Is Baker Hughes a Buy?
In July of 2017, industrial giant GE (NYSE: GE) merged its oil and gas business with Baker Hughes (NYSE: BHGE) to create an oilfield services and equipment giant. Based on revenue, the deal pushed it past Halliburton (NYSE: HAL) to become the second-largest oil services company behind Schlumberger (NYSE: SLB). That larger scale positioned it for significant upside in the eventual oil market recovery.
So far, the transaction hasn't worked out as well as hoped. The cost of integrating these two large companies has weighed on Baker Hughes' results over the past year, a situation made worse by the fact that the oil market downturn has lingered in some of the company's key markets. Because of that, shares are down about 9% since the tie-up closed. However, the company does see better days ahead, which raises the question of whether Baker Hughes' stock is worth buying now.
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The bull case for Baker Hughes
The case for buying Baker Hughes is twofold. First, after a deep downturn, the oil market has started recovering over the past year. Because of that, oil and gas companies are expected to continue ramping up their spending on services and equipment in the coming years. Analysts anticipate that total global spending by oil companies will increase at a 9% compound annual growth rate (CAGR) from 2019 through 2021. And they see spending in the offshore marketplace rising at an even faster 11% CAGR over that time frame, which is a positive for Baker Hughes since it has significant exposure to that market. Those factors suggest that the company's revenue and earnings could expand briskly in the coming years.
The second leg of the bull thesis on Baker Hughes is that the company will benefit significantly from merging with GE's oil and gas business. That's already starting to happen. Through the first half of this year, the company has captured $330 million of annual expense synergies and is on its way toward achieving its target of $700 million for the full year. Further, it expects those synergies to reach $1.6 billion by 2020. Those integration gains have already helped drive up the company's oilfield services margins from 1% to 6.6% in the past year.
Meanwhile, the company has been able to leverage its larger scale to capture new opportunities. Baker Hughes noted in the second quarter that it has been gaining market share in North America and the Middle East by offering new and innovative commercial models. It aims to continue winning market share by leveraging its scale and unique suite of services in the coming years.
Image source: Getty Images.
The bear case for Baker Hughes
While the longer-term outlook for Baker Hughes looks bright, the short-term picture isn't quite as bullish. Pipeline constraints in the Permian Basin have slowed drilling activities in that key region. That issue is causing some near-term pain in the services sector, with Halliburton noting that it's one of the factors that will knock $0.08 to $0.10 per share off its third-quarter results.
Meanwhile, the recovery offshore has been slow to develop. On the one hand, activities are on the upswing, with Schlumberger's CEO saying last quarter that exploration drilling appears to be "starting to turn the corner." However, orders from new offshore projects won't start ramping up until 2019, which means Baker Hughes won't begin generating revenue from them until 2020.
In addition to the near-term sluggishness in the services market, another thing that has weighed on Baker Hughes over the past year is its connection to GE, which remains its majority owner after taking a 62.5% stake in the combined company in last year's merger. GE has been under tremendous pressure since buying Baker Hughes, due to the sluggish oil market recovery as well as some issues in its power business and elsewhere. Those factors have caused GE's stock to plummet nearly 60% since buying Baker Hughes, which has put some added pressure on the oil services company's stock, causing it to underperform both Schlumberger and Halliburton over that time frame.
While GE is working to address its issues, it has also unveiled plans to separate several of its business units, including Baker Hughes. It's unclear how or when GE will dispose of its stake in the company. It could slowly sell it off -- which it can't begin doing until the middle of next year as part of the merger agreement -- or spin it out to investors. Until there's more clarity on what GE will do with its stake in Baker Hughes, the uncertainty could continue weighing on its stock.
It could be a good buy eventually
While there's a lot to like about Baker Hughes' potential, several near-term uncertainties could continue weighing on the stock. That's why it doesn't look like an attractive buy just yet. However, investors should keep this stock on their watch list since there will be a much stronger case for buying once there's more clarity on the timing of the offshore recovery and GE reveals its exit strategy.
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Matthew DiLallo owns shares of General Electric. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
