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Morningstar | Halliburton's 1Q Affected by North American Slowdown and International Margin Pressures

As expected, Halliburton's first-quarter results were affected by ongoing headwinds in North American markets, due chiefly to the temporary slowdown in U.S. shale activity. Overall company revenue was down 3% sequentially and flat year over year, with a 7% year-over-year fall in North America revenue offsetting an 11% increase internationally. Adjusted operating margin fell from 10.2% in the prior quarter (and 10.8% a year ago) to 7.4%, the company's worst posting in two years. Halliburton's adjusted operating margin fell below that of peer Schlumberger (which posted an 8.2% figure) for the first time since the second quarter of 2017, probably reflecting Halliburton's greater exposure to the weaker North American market. Our fair value estimate and narrow moat rating are unchanged for now.

Somewhat surprisingly, not only did Halliburton's North America-focused completion segment see a large sequential operating margin drop of 300 basis points, but the more internationally focused drilling segment also saw a 300-basis-point operating margin drop. This was due partly to temporary mobilization costs in preparation for increased activity levels in 2019. However, management also noted the effect of pricing pressure internationally, with contracts rolling over to the low pricing levels prevailing over the past year or so. To some degree, this is a product of Halliburton's strategy of grabbing international market share in the last couple of years. However, management noted that it will be pivoting to prioritize pricing improvement internationally in 2019, echoing recent remarks by Schlumberger management. A concerted effort by the two largest oilfield service companies to drive pricing improvement should accomplish this objective in 2019, especially given the backdrop of 5%-10% increases in oil and gas capital expenditures.

In North America, we think Halliburton will face persistent pricing pressure even as U.S. shale activity recovers from the temporary slowdown imposed by pipeline bottlenecks. Management noted that Halliburton's pressure pumping activity in the first quarter of 2019 actually exceeded 2018 levels (in terms of stages pumped), but revenue was much lower (we estimate at least 10% lower) due to weaker pricing. Halliburton will probably experience some recovery in 2019-20, but in the long run, we expect its returns on capital in the pressure pumping business and broader completion segment to be capped by fierce competition in the North American market.