3Q Earnings Review: Cost Reduction Efforts Allow Baker Hughes To Beat Market Earnings Estimate Even In A Challenging Environment

Baker Hughes (NYSE:BHI), the world’s third largest oilfield services contractor, announced a positive set of third quarter results on 21st October 2015 ^[1], exceeding the consensus estimate for revenue as well as earnings. Despite the fact that the weakness in the US drilling demand pulled down the company’s top line, the Houston-based company managed to post an improvement in its bottom line driven by its right-sizing efforts to control its operational costs. While the outlook for oil markets remains challenging, the company expects its production offerings to pick up due to the shift of customers towards products that optimize production from existing wells and increase ultimate recovery. Over the next couple of quarters, we expect to see a drop in Baker Hughes’ top line due to the depressed oil prices, while its earnings are likely to be resilient due to its cost reduction initiatives and better performing international markets. Here we discuss the key highlights of the company’s September quarter earnings release and its outlook going forward.

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Resilient International Markets Augment Baker Hughes’ Earnings

Baker Hughes reported third quarter revenue of $3.8 billion, down 5% sequentially and 39% on a year-on-year basis ^[2], largely due to the weak drilling demand in the US. Given the plummeting oil prices, the US rig count dropped to 838 units at the end of the September quarter, representing a 54% decline since the beginning of the year, while the international rig count plunged a little over 13% during the same period. Thus, while the North American operations continued to create a dent on the company’s revenues, the international markets remained resilient, dampening the effect of declining US drilling activity during the latest quarter.

Source: Baker Hughes Form-10Q, 21st October 2015

The oilfield services company suffered an adjusted loss (Non-GAAP) of $22 million, or 5 cents per share compared to a loss of $62 million, or 14 cents per share posted in the last quarter. This improvement in its bottom line was attributable to its cost cutting initiatives and better-than-expected results from the international markets. Going forward, the company will remain focused on proactively managing its cost structure, efficiently reducing its working capital, and strategically targeting revenue opportunities to survive the current downturn.

Source: Baker Hughes Form-10Q, 21st October 2015

Shift In Product Mix Is Likely To Improve Future Revenues and Margins

Since the timing of the oil price recovery is unknown, most of the oil and gas companies continue to hold back their upstream spending and aim to optimize the productivity and flow rates of their existing wells through better services. This could be good news for Baker Hughes, as these production-oriented services, such as pressure pumping, constitute a significant part of the company’s production offering, and an increase in demand for these services could boost the company’s declining revenues. To tap this new opportunity, the company has proactively launched a new product, or segment, called DeclineShift, which is a consulting and optimization execution service that will be used to improve the performance of assets experiencing a decline in production, rise in operating costs, or a combination of both. This new service will enable the company to attract more customers and stop its revenues from dropping further. Since, Baker Hughes has significant in-house expertise to offer this value-added service to the customers, it will be able to generate higher margins from this product, that will, in turn, improve its earnings.

Committed Towards Closing The Merger

Despite facing a number of regulatory hurdles, Baker Hughes and Halliburton have been committed towards completing the proposed merger by the end of 2015. Baker Hughes has announced the sale of its core completions business (packers, flow control tools, and subsurface safety systems), its sand control business in the Gulf of Mexico, and its offshore cementing businesses in Australia, Brazil, the Gulf of Mexico, Norway, and the UK, while Halliburton will divest its expandable liner hangers business, in addition to its drill bits and drilling services business worth $7.5 billion. However, it is yet to be seen if these divestitures would be sufficient to obtain the anti-trust clearances. The two companies expect to generate synergies of almost $2 billion from this merger. In order to complete the merger within 2015, the two companies need to obtain regulatory approvals from the US Department of Justice’s (DOJ) antitrust department, at the latest by 15th December 2015. However, the companies do have an option to extend the merger completion to early 2016. While we agree that the merger could provide an upside to Baker Hughes’ investors, the timing of the merger completion would play a crucial role in determining the magnitude of this upside.

Source: Google Finance

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1. Baker Hughes Announces 3Q Results, 21st October 2015 [↩]
2. Baker Hughes Form-10Q, 21st October 2015 [↩]