Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

It takes a lot to turn a profit warning into a party. But Halliburton Co. somehow started the weekend celebration early with what should have been a downer.

There was trepidation heading into Friday morning's hastily scheduled update call with the oilfield services giant, especially with oil prices sliding this month. And Halliburton did deliver a profit warning. It just happened to be one of the more ebullient profit warnings I can remember: The stock actually jumped by almost 2 percent soon after the market opened (and just as the call was ending).

Even as of writing this the stock was down only barely, despite Halliburton's new guidance implying that first-quarter earnings per share would be at least 70 percent lower than the current consensus forecast.

Good Warning
Halliburton's stock shrugged off its profit warning
Source: Bloomberg
Note: Intraday times are displayed in ET.

It helps that the first quarter's earnings only account for about 11 percent of the full-year forecast of $1.19 a share, according to data compiled by Bloomberg. Assuming first-quarter earnings come in at 3 cents rather than the 13.6 cents analysts had expected, Halliburton can make that up by beating expectations for the rest of the year by 10 percent.

Most of the call consisted of explaining why Halliburton thinks it can make that up -- and then some.

The hit to earnings isn't because customers aren't showing up -- far from it. The number of rigs operating onshore in the U.S. has jumped by more than a fifth so far this year and is now almost double what it was at the end of last June.

Halliburton had already expected it would bring a lot of its pressure pumping equipment -- used for fracking -- out of storage and back to work this year. But if demand from its E&P clients remains as strong as it is now, the company says it will reactivate double that original amount of equipment in the first half alone. To keep up, it has been refitting old fracking sets with new pumps -- thereby deploying them at half the cost of newly built sets, it says. It is even hiring again after deep cuts.

There is, however, one crucial difference from the last time Halliburton saw a surge of drilling at this sort of pace: margins.

This chart shows the quarter-on-quarter growth of Halliburton's North American revenue and the U.S. onshore rig count, as well as the company's operating profit margin. For the first quarter of 2017, the revenue and margin data are my estimates derived from Halliburton's new guidance, and the figure for rigs reflects the growth so far this year:

History Rhyming, Not Repeating
Halliburton's North American growth and margins usually follow the onshore rig count but this recovery has been different so far
Source: The company, Bloomberg, Bloomberg Gadfly analysis
Note: Growth data are quarter-on-quarter. Assumes revenue growth of 25% and an operating margin of 2 percent in 1Q 2017. Rig count for 1Q2017 reflects growth through March 17th.

Note how, back in 2009 and 2010, Halliburton's North American revenue jumped right alongside the rig count, and margins followed very quickly.

This time around, things are different. Rigs in general have been going back to work since the beginning of the third quarter; by the end of 2016, they were up by 60 percent. Halliburton's revenue, though, had risen by just 5 percent.

The oil bust left a lot of excess equipment lying around, making an already cut-throat services business positively visceral. Halliburton held back from taking on some business in order to preserve pricing and margins. This quarter marks the reversal of that approach; and, because of the timing of equipment getting back to market, revenue growth should accelerate further in the second quarter.

The price of all that equipment being reactivated and staff being hired and retrained is paid in Halliburton's margins. James West of Evercore ISI points out that in the 2009-10 recovery, there was slack in the supply of inputs such as sand. Not this time. Halliburton said it was seeing some grades of sand for fracking command double its contract price in the spot market -- which is why shares in suppliers such as Fairmount Santrol Holdings Inc. joined the party on Friday morning, jumping as much as 8 percent (something I pointed to in this column earlier this week).

If history is any guide, though, margins should start to catch up soon. Prior to Friday's call, Halliburton's North American business was expected to get back to margins of 20 percent or more by mid-2018. It now looks like that could happen by the end of this year -- hence the market's reaction.

That's great for Halliburton, but its guidance muddies further an already murky outlook for oil this year. The company says it hasn't seen any slowdown in activity from E&P companies due to recent weakness in oil prices, suggesting OPEC's supply cuts have helped the shale patch. If anything, Halliburton's commentary suggests the rebound is happening faster than anyone expected.

For investors in E&P companies, they must factor in what a recovery in Halliburton's pricing power means for margins per barrel later this year. If Saudi Arabia and other OPEC members listened into the call, they must know their balancing act on prices, supply and demand just got tougher.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in New York at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net