Halliburton (HAL) Undervalued Growth

My previous post on Halliburton was mainly focused on presenting the company’s growth prospects on the back of the American oil boom. Now there’s even more reason to buy the company besides its relative undervaluation and high growth potential.

Baker Hughes Acquisition

Halliburton recently put out a bid for Baker Hughes for $35 billion. This represented a 56% premium to the price of Baker Hughes before any buyout news had started. Halliburton also attached a breakup fee of $3.5 billion to the deal, forcing them to have to give Baker Hughes 10% of the buyout amount back if the deal for some reason did not go through. The high premium and large breakup fee of this transaction did not go through well with investors, however, and they sent the share price of Halliburton tumbling a full 10% in intraday trading. This was a complete overreaction.

Those disliking Halliburton’s high premium for Baker Hughes are forgetting that Halliburton made the deal now for a reason: falling oil prices had ravaged oil companies’ share prices, sending oil majors like Baker Hughes and Halliburton down 30-40% from highs. Halliburton’s “large premium” for the acquisition of Baker Hughes was actually only 1% above the highs Baker Hughes had achieved just months ago, meaning that Halliburton had actually bought out the company at a significant discount, theoretically buying the company for only a 1% premium if oil prices stabilize.

The other investors that sold on the $3.5 billion breakup fee may have a bit more merit to their argument, however, it is still flawed. The norm of acquisition breakup fees for companies is only 4% of the total transaction amount, and Halliburton’s is 10%. This is a very hefty amount, and leaves Halliburton to lose a lot if this deal goes awry. A major issue that could cause the buyout to stop is regulators. It is not very likely that regulators would approve this deal if Halliburton had simply made the offer without any planning ahead, since the combined company would control too much power and would be able to create a virtual monopoly. However, Halliburton has already said that they are willing to sell off parts of their business that generate $7.5 billion in revenues in order to convince regulators to okay the deal. $7.5 billion for Halliburton is almost 1/4 of their total revenues, and it’s extremely doubtful that regulators would still not allow the deal if Halliburton is willing to chop off 1/4 of its businesses to get it done. Also, if the deal does indeed not go through for some improbably reason, Baker Hughes has also offered Halliburton a $1 billion breakup fee, meaning that the total amount Halliburton would lose would only be $2.5 billion.

Halliburton is a strong company with strong growth prospects riding through the American oil boom. The acquisition of Baker Hughes would only strengthen its industry position, and would let it dominate the oil services market, surpassing rival Schlumberger. Halliburton’s drop on this deal is completely unwarranted, along with the recent slump of oil prices. The company is in a great position right now, and will be even better once the Baker Hughes deal goes through.

Gilead (GILD) High Growth Potential

Gilead is a leading biotechnology company that specializes in hepatitis C curing. They are best known for their biggest drug: Sovaldi. The company has achieved stellar growth in the past two years, but is still priced at a very cheap valuation and has very high growth prospects for the future.

Undervalued

The primary reasoning for Gilead’s low valuation (forward P/E ratio of just 10) is that there are fears that Sovaldi, which generates nearly 50% of the company’s revenues, is priced too high and would not generate enough sales. This has already turned out to be a misconception, however, since the drug has already generated massive revenue streams for the company, and has proved that people would still buy and use the drug despite the price tag. Also, Sovaldi is easily the leader in the hepatitis C industry, since it has both the safest and most successful results for curing hepatitis C. Therefore, Gilead does not deserve this low-valuation multiple, and, based on the company’s success in the past and its massive pipeline that has a lot of potential for the future, is at least worth twice as much as its current market cap.

Growth Potential

Gilead’s management has already demonstrated its ability to dominate a health care industry, as they did with Sovaldi and hepatitis C. They can easily carry this ability into other industries, and are certainly trying to, with drugs for HIV/AIDs, Oncology (tumors), and Cardiovascular and Respiratory diseases in their pipeline. Also, Gilead has barely scratched the surface of international sales, with international Sovaldi sales for the first quarter of 2014 at just $200 million, while American Sovaldi sales were at $2 billion. With the rest of Gilead’s products at a 60-40 domestic to international sales ratio, Sovaldi has a lot of room to grow internationally.

Gilead is an undervalued company with an impressive, industry-dominant position. They still have a lot of growth potential ahead of them through international sales and their large pipeline, which the market is discounting due to a supposed high-pricing of their main drug, Sovaldi. This concern is misguided, however, since the drug has been performing fabulously since its inception, and should do even better in the future, once international sales get underway.

Halliburton (HAL) High Growth Prospects

Halliburton provides services to oil companies for the exploration and development of oil. The company’s share price has fallen considerably in the past few months due to a falling crude oil price, providing potential investors with an excellent opportunity for a buy.

American Oil Production

America is becoming much less reliant on foreign countries for oil, and this oil independence is causing the American oil production business to thrive. One of the prime benefactors of this shift in oil production is Halliburton, since they generate almost 50% of total revenues from America. their services and equipment are also of utmost importance when it comes to drilling and refining oil, so an increase in American oil production will likely provide a catalyst for a large uptrend in the share price. Halliburton’s ability to grow has already been shown in the past two years, when the company achieved 50% gains both years on the back of American oil production growth.

Undervalued by P/E Ratio

Halliburton’s 10-year and 5-year average P/E ratios are both around 15, while the current forward P/E ratio is just 10. This historically low P/E ratio is quite unjustified, as the current oil situation in America would only cause the company to have better prospects for the future, not the opposite. The market is currently pricing Halliburton for a 25% decline that would bring it back to its historic P/E ratio of 15, but the company’s future growth prospects look favorable for a high-growth scenario, which leads to the current stock valuation to be extremely conservative and inaccurate.

Short-Term Decline

In the past 3 months the company’s stock has already dropped 25% from highs due to a short-term worry that crude oil prices will continue to fall. This kind of a drop has plagued the entire energy sector, although the validity of the worries are very questionable. The oil bears are citing oversupply and under-demand as reasons to be short oil. However, taking a very conservative stance on the situation, oil companies have already been hammered by the fears of oil prices dropping and global economic worries, and are already priced at such absurd levels that they are already anticipating future losses. That means that the current valuations for oil companies are exceedingly low, built on fears that oil will head even lower, and already pricing in a further 15% or so of a drop in oil prices, This fear, however, is best categorized as a short-term worry that will dissipate within the next few months.

Halliburton is undervalued company because of short-term worries that will likely be gone in the next quarter or so. They also have considerable growth prospects because of America becoming more oil independent.

Micron (MU) High Growth Prospects

Micron specializes in making DRAM chips and NAND products, and occupies a dominant portion of those fast growing industries. The company is well known now for its 500% gains from just 2 years ago. However, intimidating as it is to buy into such a stock now, I believe Micron still has substantial growth ahead of it.

Large Barriers to Entry

Almost all of Micron’s ability to grow lies in the maintaining of its semiconductor chip industry power. PC sales growth as well as the common popularity of iPhones has allowed Micron to rack up substantial gains, considering its dominant place in the industry that supplies the chips for these electronics.  Naturally, however, the company would also be at a great risk if other corporations were to invade the industry, stealing away precious market share from Micron. That would be very unlikely to happen, however, as there are various barriers to entry in the semiconductor chip market: advanced technology and skilled workers are necessary for the production of semiconductor chips, initial investments for getting into the industry are high, and Micron already has the rights to thousands of patents that they made to protect their products.

Low Current Valuation

The current valuation reflect a lot of fear baked into a company that is quite unjustified. A trailing P/E ratio of 13 and a forward P/E ratio of just 8 are both well below the market’s, which makes little sense, as Micron has already demonstrated its exceptional ability to grow, and there is no foreseeable headwind for the company in the future. These valuations most likely reflect the fear of newcomers to the semiconductor chip market that would thereby cause Micron to lose market share, but the point against that scenario was already made in the previous paragraph. Micron’s valuation is exceptionally low for such a fast growing company, and therefore provides investors with a large margin of safety for buying into a high growth stock.

Hedge Fund Investors

Large hedge funds absolutely adore Micron as a stock; David Einhorn and Seth Klarman lead the pack with Micron as their largest holdings (19% and 34% of their total portfolios, respectively). Also, over 20 of the world’s largest hedge funds own Micron as a holding that is more than 5% of their total portfolios. This kind of trust put into a company by such a large amount of hedge funds shows that many of the world’s greatest investors consider Micron to be a strong investment, and are also more than willing to put their money where their mouth is.

Micron is a high growth company with minimal risks, the largest of which is just speculation and can be disproved by a variety of factors. Large hedge funds are also heavily invested into the company, and its low valuation and high growth prospects lead it to boast an extremely favorable risk to reward ratio.