Baker Hughes Q4 Preview: Cost Cutting And Overseas Operations In The Spotlight

Oil field services major Baker Hughes (NYSE:BHI), is set to release its Q4 2012 earnings on January 23. Like most large oil field service companies, the firm’s results have been set back by a weak North American market and high input costs over the past few quarters. In Q3, the firm reported revenue growth of 3% while operating margins were down by nearly 50%, compared to the previous year. Things don’t seem to have improved much this quarter either with the firm warning that it could witness margin contraction once again on the back of continued pressure in North America and certain delays and a decline in rig count in some international markets. Here’s what to look for when the firm releases earnings Wednesday.

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North America: Pressure Pumping Improvements In Focus

The firm’s North American operations account for more than half the firm’s revenues. For this quarter, the firm expects profit margins from the region to be between 8.5% and 9.5%, down from around 11.7% in Q3 due to its heavy exposure to the oversupplied pressure pumping market and a decrease in land based drilling. ((Baker Hughes Press Release))

The overall North American rig count declined by around 15% over the last year while the number of gas rigs declined by around 45% as low natural gas prices prompted oil and gas companies to cut down on gas drilling. This has driven down demand and pricing for pressure pumping services like fracking that are used to extract gas from shale rock formations, severely impacting margins of most large oil field firms including Baker Hughes. Additionally, the firm’s margins were also squeezed by higher costs for guar gum, which is a raw material used in the fracking process. In response to the margin decline, the firm has been holding back on capital expenditures and focusing on cutting costs for pressure pumping by improving utilization levels and exploring alternative technologies. (See Also: Transitioning Fracking Fleet To Natural Gas Can Help Baker Hughes Improve Margins) Although we believe that a complete revival in the pressure pumping space will be contingent on the recovery of gas prices, we will be watching the firm’s progress in improving operational efficiency.

The trend has been more encouraging on the oil drilling front, with the number of rigs growing by around 6% for the year as the United States in particular ramps up oil production. The U.S. is expected to become the world’s largest oil producer by the end of this decade, leveraging unconventional resources like shale oils and tight oils. This could help the firm in improving its revenues going forward. 

International: Middle East Operations In Focus

For the fourth quarter, Baker Hughes expects international operations to be impacted by a lower rig count in Brazil and Columbia and activity delays in the North Sea. The firm expects operating profit before taxes for Q4 to be around 12%, which are similar to margins seen in Q3.

We will be interested in tracking the firm’s progress in Iraq where it has bagged contracts over the past two years for drilling in the West Qurna-2 and Zubair oil fields. While the drilling market in the country holds huge potential given that the  country’s holds as much as five times the gas reserves of the U.S., the firm’s operations in the region have been slow to pick up. The firm has been experiencing high start-up costs relating to equipment movement and logistical issues. Institutional inefficiencies and a lack of clarity in rules have also been impacting the firm’s operations in the country.

International unconventional plays are a target for most large oil field service firms, who are presently dependent on the U.S. for their unconventionals business. Baker Hughes has been slowly gaining ground in unconventional plays in Saudi Arabia, a country which could hold the world’s fifth largest shale gas reserves. ^[1] Given the head start and existing infrastructure that Baker Hughes has in the region, it could provide a solid growth opportunity in the future. We will be watching the firm’s progress in bagging contracts expanding its reach in this market as well as other countries rich in unconventional plays like China.

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1. Saudis May Have Fifth-Largest Shale Reserves, Baker Hughes Says, Bloomberg [↩]