HAL has had a very steep fall from grace in the past 4 months, going from an all-time high of $74.33 on July 23rd to yesterday’s intraday low of $47.74, just a touch above the January low of $47.60:
The main catalyst for the decline has of course been lower oil prices, but Monday’s announcement of the terms of the BHI deal has led to a 10% decline so far this week (even with today’s bounce).
However, HAL’s valuation has gotten quite cheap, with a trailing 12 month P/E of 13. Granted, sales and EPS growth in 2015 and 2016 are likely to fall far short of analyst estimates of 5-10% and 13-18% respectively, but even if those growth expectations are cut in half, the stock is still a better value than most of the U.S. stock universe.
I went back to read the conference call transcript from the Oct. 20th earnings report to get a sense for what management expected for 2015 given the drastic fall in oil prices over the past few months. I was surprised to see that HAL management had not seen its customers plan budget cuts so far, though it might simply be a case of optimism before reality sets in. Nonetheless, here was some of their commentary:
Nevertheless, we are keenly aware that there is a risk of a moderation in activity if oil prices remain weak for an extended period of time. What I can tell you is that in recent conversations with our North America customers, we have not received any indication of activity level slowing as we transition into 2015.
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We’re in the heavy part of our renewal period now. And I would tell you that renewals are rolling up, not down. And as of last week — I talked to a lot of customers, and budgets are moving up, not down.
So in terms of activity, everything I see looks like it’s increasing into 2015. And quite frankly, our strategy that we have in place around delivering the lowest cost per barrel, cost per BOE, in the market’s more valuable than ever.
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One, the projects that are started have to continue. These are long duration type projects. They don’t turn on and off. And then secondly, there are a lot of mature field type activity that we know with lower exploration risk, almost nil exploration risk, those are projects that create terrific returns for our customers. So I think those two conspire to give you an inelastic sort of outlook.
One key takeaway for me was that HAL management sees the risk of lower oil prices as affecting producers’ revenues and profits more keenly than the servicers. The inelasticity of demand that management mentioned essentially refers to the fact that oil producers need the servicing resources for an ongoing project that is continuing to produce, whether oil is $80 or $100. Unless the producing project is stopped, which is rare, then HAL’s revenues are not affected much. Now that does not mean that HAL won’t be affected by far fewer new projects coming on line next year, but it does imply that existing production that remains online will remain a consistent source of revenues for HAL.
As for break-even levels on North American shale oil, HAL cited this IEA statistic on the call:
For example, last week the IEA commented that approximately 98% of North America liquids projects have a breakeven price below $80 per barrel and over 80% were below $60 a barrel.
With that in mind, I only see serious downside risks for HAL if WTI crude oil gets below $65 per barrel, where many more projects will stop current production.
In that context, the BHI deal looks more opportunistic than desperate, as HAL management likely senses an opportunity to lower its own cost of operations and expand its market reach through acquiring BHI. That would put the squeeze on the other North American servicing companies, who are going to be in a much more difficult spot to compete. Finally, the large break-up fee is one more vote of confidence from HAL management that this deal will pass regulatory scrutiny (for better or for worse, my guess is that HAL’s political connections will come in handy there).
Add it all up, and I think HAL is positioned for upside over the next 3-6 months as investors become more comfortable with the 2015 outlook, and the hectic reaction to the BHI deal subsides. The $55-$60 area is the obvious area to watch on the upside. One trade that could make sense is the April 50/60/70 call butterfly. Implied volatility is high (around 40), which makes vertical call spreads less attractive. The April 50/60/70 call fly targets the $60 level, but still has more than 4 months until expiration. That structure is currently priced around $2.00, but I’d rather pay closer to $1.50-$1.75 for a good risk/reward trade. We’ll keep an eye on this one in case the butterfly price reaches that area.