading water.
It could worsen until the economy reopens and demand for oil drives prices higher. I envision the company will employ cost take-outs through the first quarter of 2021 to help preserve margins. As the economy slowly reopens, oil markets and Halliburton’s operations should begin to stabilize.
Solid Balance Sheet
Oil services firms must maintain ample liquidity in case oil markets continue to falter. Halliburton has cash of $1.8 billion, down from $2.3 billion at year-end. Working capital at Q2 was $5.8 billion, down from $6.3 billion at year-end. About $3.3 billion of working capital was tied up in inventory. As the business continues to slow, the company must liquidate inventory and monetize working capital in order to drive cash flow.
Free cash flow (“FCF”) through the first six months of the year was $468 million, up from -$438 million in the year-earlier period. Halliburton cut capital expenditures to the bone; capital expenditures during the first six months of the year were $355 million, down from $855 million in the year-earlier period. This should give an indication where management thinks the business is going. Instead of investing for the future, Halliburton is battening down the hatches and trying to preserve as much capital as possible.
The company has an enterprise value of $21 billion and trades at 6.5x EBITDA. I believe the valuation is appropriate given the headwinds faced by the oil industry and the likelihood that EBITDA could fall further. Its $9.8 billion debt load exceeds 3x, and could become cause for concern if the EBITDA and credit metrics continue to slide.
HAL has spiked off its March lows. The stock could remain in a trading range until the economy reopens. I rate HAL a Hold.
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