Similar Symptoms, Even Similar Diagnosis do not Imply Similar Treatment

By Ankit Agrawal - September 18, 2012 | Tickers: BHI, HAL, SLB | 0 Comments

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Major oil and gas companies like Baker Hughes (NYSE: BHI), Halliburton (NYSE: HAL) and Schlumberger (NYSE: SLB) have been facing some issues regarding commodity prices, lower demand, etc. Although these companies are facing similar issues, they are handling these issues in different manner. Whose strategies will prove to be most fruitful? This article is all about the answer of this question. Before going further, let’s have a look at the recent important updates given by these companies.

• Baker has given the indication that pricing has bottomed in dry-gas basins while the decline is stable in the Permian and Bakken whereas it is slowing in the Eagle Ford. I believe this is an incrementally positive data point as there have been worries of pricing declines in the Permian and Bakken.

• Last month, Halliburton updated its 2012 and 2013 outlook. Now, 210 bps reduction in margins due to high-cost guar inventory and 250-300 bps margin deterioration due to pricing pressures are expected.

• Schlumberger has indicated that it has increased focus on technology in existing contracts which tends to be higher margin products and services. I believe field reliability and technology have always been important drivers of new contract awards.

The following chart summarizes the stock price movement of SLB, BHI and HAL:

Source: Ycharts

It’s not a brain teaser to find out that these three industries should have same trend of stock price movement on large scale. Even though the same trend implies that these companies share prices are dependent more on the overall demand rather than relative performance in the long run, I believe relative performance should not be neglected as it could make all the difference in near term.  Thus, I have taken each issue separately and done the analysis to find out which company has best position to challenge a particular issue. (X > Y means X is better positioned than Y)

BHI, SLB > HAL on Frac Repricing Issue

I think BHI and SLB will perform better than HAL in Q3 on the front that neither have stockpiled expensive guar like HAL. Further, I think that HAL's contract coverage has delayed downward re-pricings to a greater extent than BHI and SLB. In my view, it implies that BHI and SLB have already accommodated the blow of frac re-pricings than HAL.

BHI, HAL> SLB on High Guar Prices and Internal Fundamentals

In 2Q12, HAL introduced PermStim (an alternative for guar) which has replaced about 5% of guar demand for the company. Baker Hughes has also developed a substitute called AquaPerm, which has offset approximately 5% of the Baker's guar bean requirements. However, there is no update of any such alternative from the Schlumberger. Therefore, I believe Schlumberger is lagging behind on this front and could suffer largely in the near term.

I expect BHI to see some margin tailwind in Q3 from its efforts to improve its internal supply chain. Halliburton is also targeting a 20-25% reduction in costs from several initiatives to decrease the frac spread footprint for equipment and labor which could prove to be a huge tailwind in Q3.

BHI< HAL= SLB on Lower Than Expected Canadian Activity

Earlier this month, the large cap Oilfield Service companies like BHI, HAL, and SLB  disclosed that the Canadian rig count has been down by 100 rigs quarter to date (~23%) as compared to last year count.  I believe the lower rig count will provide more downside to the  top line of BHI than SLB’s and HAL’s as BHI has more exposure to slower than expected Canadian activity while SLB and HAL are almost equally exposed in terms of revenues generation in Canada.

SLB=HAL> BHI on Valuation

The following table summarizes the expected EPS growth (for next 5 years) and Forward PE of SLB, BHI and HAL:

In terms of valuation, SLB’s premium valuation and HAL’s discounted valuation seem justified as SLB has highest expected EPS growth among its peers and HAL has the lowest in the same group. However, BHI seems undervalued on absolute basis given the company’s consistent growth profile. The following chart summarizes the EPS growth (in last 5 years) of SLB, BHI, and HAL:

The Bottom Line

Overall, I expect BHI to perform better than SLB and HAL due to the strong execution, superior outlook and strong fundamentals. Although the company is relatively more exposed to Canada which is expected to remain a headwind in near term, but importantly it is more immune to high guar prices and Frac repricing issues than HAL and SLB. I believe that the company’s improving internal supply chain and possession of Aquaperm will drive upside to the earnings. I believe Baker has more good apples in its basket than SLB’s and HAL’s.  Thus, I recommend Baker a buy.

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