Baker Hughes (NYSE:BHI) is preparing for a protracted downturn in its business despite being so busy that it had to "turn down business in the third quarter".

Some may take this as a sign that the industry could be in for a lean 2009, but this prudence should serve the company well if the worst case scenario becomes a reality.

Cautious Outlook
Baker Hughes reported net income for the third quarter of 2008 of $428.9 million or $1.39 per diluted share. This included a $0.13 charge for a litigation settlement, and a tax benefit of $0.10 per share. Revenue was $3.0 billion.

Although revenue and earnings were strong, investors were more fixated on the company's outlook, which was provided by Chad Deaton, the president and CEO. Here are the highlights.

  • Baker Hughes expects international markets to hold up and provided guidance of revenue growth in the range of 14-15% in the fourth quarter of 2008. The company did say, "We could see a slowing of spending growth in some markets."
  • Baker Hughes believes the rig count will end 2008 between 1,800-1,840 rigs, down 190-230 from the peak of 2,031 reached in August 2008. This differs slightly from the forecast of Nabors Industries (NYSE:NBR) who said in a recent conference call that a 300-count drop was possible.
  • Deaton seemed to be more optimistic on the economics of oil in the U.S., and said, "The price of oil has been cut in half from its summer highs, but it is still high enough to provide attractive returns to many of our customers."

Baker Hughes did not indicate that it would cut its capital expenditures for the fourth quarter of 2008, keeping the full year 2008 at $1.3 billion, although Peter Ragauss, the CFO said, "Given the uncertain nature of the current credit markets, we will remain prudent with the use of our cash in the near-term."

Worst Case Scenario
Bill Herbert, an analyst with Simmons and Company, asked the company how it would handle a much larger drop in the rig rate, perhaps as much as 400 rigs. Deaton outlined the actions that Baker Hughes could undertake to keep margins up if that occurred:

  • A slow down in hiring in North America.
  • A focus in working capital improvement, including controlling inventories and better collection of receivables.
  • Negotiate better pricing with its suppliers to offset weaker pricing for its products and services.
  • Adjusting the workforce.
  • Closing and/or consolidating facilities.

Analysts also tried to get a feel for whether international growth was slowing down. Doug Becker, an analyst at Banc of America, noted that Baker Hughes was growing slower than its large cap peers. Deaton denied the slower growth and said "U.S. land was up 25% year-over-year." He also said "we have not heard anything from any of our clients on offshore rigs and deep water that says they are going to cut back."

Schlumberger (NYSE:SLB) and Halliburton (NYSE:HAL) reported faster growth in international revenue than Baker Hughes measured on a year-over-year basis from the third quarter of 2007.

Q3-2008 Year-Over-Year Growth
- Latin America Europe Middle East
Baker Hughes 18.6% 9.4% 8.2%
Halliburton 41.9% 21.5% 19.5%
Schlumberger 32.0% 28.0% 22.0%

Bottom Line
During the Baker Hughes conference call, analysts focused on two areas: the ability of management to handle a protracted downturn through expense control, and whether management saw any signs of cuts in capital expenditures by larger players like big oil companies. Based on Management's answers, investors should feel confident that the company has a plan for a cutback if necessary. The company is
prepared for a possible protracted downturn despite being at full capacity in some lines of business in the third quarter. This prudence should serve Baker Hughes well.

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