The oilfield services industry has been under pressure for the past several years. The sector still hasn't recovered from the crash in crude prices that began in late 2014. While market conditions had started improving in the past year, they took a turn for the worse toward the end of 2018 when crude crashed again. This renewed slump in oil prices led many oil companies to reduce capital spending for 2019, which will negatively affect oilfield service companies.
However, there have been a few bright spots in the industry, especially in the offshore and international drilling markets, which finally appear to be rebounding. That's good news for oil service giants Baker Hughes (NYSE: BHGE) and Schlumberger (NYSE: SLB), which focus more on those regions. Though while both should benefit from an improvement in those markets, one looks like the better buy right now.
A look at the numbers
Schlumberger and Baker Hughes are two of the three largest oilfield service companies by revenue (Halliburton slots in between them). Here's how these two compare across several key financial metrics:
Free Cash Flow
Free Cash Flow As a Percentage of Revenue
Data sources: Baker Hughes and Schlumberger.
As that table shows, not only does Schlumberger generate more revenue, but it's much more profitable than Baker Hughes. The company has significantly higher operating margins and converts a greater percentage of its sales to free cash flow.
Margins have been a trouble spot for Baker Hughes in recent years. That's due to two things. First, the company is working to integrate its legacy oilfield service operations with GE's (NYSE: GE) oil and gas business after the industrial giant acquired a sizable stake in Baker Hughes a couple of years ago. On top of that, the company's oilfield equipment business has been under pressure due to the continued troubles in the oil market. That business is barely profitable -- generating a mere 1.7% operating margin in the fourth quarter -- which is weighing on Baker Hughes' overall margins.
Image source: Getty Images.
A look at what's ahead
Baker Hughes is working hard to boost its margins. The company is wringing out costs as it continues integrating its oilfield services business with GE's oil and gas operations. It has already realized $800 million of operational synergies from the merger and expects that number to reach $1.6 billion by the end of next year.
However, Baker Hughes has some headwinds ahead that will negatively impact its results, at least in the near-term. The company's CEO, Lorenzo Simonelli, stated on the fourth-quarter conference call that the slump in oil prices at the end of 2018 would hurt drilling markets in the U.S. and Canada. "[W]e expect the activity slowdown and pricing deteriorations in these markets in the first half of 2019 to negatively impact our well construction product lines," he said.
It wasn't all bad news, though. The CEO also noted:
Our international outlook for 2019 remains unchanged, with solid growth in key regions like the Middle East and the North Sea. Our outlook for offshore is relatively unchanged. ... We are seeing a positive change in the LNG market. Given the continued strong demand dynamics, likely project sanctioning is accelerating faster than we previously anticipated.
This outlook leads the company to believe that it will experience some softness in the first half of the year, though its revenue and margins should improve throughout 2019, especially in the second half.
Schlumberger's CEO, Paal Kibsgaard, made similar comments on his company's fourth-quarter conference call: "[N]ot surprisingly, the recent oil price volatility has introduced less visibility and more uncertainty around the E&P [exploration and production] spend outlook for 2019, with customers generally taking a more conservative approach to the start of the year, again delaying the broad-based recovery in the E&P spend that we expected only three months ago."
However, he also stated that "from our customer discussions, we are seeing clear signs of E&P investment sentiments starting to normalize in the various parts of the world." That's especially true internationally, where the company still expects "solid year-over-year revenue growth in the international markets in 2019, starting off in the mid-single digits for the first half of the year." That has the company optimistic it can grow revenue, margin, and cash flow this year.
A quick look at valuation
Schlumberger has done a better job navigating the ups and downs of the oil market in recent years, as evidenced by its much higher profit margins. The company should continue doing well in 2019, which appears as if it will get off to a slow start before improving throughout the second half. However, despite being a more profitable company, Schlumberger's stock trades at a cheaper valuation than Baker Hughes:
While Baker Hughes' financial results should meaningfully improve in 2019, investors seem to be overly optimistic by giving it a premium valuation.
Verdict: Schlumberger is a better buy
Schlumberger is not only a much more profitable company but also trades at a relatively cheaper valuation. It looks like the better buy between these two right now in my opinion, especially given the potential near-term weakness in the oil services market.
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