Halliburton Cut to Underperform

Following Halliburton Company’s ( HAL - Analyst Report ) second quarter profit warning, we have downgraded the oilfield services behemoth to Underperform from Neutral.

Houston, Texas-based Halliburton is one of the largest oilfield service providers in the world, offering a variety of equipment, maintenance and engineering and construction services to the energy, industrial and government sectors. The company operates under two main segments: Completion and Production, and Drilling and Evaluation.

Halliburton recently cautioned investors that a higher-than-expected spike in the cost for guar gum – a key constituent of the company’s market-leading hydraulic fracturing ('fracking') procedure – will adversely impact its second quarter results.

Guar gum, a bean grown mostly in India, apart from being a dairy products thickener is also a main ingredient of the fracking process, which is used to extract natural gas by blasting underground rock formations with a mixture of water, sand and chemicals.

As per Halliburton, demand for guar gum has gone through the roof in North America following the growing use of fracking in the extraction of oil and natural gas liquids from shale. This has led to concerns about the commodity’s potential shortage later in 2012, thereby driving up guar gum prices more rapidly than previously expected.

The rising costs, according to the company, have affected its second quarter profitability in North America. The world's second-largest oilfield services firm after Schlumberger Ltd. ( SLB - Analyst Report ) now sees margins in the region to be down by 300 basis points more than the previous forecast of a 200–250 basis points squeeze, implying a 500–550 point drop from the first-quarter levels.

Additionally, the North American land rig count, which has experienced strong upward momentum over the last twelve months, may plateau in the near future as growth in highly-productive horizontal drilling has led to a natural gas supply overhang and relatively weak natural gas prices in the U.S. market. This is likely to be only partially offset by the continued growth of oil- and liquids-rich reservoirs. A slowdown in U.S. land drilling will adversely impact Halliburton’s business.

Lastly, we expect Halliburton shares to remain soft until it fully works its way through claims related to the Deepwater Horizon incident. We are also concerned by the slow and geographically uneven recovery in Halliburton’s international markets.

Given these concerns, we expect Halliburton to perform below its peers and industry levels in the coming months. As such, we see little reason for investors to own the stock.