Baker Hughes Transitioning Into a Value Trap
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Baker Hughes (NYSE: BHI) adopted a transition strategy in the year 2009. Since then, the company has seen its customer satisfaction rating decline 8.9% on an adjusted basis. The current phase of its transition plan is proving challenging and impacting the stocks’ performance.
Baker Hughes supplies oilfield services, products, technology and systems to the international oil and natural gas industry along with downstream products and services. And it’s that transition to a more full service company than a simple oilfield services firm that is proving difficult. Its latest quarterly earnings reveal a company that is too heavily dependent on North America’s natural gas glut.
The company has gained the customer satisfaction rating against its rivals such as Schlumberger (NYSE: SLB) and Halliburton (NYSE: HAL) in surveys conducted by EnergyPoint, but still the company’s transition strategy is proving more difficult than it anticipated when they began back in 2009.
Part of this trouble has been adapting the internal culture of the company over the previous years. This has trickled down to customers and contractors, leaving them to complain about the declining performance at the individual level. Though the transition strategy promised many things, it has failed to create value and, if anything, has alienated customers.
So, we couple that with the issue of homogeneity. While nature may abhor a vacuum, margins abhor a copycat, unless that copycat is better on price, but then branding issues come to play. So, in attempting to gain market share by copying the larger players, Baker-Hughes lost what Baker-Hughes was good at. Under those conditions more than anything else customers differentiate on price and the ability to deliver. As the smallest of the big three oil servicers, Baker-Hughes doesn’t have the scale to compete on that basis alone.
So, where are they now? Baker-Hughes is heavily invested in North America, a market struggling with over-supply and a falling rig count after the price of natural gas collapsed last year and still has not fully recovered. Q4 earnings results revealed a sharp drop in profit overall from $0.72 per share to $0.49 on slightly lower revenues (1.4%) of $5.22 billion. But, North American revenue dropped 9.6% to $2.559 billion. Pre-tax profit margins fell from 15% to 9%. For all other segments Pre-tax Margins increased (except Latin America; from 3% to 1%) and revenue expanded. Of particular note has been the improvement in performance of the Europe/Africa/Russia Caspian division with revenue expanding both sequentially and year-over-year and margins improving to 18% from 11% a year ago.
What is encouraging for Baker-Hughes and one of the reasons why I have, in the past, been more bullish on Schlumberger in this segment, is that North America is both growing in revenue and becoming less important to the company’s overall revenue stream. But, in concert with the issues discussed above, pre-tax margins have dropped from 19% to 12% year over year, even though revenue is up 5.4%. Asia-Pacific revenue grew at an impressive 14.8% for the year and now represents 15.6% of the company’s total revenue.
But these growth rates are anemic compared to Schlumberger’s fourth quarter, where earnings fell slightly in the quarter year over year but far less than it had guided in mid-December. And, as well as Baker-Hughes performed in ME-Asia Pacific, Schlumberger outperformed that with revenue rising 21% and the company gutting its North American capex budget for 2013. Halliburton, too, had an excellent quarter. As we move into 2013 and are staring at higher energy prices in dollar terms thanks to highly inflationary monetary policy and potentially higher margin growth, there is no doubt that the oil servicer big three will have plenty to do.
So, the question is now, three years on, is Baker-Hughes working harder to generate less creating a classic value trap? I think that may be the case. Growth is coming simply on the back of higher demand for energy, so it will be a good business, but until margins begin expanding in its growth markets, it won’t outperform either its peers or the oil sector in general.
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