How This Oil Services Company Can Outperform in 2014
As ever when looking at oil services stocks like Halliburton and Baker Hughes , your long-term outlook will be defined by your view on the future of oil prices. While this rule still applies, there are also many changing trends within the oil services market, which Baker Hughes has positioned itself to benefit from. If you are bullish on oil, then Baker Hughes looks particularly well placed.
A bifurcated market in oil services
The biggest story in oil production in recent history is the wide-scale adoption of fracking technology in energy production in the U.S. -- the result of which has been the reversal of a seemingly inevitable decline in U.S. crude oil production.
The good news for the oil services companies is that production has gone up over the last two years, but the bad news is that oil prices have been relatively flat. Moreover, the most wildly followed barometer of the U.S. oil and gas services industry (rotary rig counts) has been in decline over the last couple of years.
All told, the result has been to bifurcate the global oil services market into good growth in emerging markets versus weaker growth in the U.S. Moreover, if oil prices fall then some current U.S. production will prove commercially unviable.
What the industry is saying
Indeed, some of the underlying issues were touched on in General Electric's recent conference call. When questioned by an analyst on the outlook for GE's oil and gas segment, CEO Jeff Immelt articulated the bifurcation in oil and gas services prospects between North America and the rest of the globe:
"If you look at the national oil companies versus the integrated oil companies, our view is that the NOCs really haven't backed off at all...the place that we still think is reasonably weak is maybe around North America, some of the drilling and surface stuff"
It was a similar story from Halliburton. Its North American revenue declined 4.9% in 2013, while outside of North America its revenue increased 13.5%. Halliburton's management sees the current North American market as "driven by increased drilling and completion efficiencies with a relatively flat overall rig count and industry overcapacity."
Putting these elements together, a picture is emerging of a bifurcated market that is seeing U.S. oil services companies being challenged in their core domestic market. In addition, North American subsea/deepwater operations are outperforming vertical onshore drilling. Meanwhile, increased usage of fracking has enhanced productivity, which further contributes to overcapacity in North America.
How Baker Hughes is adjusting
Baker Hughes' last earnings report was quite impressive, not least because it highlights the adjustments that the company is making to deal with changing conditions. There are four key factors:
- Baker Hughes' share of total pre-tax profits from North America was only 43.7% in 2013. Latin America was weak, but the other segments (Europe/Africa/Russia, Middle East/Asia Pacific, and industrial services) saw pre-tax profits grow 14.9%
- Its North American pressure pumping business (heavily reliant on fracking activity) is seeing improved profit margins as the company takes action to overhaul the business in response to overcapacity
- The company sees itself as a deepwater specialist, a sector that is outperforming most of the oil industry
- Management has taken impressive measures to decrease working capital and increase cash conversion, the result being a record $1.5 billion in free cash flow
Where next for Baker Hughes?
Looking ahead, Baker Hughes' management sees the U.S. onshore rig count as being "essentially flat," while Halliburton expects a modest increase. However, recall that Baker Hughes is taking measures to improve margins, and its forecast for the onshore well count is for a 5% increase. In addition, U.S. offshore rig count is expected to increase 5%. Conditions appear to be getting better.
Meanwhile, its international operations are forecast to receive a boost due to an estimated 10% increase in the international rig count. Add in the improved operational efficiencies and increased cash flow generation, and the stock is starting to look attractive. In fact, analysts have it on a forward P/E ratio of less than 14 times earnings, as I write. If you are bullish on the outlook for oil, then Baker Hughes is well worth looking at for 2014.
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The article How This Oil Services Company Can Outperform in 2014 originally appeared on Fool.com.Lee Samaha has no position in any stocks mentioned. The Motley Fool recommends Halliburton. The Motley Fool owns shares of General Electric 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.
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