You don't have to the biggest or the best to succeed in energy services, but you do have to execute on the opportunities in front of you. On that score, Baker Hughes (NYSE:BHI) still has work to do. Although the company is making some progress with its North American pressure pumping business and the Mideast continues to be a solid source of growth, there is still the risk of a one-two punch from softer margins and less E&P spending than expected. Baker Hughes is still undervalued today and arguably has more upside from better management execution, but it's tough to work up a lot of enthusiasm for the stock.

Q2 Results Miss The Mark
While there was a lot of talk of “beat and raise” from Baker Hughes on improving North American conditions, that's not what happened. Although management was optimistic about the prospects for significant margin improvement in the second half of the year, this quarter was not so strong.

Revenue rose 3% from the year-ago period and 5% from the first quarter on ongoing growth in the international business, and Baker Hughes did beat expectations here. North American revenue grew 3% sequentially despite some tough weather-related challenges, while international revenue was up 7% as strong growth in Russia, West Africa, and the Mideast offset a mid-single digit decline in Latin America. 

On the margin side, the news wasn't nearly as good. Gross margin fell about three points from the year ago period and just slightly from the prior quarter. North American margins were weak on challenging weather in Canada and North Dakota, and Latin America was barely breakeven as the company couldn't reduce costs fast enough in the wake of less business from Petrobras (NYSE: PBR) and in Mexico's Chicontepec field. All told, operating income fell 27% and 2%, with North American operating income down 7% sequentially and international down 4%.

SEE: A Look At Corporate Profit Margins

Weather Won't Be Bad Forever, But Will The Market Rebound As Much As Hoped?
Baker Hughes does seem to be continuing to take share in North America, and the company has managed to move about 45% of its fracking fleet to 24-hour operations (with a target of 50% or more by year-end). Coupled with stabile-to-slightly better pricing across an array of services, that's positive. Even with that, though, Baker Hughes is well behind Schlumberger (NYSE:SLB) and Halliburton (NYSE:HAL) in terms of share and scale.

On the flip side, Baker Hughes' above-average exposure to Canada has bitten the company this year with a worse-than-normal stretch of weather. It's also well worth mentioning that the big recovery in the second half of the year may well not materialize. E&P companies are getting a great deal more careful with their spending and many may well choose to shore up their balance sheets in favor or reinvesting/redeploying capital to drilling.

Baker Hughes Needs To Get Better, But What About Bigger?
One of the challenges facing Baker Hughes is in better decision-making. Not unlike Weatherford (NYSE: WFT), Baker Hughes has made the mistake of pursuing a “growth at any cost” philosophy at various points. Latin America provides one example – while this is a credible and worthwhile region for energy services company, Baker Hughes over-committed resources, suffered from under-utilization, and now may well over-correct in response.

SEE: Oil And Gas Industry Primer

I do wonder, though, if Baker Hughes could still be a consolidator in the space. An acquisition of Weatherford would add scale in ares like wireline, tools, casing, and artificial lift and could create some longer-term synergy possibilities. I'm not predicting this (and I certainly have a vested interest in seeing Weatherford get an attractive buyout bid), but I wouldn't rule it out either.

The Bottom Line
Comparing the performance of Baker Hughes to Schlumberger, it's hard for me to get all that excited about these shares, even though they do seem undervalued. I suppose the most bullish case I can make for Baker Hughes is that there's more room for improvement here than with Schlumberger – if the market really picks up and/or if management decides to consolidate the industry further, they could have more to gain that a well-run rival like Schlumberger.

At a 6.5x EBITDA multiple, I think Baker Hughes is worth about $54 today. That's not a huge incentive to buy, but it does still make Baker Hughes an undervalued play on a better/improving energy market for investors looking to make that sort of trade.

Disclosure – As of this writing, the author owns shares of Weatherford.

Related Articles
  1. Stock Analysis

    3 Resilient Oil Stocks for a Down Market

    Stuck on oil? Take a look at these six stocks—three that present risk vs. three that offer some resiliency.
  2. Economics

    Keep an Eye on These Emerging Economies

    Emerging markets have been hammered lately, but these three countries (and their large and young populations) are worth monitoring.
  3. Stock Analysis

    Is Pepsi (PEP) Still a Safe Bet?

    PepsiCo has long been known as one of the most resilient stocks throughout the broader market. Is this still the case today?
  4. Investing

    The ABCs of Bond ETF Distributions

    How do bond exchange traded fund (ETF) distributions work? It’s a question I get a lot. First, let’s explain what we mean by distributions.
  5. Stock Analysis

    3 Stocks that Are Top Bets for Retirement

    These three stocks are resilient, fundamentally sound and also pay generous dividends.
  6. Investing News

    Are Stocks Cheap Now? Nope. And Here's Why

    Are stocks cheap right now? Be wary of those who are telling you what you want to hear. Here's why.
  7. Investing News

    4 Value Stocks Worth Your Immediate Attention

    Here are four stocks that offer good value and will likely outperform the majority of stocks throughout the broader market over the next several years.
  8. Investing News

    These 3 High-Quality Stocks Are Dividend Royalty

    Here are three resilient, dividend-paying companies that may mitigate some worry in an uncertain investing environment.
  9. Stock Analysis

    An Auto Stock Alternative to Ford and GM

    If you're not sure where Ford and General Motors are going, you might want to look at this auto investment option instead.
  10. Mutual Funds & ETFs

    The 4 Best Buy-and-Hold ETFs

    Explore detailed analyses of the top buy-and-hold exchange traded funds, and learn about their characteristics, statistics and suitability.
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!