Higher Margins, Higher Revenues: Buy This Stock

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Thanks to hydraulic fracturing and horizontal drilling, natural gas production has reached its all-time highs. This production bonanza was, however, not matched by an increase in demand. This caused natural gas prices to plunge to 13 year lows. This crash in prices has forced natural gas producers to temporarily shut down their rigs in North America and is causing a drag on exploration and development companies like Baker Hughes.

Baker Hughes (NYSE: BHI), the world’s third largest oilfield company, posted weaker than expected quarterly results. On a quarterly basis, EPS stood at $0.73 against the estimated $0.85, and revenues increased marginally by 3.2% YoY. Baker Hughes’s management reported a 30% decline in Canadian drilling activities, along with a 17% drop in the number of rigs in Brazil, Columbia, and Norway.

Halliburton (NYSE: HAL) also posted higher quarterly revenues, up 9% YoY. But due to rising input costs and lower natural gas prices in the North American region, its net income fell to $604 million, down from $685 million. The North American profit margins for Halliburton shrank by 6%.

Baker Hughes conducted a survey outside North America, under which it was found that the rig count was up 6% this year. Due to reduced activity in North American countries, Schlumberger (NYSE: SLB) also reported a decline in its sales and margins from the region. However, it should be noted that Schlumberger earns 70% of its revenues from international markets. On the back of strong international activity, Schlumberger reported quarterly revenues 11.1% higher YoY, and an EPS of $1.08, beating the street’s expectations. Quarterly net earnings rose from $1.3 billion to $1.42 billion and Schlumberger’s Middle East and Asian revenues were 7% higher YoY. Also, Schlumberger’s margins were impressive, beating the margins of both Baker Hughes and Halliburton.

Schlumberger has enjoyed a profitable ride so far, and that doesn’t deter it from entering new deals. Recently Schlumberger and TNK-BP agreed to jointly develop hydrocarbon reserves in Western Siberia. The company also entered an agreement with oilfield service provider Cameron International to jointly develop SubSea oil properties.

Schlumberger trades at a forward P/E of 14.53x and PEG of 1.03. The company TTM debt/equity ratio is 33%. Schlumberger yields 1.55%, paying out a modest 25%, and the company has a history of consistent pay-outs for the past 10 years. During the first quarter, the company repurchased 2.2 million shares, highlighting the amount of faith the board members have in the company’s future.

Since both Halliburton and Baker Hughes have a higher presence (and dependency) in the North American region, their profitability will remain under pressure unless they capture a higher international market share. The revenues from North America account for close to half of the total revenues of Baker Hughes. European and Asian countries are yet to see a natural gas production boom, which is why the commodity is priced 4-6 times higher than it is in the US. Development and marketing of natural gas is still profitable in the other half of the world.

Also, demand for oil is rising at 6-8% annually, which is not being matched by a ramp up in production. Companies are now exploring for high margin oil, as their existing reserves are depleting. This calls for increased oil E&P activity, and Schlumberger seems to be well poised to take advantage of the growth opportunities presented.


PiyushArora has no positions in the stocks mentioned above. The Motley Fool owns shares of Halliburton Company. Motley Fool newsletter services recommend Halliburton Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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