Energy services giant Baker Hughes (NYSE:BHI) provides a good example of something I've often said about commodity-related companies - calling/playing a bottom in the cycle is always risky, because these companies have a way of finding new peaks and carving out new troughs that are higher/lower than you think they could be. While Baker Hughes does seem undervalued today, and should be well-positioned to benefit from a recovery in North America and ongoing growth outside, it takes a little faith and even more appetite for risk to buy today on that thesis. By the same token, if you wait for definitive proof of the turn, you'll leave a meaningful amount of capital gains on the table.

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Third Quarter Results - North America Under Pressure, but International Even More Disappointing
That Baker Hughes posted disappointing third quarter results was not entirely surprising; there had been more than enough warning signs that operating conditions were not getting better. Nevertheless, the magnitude of the disappointment was a little surprising and bears may try to make the case again that Baker Hughes still significantly lags behind operators such as Halliburton (NYSE:HAL) and Schlumberger (NYSE:SLB). Revenue at Baker Hughes rose 3% relative to 2011 results, but barely rose even 1% from the June quarter. The North American business was actually a little better than many expected, with revenue up 1% annually and 3% sequentially. International was disappointing, however, rising only 3% annually, and falling 2% sequentially with most of the weakness in Latin American and Europe/Africa/CIS.

Margins were even more disappointing. Operating income fell 16% annually, with a drop in both the North American and international business. North American results were hurt by ongoing overcapacity (and price declines) in pressure pumping and weather-related disruptions in the Gulf of Mexico. Although Baker Hughes' North American margins actually held up better than those at Halliburton or Schlumberger, the absolute level is still lower. The international business was a pretty big miss, and it was a broad-based miss. For better or worse, it appeared to be a collection of country-specific one-off issues - startup costs in Iraq, reduced activity in Colombia and Brazil and strikes in Norway made worse by high-fixed costs. In any event, while some have made the case that Baker Hughes lags behind its peers due to insufficient overseas exposure, this quarter would suggest execution is also an issue.

Things will Get Better ... Eventually
I wish Baker Hughes provided more specificity about its individual businesses such as pressure pumping and artificial lift. That would make it a little easier to put things in context with other smaller service providers such as Lufkin (Nasdaq:LUFK) and see whether the company was gaining share with products such as electric submersible pumps and its guar substitute, AquaPerm. In any case, the thesis on major service providers remains basically the same - North American business will trough at some point and increased exploration and production activity overseas will continue to drive growth in service demand. Has North America seen its trough? Pressure pumping prices continue to decline, but at a slower rate, while rig counts are likely to continue declining in the fourth quarter. Consequently, a business rebound probably won't be evident until 2013. Even then, there's still a question as to just how healthy the budgets will be for energy companies in 2013, particularly the smaller ones.

The Bottom Line
I've already made my picks in the energy sector, choosing to go with the equipment provider Cameron (NYSE:CAM) and the very risky high-risk/high-reward Weatherford (NYSE:WFT). Along those lines, I think equipment is probably still a better place to be today relative to services. When it comes to Baker Hughes, it's worth noting that sell-side estimates for 2013 EBITDA have dropped 10% in just the last quarter, while the stock has dropped about 3%. Assuming these newer numbers are more accurate, fair value looks to be in the low-to-mid $50s on Baker Hughes. That's not tremendous undervaluation today, particularly for a company that isn't a leader and doesn't have a differentiating angle (unusual growth, new products, restructuring, etc.). Consequently, while I think better days are ahead for energy service companies, it's hard for me to get especially excited about Baker Hughes right now.

At the time of writing, Stephen D. Simpson owned shares of Cameron (CAM) and Weatherford (WFT) since September 2012.

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