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Energy Losers: Has Halliburton Peaked?

Halliburton beats again, but not by enough to impress the Street.

(Halliburton, energy losers story updated with added analyst commentary)



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has been one of the energy sector's most consistent earnings outperformers in 2010, but another beat of the Street consensus on Monday morning wasn't enough to rally Halliburton shares.

Halliburton reported earnings of 60 cents per share, ahead of the Street consensus of 56 cents and twice the earnings generated in the same quarter 2009. Yet the whisper number had edged higher than the Street consensus in recent weeks. Halliburton shares had also reached a 52-week high last Friday ahead of the earnings on expectations that the oil services company would again impress.

Halliburton didn't make the higher end of expectations and Halliburton shares have had a nice run so "sell on the news" seemed to be the earnings takeaway.

Halliburton shares fell close to 5% on Monday. Trading in Halliburton shares was well above average, with just short of 30 million shares traded, or three times Halliburton average daily volume.

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Halliburton results continued to be bolstered by the U.S. land drilling business, while the global drilling outlook remains uncertain. The lack of earnings power on the global side of operations was no surprise, but signs of a slowdown in margin improvement in North American operations may be weighing on investors.

"The bottom line is that the North American business didn't beat by as much as people expected or had priced into the shares," said Scott Burk, oil services analyst at Oppenheimer & Co.

Alan Laws, oil services analyst at BMO Capital Markets said the Halliburton selling showed that investors "just don't get Halliburton." Laws is even more bullish on Halliburton after the Monday selling action, arguing that investors against have an opportunity to enter Halliburton shares at a decent valuation.

"If there was something endemic about the oil services story in the Halliburton numbers, there would have been lateral names being smoked all day in trading," Laws argues. The lack of a read-through on other names in the oil services sector leads the BMO analyst to believe that the Halliburton selling was event-driven and investors now can pick up 300 basis points, in his estimation, when buying into Halliburto shares before the stocks picks up again. "I think Halliburton will be back at $35 before the end of next week," Laws said.

Questions about a peak being reached in Halliburton's North American business could be the earnings detail that has led some investors to flee the oil services stock, especially since the previous quarter had been the standout quarter in terms of earnings outperformance and margin improvement.

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In the second quarter, Halliburton posted its most dramatic beat of the consensus number, and margins from its North American completion business almost doubled, from 12% to 21.6%. The margin improvement had been consistent since the last quarter of 2009, with Halliburton increasing its North American completion business margin level from 5% in the fourth quarter 2009, to 12% in the first quarter 2010. With margins only moving up to 26.8% in the third quarter from 21.6% last quarter, it gives credence to the argument that margins may be peaking.

"North America continues to perform well, but the expectations were moving up dramatically in the past month. These were good results, not great results," said Oppenheimer's Burk. "Likewise, the completion business was still good, but not great."

The Halliburton outlook remains primarily about the land-based completion and production business in North America because there is a healthy backlog there, while drilling operations in the Gulf of Mexico remain a wildcard, and the global market is not expected to be a driver for oil services players in the near-term.

The Oppenheimer analyst doesn't buy the peak margin argument for 2011, though, and he believes Halliburton shares are still relatively cheap for those investors who don't believe that 2011 will be a peak year.

The BMO analyst also takes issue with the idea that Halliburton has reached a peak, also. For one, the analyst says the way to play Halliburton is for the longer-term international story, and that's a longer part of the cycle. "You don't own Halliburton for the North American business," Laws said. "Trying to make a bear case out of the North American story if international starts to grow is just coming up with an excuse for event-driven investors getting overexcited," the analyst added. It may not be time to pound the table on oil service stocks based on the international story, but an upswing is still coming, the analyst argues.

Oppenheimer's Burk did find it interesting that Halliburton management talked on its earnings conference call about a new business model under which it will restrain pricing in the natural gas market so it doesn't "squeeze" its customers.

"That could signal there may be a peak in pricing, so even if you're bullish on the story, it implies peaking in what is 60% of Halliburton's North American activity," the analyst said. "2011 being a peak year for Halliburton is a reasonable concern, but any kind of broader economy recovery would dispel the fear," said Burk.

The BMO analyst also argued that the pricing concessions discussed by Halliburton amount to no more than the oil service giant using its leverage to gain more market share while making sure that pricing doesn't force clients out of business. Halliburton is smart enough to not attempt to go for a short term peak, but rather, make a cycle last longer at a lower top price, and ultimately, grow market share as a result. "They can't get much more pricing upside in natural has, but all Halliburton is saying is that they don't want to kill the goose that laid the golden egg," Laws said, adding that pricing power in the oil market hasn't gone away.

The broader bullish counter argument is that there is still a healthy backlog for wells that have not been completed and a shortage of equipment, and these factors will continue through 2011, making the 2012 the real peak concern year for Halliburton.

-- Written by Eric Rosenbaum from New York.


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