We reaffirmed our Neutral recommendation on Baker-Hughes Incorporated (BHI), one of the largest oilfield service companies in the world, on May 2, 2013. Operational efficiencies in Iraq drove margin improvement. However, high mobilization costs for the newly integrated drilling services in Norway restricted earnings. The company holds a Zacks Rank #3, which is equivalent to a short-term Hold rating.
Baker Hughes' strong portfolio of products and services should help it post better-than-average results in North America and enable it to further expand in the international markets. The company also has a competitive set of technologies, which allows it to bolster its activity in the deepwater Gulf of Mexico (GoM). The company has successfully introduced products such as the AutoTrak Rotary Steerable System and advanced completion systems in regions that have a meaningful impact on its earnings and cash flows.
In 2013, management believes the Middle East/Asia Pacific, and Europe/Africa/Russia/Caspian regions, in particular Iraq and Saudi Arabia, are likely to be the primary growth drivers. Saudi Arabia is expected to drive the earnings of the Middle East/Asia Pacific segment, while Norway is likely to witness operational growth and margin improvement. North America also witnessed improvement in earnings during the quarter mainly on better utilization of pressure pumping in the U.S. and stepped up activity in Canada.
Baker Hughes has taken effective steps for the nagging pricing weakness in the pressure pumping market in North America. As part of the effort, it has trimmed its 2013 capex estimate by 30% to $2 billion, on an annualized basis. With lower capital spending expected this year, we believe the company will be able to generate free cash flow and begin to repurchase shares more aggressively.
However, Baker Hughes’ first quarter earnings fell 24.4% from the year-ago level. The underperformance mainly stemmed from seasonal weakness, in particular the Europe/Africa/Russia/Caspian segment. Moreover, weak activity in several important markets of Baker Hughes resulted in an unfavorable mix. We remain apprehensive about the reduction in rig activity levels in 2013 and the company's broad exposure to pressure pumping, which could affect earnings going forward.
Other Stocks to Consider
While we prefer to remain on the sidelines for Baker Hughes, there are other stocks in the sector that appear rewarding. These include Dawson Geophysical Company (DWSN), SM Energy Company (SM) and Exterran Holdings, Inc. (EXH), which are expected to perform impressively over the next few months and carry a Zacks Rank #1 (Strong Buy).
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