Oil field services major Baker Hughes (NYSE:BHI) will release its third quarter earnings on October 19. We expect the company to report sequential revenue and margin growth in its international operations owing to a recovery in global oil prices during the quarter. In the North American region, which contributes to over half of the company’s valuation, we expect revenues and margins to be strained due to a weak rig count and the company’s heavy exposure to the pressure pumping market.
Margin Pressures In North America Despite Falling Guar Prices
The North American rig count dropped by 6% over the quarter while the number of rigs directed at gas exploration fell sharply by 20%.  Depressed natural gas prices coupled with growing overcapacity of fracking equipment are causing severe competition in the market for hydraulic fracturing services, hampering the company’s pricing power.
On the cost front too, we believe the company will continue to experience pressures despite the falling price of guar gum, a key raw material used in hydraulic fracturing. Guar prices have declined by around 60% since March, but we do not expect this to have a significant impact on the margins as the company is expected to consume from the inventory procured at higher rates in the second quarter. Given the oversupply of fracking equipment, the company will find it difficult to pass on the costs to the customers.
The drop in US activity should be marginally offset by the increase in drilling activity in the Gulf of Mexico and the seasonal increase in activity in Canada; however, margins are expected to remain weak in Canada due to poor market conditions.
International Results Expected To Be Encouraging
The international rig count has remained largely flat despite the recovery in global oil prices. However, results from the international operations are expected to be encouraging as the company has lower exposure to the global pressure pumping space and enjoys better pricing power for its services. The company has also been focusing on improving its international margins by realigning its supply chain by sourcing from lower cost locations.
We expect the company to post strong results for its Europe/Africa/CIS operations on an increase in the European offshore rig count and renewed demand from the African market. Latin American operations are also expected to receive a boost due to the shift to higher revenue services. In the Middle East, the long-term contract wins in Saudi Arabia and the rapidly increasing upstream activity in Iraq should help the company post strong numbers.
We will revisit our $59 price estimate for Baker Hughes, which represents a 32% premium over the current market price, following the earnings release.Notes: