Baker Hughes Has A Good Quater As North American Margins Expand

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Baker Hughes (NYSE:BHI) released its Q2 2014 earnings on July 17, reporting a strong set of results that beat market expectations on both revenues and earnings. The company’s results were driven by higher global upstream activity, improvements to its North American pressure pumping business, new product introductions and market share gains in some key offshore regions. Quarterly revenues rose by around 8% year-over-year to around $5.93 billion while profit before tax margins rose from around 9% to around 13%. [1] The company could see its earnings grow through the remainder of the year as well, owing to higher international rig counts and an expanding well count in North America. In this note we take a look at some of the key factors that aided the company’s earnings for the quarter.

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North America Drives Margins Improvement

Baker Hughes’ North American operations benefited from higher onshore and offshore activity in the United States, although Canada remained lackluster due to the seasonal spring breakup, which lowered drilling activity. Baker Hughes’ pressure pumping business, which had been a source of margin pressure for the company in recent months, was one of the key drivers of the North American business, while new product introductions and better offshore activity also likely helped improve margins. Revenues from North America rose by around 6% year-over-year to about $2.84 billion, while margins improved from around 8% a year ago to around 12%.

Pressure Pumping Improvements Driven By Permian Demand: The pumping product line accounts for about 20% of the company’s global revenues (FY 2013) and remains one of the crucial drivers of Baker Hughes’ North American business. Although the company doesn’t break out financials for individual product lines, it noted that the pumping division had seen an uptick in margins. Higher unconventional drilling activity in the Permian basin, which is one of the most prolific oil producing regions in the United States, was a key driver of the pumping demand growth. The overall well count in the Permian was up by around 18% year-over-year during Q2 and the basin accounted for close to 30% of all wells drilled in the U.S. during the period. An increasing proportion of the wells drilled in the basin are horizontal wells, which require fracking to unlock their hydrocarbon reserves. The number of horizontal rigs in the basin has jumped by nearly 70% year-over-year, indicating that demand could remain strong, as more horizontally-directed wells are drilled. ((Permian Basin Rig Count by Type and Target, Energy Economist, July 2014)) Baker Hughes has also been seeing the service intensity of its pumping operations improve. This has translated into higher stage count and pressure pumping volumes, which should aid the company’s top line. The pumping operations could see their margins improve through the remainder of the year, aided by a further tightening of excess horsepower in the market which should lead to better asset utilization and higher revenues per stage.

New Product Introductions: Baker Hughes noted that new products introduced over the last two years accounted for roughly 35% and 50% of the company’s total revenues for the quarter. [2] This is likely to be one of the drivers for higher margins for the quarter. Some new technology deployments that have been seeing strong demand in North America include the company’s well construction and production technologies such as hybrid drill bits and production solutions.  New products typically bring in better margins compared to existing products, making them a key driver for earnings growth.  Previously, the company had indicated that new product revenues would touch $1 billion this year, with the number growing by around 20% year-over-year over the next several years.

Shift From Drilling To Completion Activity In Gulf Of Mexico: Offshore activity in the United States has remained strong, with the average offshore rig count in the U.S. rising by 7% year-over–year to around 56 rigs during Q1. The company noted that the rising market share in areas such as drilling services and strong sales of completion products helped its operations in the Gulf of Mexico grow sequentially. Going forward, Baker Hughes could benefit from the increasing proportion of deepwater rigs in the region performing completions work – an area where it has a competitive advantage. In general, deepwater services are quite lucrative for oilfield companies because they have  high service intensity, long contract lives and they allow companies to provide integrated services. Higher deepwater activity levels could help to boost the company’s margins in the long term.

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Notes:
  1. Baker Hughes Q2 2014 Earnings Press Release, Baker Hughes, July 2014 []
  2. Baker Hughes’ (BHI) CEO Martin Craighead on Q2 2014 Results – Earnings Call Transcript, Seeking Alpha, July 2014 []