Given how much share of the North American energy services industry is controlled by the Big Four, investors cannot just ignore the trends that come out of the earnings releases. With Schlumberger (NYSE:SLB), Halliburton (NYSE:HAL) and Baker Hughes (NYSE:BHI) having reported in the past few days, it's pretty clear that business conditions in North America are not great. The question, though, is whether this sector will once again start trading on the strength of oil (versus the weakness in gas) and whether a company like Baker Hughes should trade this far below historical forward valuations.
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A Familiar Story in the December Quarter
Baker Hughes missed bottom-line expectations for the quarter, though expectations of a miss should mitigate the immediate damage to the stock. Not surprisingly, revenue was weaker than published estimates this quarter, up just 4% sequentially (though up more than 20% from last year). The company's North America business was the disappointment; up a little less than 4%, while the international segment saw growth of 6%, which was quite consistent across geographies.
Margins were also a familiar mixed story in the quarter. International margins were surprisingly strong, up over three points sequentially to more than 15%. North American margins, though, went in the opposite direction and fell more than three and a half points to under 19%. This compares rather poorly to the results posted by both Schlumberger and Halliburton (up 1.6% and down 2.1%, respectively). (Find out how to put this important component of equity analysis to work for you. For more, see Analyzing Operating Margins.)
Are Q4's Problems Temporary?
Baker Hughes blamed a lot of the North American shortfall on higher costs, transportation issues and outages of materials, like sand and gel used in fracking and pressure pumping. This has been an issue from time to time in energy services, so investors will just have to see if the company can work through this. One potentially encouraging note is that Baker Hughes gets more business from Canada than its Big Four peers and that should help boost results in the next quarter.
Still a Strong Story Overseas
It's becoming pretty clear that the international energy market is getting healthier. With companies like Petrobras (NYSE:PBR) significantly expanding their drilling activity, all manner of service companies and equipment players (including Cameron (NYSE:CAM) and General Electric (NYSE:GE)) should see improving results. One particular takeaway from Baker Hughes' report may be of interest to those holding or considering Weatherford (NYSE:WFT) shares: BHI made multiple references to demand for artificial lift services in Latin America, and that's a market where Weatherford has good exposure and service offerings.
The Bottom Line - Balancing Risk and Opportunity
It certainly seems that plunging natural gas prices have done the energy services sector no great favors. At the same time, interest in oil is picking up again and should fill in a lot of the gaps of lower gas drilling and production activity. There are going to be margin costs in shifting resources, but it is not as though Baker Hughes is so dependent on gas that it can't make the switch.
Right now the top players in the sector are trading below historical forward EBITDA multiples and relatively too close to the bands that mark the normal lows. Although it seems counter-intuitive to buy into energy services in the face of weak gas prices and general economic uncertainty, history shows that investors usually have to buy into the ugly news, to really make money in the sector. Insofar as that goes, then, Baker Hughes looks like an undervalued play on ongoing energy demand and drilling activity, both here and abroad. (For related reading on EBITDA, see A Clear Look At EBITDA.)
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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.