Baker Hughes 2Q Preview: Lower US Drilling Activity to Drive Down Results

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Oilfield services major, Baker Hughes (NYSE:BHI), which continued to face a tough quarter due to the sluggish upstream spending on the back of weak crude oil prices, is scheduled to release its second quarter performance before the market opens on Tuesday, 21st July 2015 [1]. However, since the company’s merger with Halliburton (NYSE:HAL), its closest competitor, is still underway, it will not conduct a conference call to discuss its quarterly results. We expect the decline in the US drilling activity (indicated by the low US oil rig count) to have a prominent impact on Baker Hughes’ top line, as the company has a large exposure to the North American land drilling market. In addition, the impact of the reduced drilling activity in the last quarter will also be visible in this quarter’s results. Here’s a quick look at what we expect from Baker Hughes’ 2Q results.

We will be updating our price estimate and rig count forecasts post the earnings release.

See Our Complete Analysis For Baker Hughes here

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Weakness In US Drilling Demand Pulls Down Baker Hughes’ Top Line

Similar to its largest rival Halliburton, Baker Hughes also derives almost half of its revenues from the North American market, which is dominated by shale and tight oil projects which have higher marginal costs of production and shorter planning horizons. In the midst of plummeting crude oil prices, North American oil companies, who rely on large amounts of debt to finance their drilling activities, have cut back on their exploration and drilling budgets. Consequently, the US oil rig count fell sharply from 1,482 units at the beginning of the year to 628 at the end of the June quarter((Baker Hughes Rig Count)). Thus, we estimate this notable drop in US drilling activity to weigh heavily on Baker Hughes’ revenues for the latest quarter.

However, the drilling activity in the international market has not declined as steeply as the North American market. During the latest quarter, the international oil rig count dropped by around 13% on a year-on-year basis as opposed to a more than 50% fall in US oil rig count in the same period((Baker Hughes Rig Count)). As a result, we believe that Baker Hughes’ international exposure will dampen the effect of the sharp plunge in the US drilling activity. The market estimates the company to report a revenue of $3.88 billion for the quarter, 16% lower on a sequential basis.

Oil rig count

Source: Baker Hughes Rig Count

Further, the fall in demand for US drilling equipment has enabled the customers to negotiate better pricing for new contracts, reducing the pricing power enjoyed by large oilfield services companies, including Baker Hughes. Accordingly, we expect the company’s margins to suffer due to the lower margins generated on the newer contracts, leading to a drastic decline in its bottom line. The analysts expect the company to register a loss of 9 cents for the June quarter.

Shift In Revenue Mix Could Be A Silver Lining

While Baker Hughes’ drilling revenues are expected to take a hit due to the falling rig count, its production-related offerings could bring some relief for the company. With the lower drilling activity and cost deflation, most of the oil and gas companies will aim at maximizing their productivity and flow rates on already drilled wells (Read: Recent Trends In The U.S. Land Drilling Market: Re-fracking, Growing Well Inventory, Lower Rig Counts). Consequently, the demand for production-oriented services, such as pressure pumping, is expected to go up. Since these services constitute a significant portion of Baker Hughes’ revenues, such trends could ease the pressure on the company’s top line.

Merger With Halliburton Will Help Face The Downturn

The high profile merger of the two oilfield services giants, Baker Hughes and Halliburton, has received the approval of the shareholders of both the companies and is expected to be closed by the end of the year, subject to the regulatory approvals and divestiture of some assets by the two companies((Halliburton and Baker Hughes Provide Update On The Merger)). The deal will broaden the geographical presence and widen the product mix which will better equip the combined entity to face the current downturn, despite the uncertain outlook of the industry.

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Notes:
  1. Baker Hughes Announces 2Q15 Earning Release Date []