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Analysts Are Super Bullish on Baker Hughes

February 25, 2014 | About:

The shares of the third largest oilfield services firm Baker Hughes (BHI) surged yesterday after analysts at Raymond James upgraded the stock to strong buy. The company is set to benefit from the increasing prices of pressure pumping due to a rise in demand of fracking services caused by an increase in the natural gas prices. This positive commentary comes just weeks after the company released its quarterly results in which it managed to beat both top and bottom line estimates.

In its results for the final quarter, Baker Hughes delivered an impressive performance, driven by strong growth in international markets, particularly in the Middle East, Africa and Asia Pacific regions. This comes despite the temporary shutdown in Iraq, which had an adverse impact on the bottom line.

In the fourth quarter of 2013, Baker Hughes reported a 10% year-over-year increase in revenues to $5.86 billion while net income increased by 16% to $248 million, or $0.56 per share. This translated into adjusted earnings of $0.62 per share. The company has surpassed Wall Street’s estimates of earnings of $0.61 per share from $5.68 billion in revenues. Analysts’ estimates typically exclude the one-off items and therefore, they correspond with the adjusted, or non-GAAP, earnings.

In the meantime, the suspension of operations in Iraq dragged Baker Hughes’ profits by $0.18 per share.

North America is the primary market for Baker Hughes as the company gets 47% of its revenues from this region. Here, Baker Hughes reported a 7.2% year-over-year increase in revenues to $2.74 billion. Analysts at Raymond James have predicted strong 17% growth in Baker Hughes’ North American revenues in 2014.

Baker Hughes has been doing an overhaul of its U.S. pressure pumping business which has caused an increase in margins in this business in all the quarters of the previous fiscal year. This trend will likely continue in the future. In pressure pumping, Baker Hughes faces tough competition from Halliburton (HAL) who is the biggest player in the domestic industry.

In terms of growth, Baker Hughes has reported even better results in Europe/Africa/ Russia and Middle East/Asia Pacific regions where it witnessed a double digit growth rate.

Segment Revenue

4Q12

(Million)

4Q13

(Million)

Change %

North America

$2,559

$2,744

7.2%

Latin America

$639

$603

-5.6%

Europe/Africa/ Russia

$950

$1,046

10.1%

Middle East/Asia Pacific

$882

$1,121

27.1%

Despite favorable pricing in pressure pumping, Baker Hughes reported a decline in profit margins (before taxes) to 8% from 9% in the prior year. This was largely due to an unfavorable product mix in the Gulf of Mexico and lower activity in Canada. Moreover, severe weather conditions and the holiday season exacerbated the situation.

Baker Hughes was able to increase its margins in only one region: Latin America. Here, Baker Hughes reported an enormous increase in profit margin from just 1% in the same quarter of 2012 to 10% in the fourth quarter of 2013. This was due to strong activity and higher sales in Argentina and Columbia.

Moreover, the profits of the leading oilfield services firms, such as Baker Hughes and Schlumberger (SLB), have been hurt by the suspension of operations in southern Iraq. Baker Hughes suspended all of its operations in Iraq for nearly a month. If it had not been for the disruption, Baker Hughes would have reported year-over-year increase in profit margins for its Middle-East/Asia Pacific segment by 500 basis points.

Baker Hughes, however, remains optimistic about its future in Iraq and a significant increase in rig count in the country is expected in the future. The good news is that the company is now operating at its pre-disruptions rig count in Iraq. Although all of the rigs are not operating at full capacity, they are quickly getting there.

In North America, Baker Hughes has predicted a recovery in margins by “at least 150 basis points’ in the first quarter of 2014. This was already being expected in the first quarter due to the absence of the holiday season. The company has also stated that it expects its U.S. onshore rig count to remain flat in 2014, but due to higher drilling efficiency, the well count is expected to increase by 5%. The company is also expecting a 10% increase in its international rig count in 2014.

Conclusion

Baker Hughes’s performance, particularly its high growth rates in Europe/Africa/ Russia and Middle East/Asia Pacific regions, clearly shows the company is making inroads in the international markets. Although Baker Hughes has reported declining margins in nearly all of its operating regions, it is expecting recovery in the current quarter. Moreover, it continues to improve its profitability in the pressure pumping business.

Baker Hughes’ shares have risen by 33% in the last six months, easily outperforming Schlumberger and Halliburton in the corresponding period. Due to the rally, Baker Hughes’ shares are not cheap as they trade at a forward price-to-earnings ratio of 15.6 and a trailing price-to-earnings ratio of 25.6. Analysts at Raymond James, however, have suggested a price target of $80, which represents an attractive upside of 27% from the current price levels.

Disclosure: This article was written by Sarfaraz A. Khan, with valuable contribution from Gohar Yousuf, research assistant at Half Bridge Business Review. Neither Sarfaraz A. Khan, nor Gohar Yousuf have any positions in the stock(s) mentioned in this article.

About the author:

Sarfaraz A. Khan
Sarfaraz A. Khan is a capital market analyst and finance writer. His specialty lies in energy stocks. He also covers consumer goods, services sector, technology stocks, emerging markets and ETFs. His work appears on TheStreet, Seeking Alpha, Motley Fool and GuruFocus.

Visit Sarfaraz A. Khan's Website


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