Baker Hughes Swings To Q1 Loss On Lower Activity And Pricing Pressure

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Baker Hughes (NYSE:BHI), the third largest oilfield services provider, posted a tough set of Q1 2015 numbers that missed market expectations on both revenues and earnings. Quarterly revenues fell by about 20% year-over-year to $4.59 billion, while adjusted net losses stood at about $32 million, versus a profit of about $369 million during the same period a year ago. ((Baker Hughes Q1 2015 Earnings Press Release)) While oilfield services companies across the board have been hurt by lower activity levels and strained upstream capital budgets, the impact of the current downturn on Baker Hughes has been more pronounced, owing to its heavy exposure to the North American land drilling market and potentially due to circumstances relating to its pending merger with larger rival Halliburton. Here’s a quick look at the trends that impacted earnings and what to expect going forward as the company prepares to be absorbed by Halliburton.

Trefis has a $71 price estimate for Baker Hughes, which is slightly ahead of the current market price. We are currently updating our valuation model and price estimate for the company.

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Activity Reductions And Pricing Pressures Weigh On Results

Baker Hughes’ North American operations saw a sharp decline in activity, with revenues falling by about 28% year-over-year to about $2 billion, while pre-tax margins swung to -10% from about 9% a year ago. This compares to revenue declines of about 9% and 13% respectively for Halliburton and Schlumberger. The North American oilfield services market is primarily driven by tight oil activity, which has higher marginal costs of production and shorter planning horizons that allow operators to respond to the commodity cycle more quickly. Activity has dropped sharply since the beginning of this year as the lower FY2015 upstream budgets took effect. Upstream spending in North America is expected to fall by an estimated 30% in 2015 and the U.S. oil rig count is already down by about 50% year-to-date, leading to a broad-based decline in drilling and completions activity. Pricing pressure has also been significant and Baker Hughes noted that equipment for services such as pressure pumping, coiled tubing, and wireline services has been seeing a significant oversupply in the market.

While the international oilfield services market has proven to be a lot more resilient compared to North America (the international rig count is down by just about 9% from its 2014 peak), Baker Hughes still saw international revenues fall by roughly 12% owing to large declines in business in the Middle East/Asia and Europe/CIS/Africa regions. Separately, the company also said that it had increased its headcount reductions to about 10,500 positions or roughly 17% of its total workforce, about 3,500 positions higher than it had previously announced. The company also closed or consolidated about 140 facilities around the world and noted that it was working with supplier to lower its input costs. Together, these actions are projected to reduce costs by more than $700 million on an annualized basis.

Merger With Halliburton Should Help Weather The Downturn

The near-to-medium term outlook for the company remains very challenging and we believe that the full impact of the current market conditions will only factor into earnings in the quarters to come as higher-priced contracts end and as new contracts are negotiated at lower rates. That said, we believe that the pending merger with Halliburton should allow the combined company to weather the downturn much more effectively. The combination of the broader geographical presence and deeper product portfolio of the combined company should be beneficial in the current environment. The deal, which received shareholder approval last month, is slated to close later this year subject to the approval of antitrust regulators and the divestiture of some assets by the two companies.

As we’ve noted before, Baker Hughes’ shareholders appear to be on the more lucrative side of the transaction. Shareholders will receive 1.12 shares of Halliburton stock along with a $19 in cash for each Baker Hughes share held, essentially giving them a significant cash premium, while allowing for a greater upside opportunity through their ownership of stock in a more stable combined entity. Halliburton has historically posted better margins compared to Baker Hughes and its revenue growth has also outpaced its smaller peer. Additionally, Halliburton’s management has a solid track record of execution and has also proven to be adept at managing industry downturns in the past.

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