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.

Forex Broker Guide: Using the right broker is essential when competing in today's forex marketplace.

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.

Related Articles
  1. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  2. Fundamental Analysis

    4 Predictions for Oil in 2016

    Learn four predictions for oil markets in 2016 including where prices are heading and the key fundamental factors driving the market.
  3. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  4. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  5. Investing News

    Is Buffett's Bet on Oil Right for You? (XOM, PSX)

    Oil stocks are getting trounced, but Warren Buffett still likes one of them. Should you follow the leader?
  6. Economics

    Will Silver Recover in 2016? (SLV, GLD, JJC)

    The end of the silver downtrend is likely to coincide with similar recoveries in gold, iron and copper.
  7. Stock Analysis

    The Top 5 Silver Penny Stocks for 2016 (LODE,AG)

    Learn about five of the top silver penny stocks and why investors may want to consider adding them to their investment portfolios in 2016.
  8. Investing News

    Chipotle Served with Criminal Probe

    Chipotle's beat muted expectations and got a clear bill from the CDC, but it now appears that an investigation into its E.coli breakout has expanded.
  9. Stock Analysis

    Analyzing Sprint Corp's Return on Equity (ROE) (S)

    Learn about Sprint's return on equity. Find out why its ROE is negative and how asset turnover and financial leverage impact ROE relative to Sprint's peers.
  10. Stock Analysis

    Why Alphabet is the Best of the 'FANGs' for 2016

    Alphabet just impressed the street, but is it the best FANG stock?
RELATED FAQS
  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 >>
COMPANIES IN THIS ARTICLE
Trading Center