Baker Hughes Price Estimate Raised To $70, Here’s Why

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Baker Hughes (NYSE:BHI), one of the world’s largest oilfield services companies, has seen its business steadily improve over the last several quarters, driven by improving market conditions, new product introductions and operational efficiencies. The company recently posted a strong set of Q1 2014 numbers, beating market expectations on both earnings and revenues (related: Baker Hughes Q1 Results Driven By Eastern Hemisphere Activity). In light of the improving performance and prospects, we have increased our price estimate for the company from about $59 to $70, which is about in line with the current market price. In this note, we take a look at some of the key trends driving the company’s valuation.

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Growth In The Middle East and Asia

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Oilfield services activity in the Middle East and Asia Pacific region has been growing at a rapid pace. This has come from stronger spending from national oil companies in the Middle East as well as due to higher upstream activity levels in countries such as China and Australia. Baker Hughes expects the compounded market growth rate for the geomarket to stand at roughly 10% through 2016. The company’s business in the region has been growing faster than the broader market in recent quarters and we believe that this trend could persist in the near term.

In China, for example, the government plans to double the share of natural gas consumption from about 5% of the country’s total energy mix to about 10% by 2020. Baker Hughes’ expertise in unconventionals and pressure pumping should prove valuable, since much of the growth in oilfield services spending in China could come from unconventional plays. The costs of shale wells in China are significantly higher compared to those in the United States and this could bode well for the company’s margins. [1] Baker Hughes could also see stronger uptake for its suite of artificial lift products in China, given the possible need to replace older rod lift pumps that are prevalent in the country’s oil industry. [2]

Baker Hughes has also been ramping up its presence in Iraq over the last few years. Iraq has emerged one of the world’s fastest growing oil exporters, after decades of stagnation, as large operators such as BP (NYSE:BP), Shell, Eni and Exxon Mobil (NYSE:XOM) have bagged contracts in the country. [3] While Baker Hughes’ Iraqi business is currently loss-making, the company expects margins to improve going forward.

Recovery In North America

Baker Hughes’ North American operations account for about half of the company’s total revenues. Business in the region should do better going forward on the back of stable commodity prices and better spending by oil companies. According to Barclays Capital, oil companies in North America will see capital spending grow by roughly 7% this year to about $156 billion. Baker Hughes could benefit from a recovery in the market for pressure pumping services, which had been impacted by an oversupply of horsepower and stiff competition from smaller companies. The excess horsepower in the market has been tightening much faster than expected due to higher service intensities as well as due to growth in unconventional drilling activity in the Permian basin.

New Product Introductions and Recent Deals

Baker Hughes expects new product revenues to touch around $1 billion this year, with the number growing by around 20% year-over-year over the next several years.  New products typically bring in better margins compared to existing products that are in the market, making them a key driver of earnings growth. Besides internal developments, the company has also been focusing on acquisitions and collaborations to improve its product portfolio. For instance, it acquired Perfomix, an oilfield software technology company that provides tools to enhance the performance of oil and gas reservoirs (related: Baker Hughes Focuses On Reservoir Productivity With Perfomix Acquisition). The company also inked a joint venture with Norway’s Aker Solutions to develop technologies that will reduce costs and increase the production and recovery rates for subsea wells (related: Baker Hughes’ Aker Solutions Alliance Highlights The Importance Of Subsea Technologies).

Increasing Distributions To Shareholders

Baker Hughes repurchased about $200 million worth of shares during Q1 2014 and around $350 million worth of shares in Q4 2013. The company still has around $1.45 billion remaining under its current share buyback authorization. While Baker Hughes’ buybacks haven’t been as large as its peers Halliburton and Schlumberger, they have been quite effective in bolstering the company’s stock price. Baker Hughes also recently increased its quarterly dividend from the usual $0.15 per share that it had been paying over the last 5 years to about $0.17, in line with its increased earnings. We believe that the increasing distributions to shareholders are a reflection of management’s confidence in the company’s future earnings prospects and business outlook.

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Notes:
  1. China Seen Outspending U.S. Drillers to Chase Shale-Gas Boom, Bloomberg, May 2014 []
  2. Baker Hughes Incorporated 2014 Analyst Conference, Baker Hughes, May 2014 []
  3. Iraq sees hefty return to oil growth in 2014, Reuters, Oct 2013 []