Baker Hughes (NYSE: BHI ) recently reported earnings that beat analysts' expectations. For the first quarter of 2014, Baker Hughes reported adjusted income of $0.84 per share, which was up 29% year over year. Its revenue was up 9.6% year over year, coming in at $5.73 billion. The results beat analysts' expectations for earnings of $0.79 per share on $5.63 billion in revenue.
The market loved the report and sent the oil service company's stock up 3% on Friday with additional gains Monday morning following a strong report from Halliburton.
The quarter showed several favorable trends. First, Baker Hughes bought back $200 million worth of its shares. While $200 million may not seem like much for a $30 billion company, the buyback does reverse the trend in share count seen over the past couple of years. If the company continues its buybacks at this rate, the buybacks should increase its earnings growth by 3% on an annualized basis.
Second, Baker Hughes' Iraq operations have stabilized. The company experienced a significant disruption on November 9, 2013 that knocked off approximately $0.04 from its earnings per share last quarter. This quarter, Baker Hughes' Iraq operations are running, and while the company is not making any profit from Iraq as a whole, Baker Hughes does expect that its Iraq margins will increase over time.
Third, Baker Hughes expects the U.S. well count to continue to rise, led by growth in the Permian basin. The company believes the U.S. onshore rig count will rise by 4% and the Permian basin rig count will rise by 10% for 2014.
The company is also optimistic about the U.S. natural gas rig count, which it believes will increase if natural gas prices continue to rise.
The bottom line
With the earnings report out, Baker Hughes and other leading oil service companies remain good bets.
Even though they have rallied significantly year to date, Baker Hughes and Schlumberger (NYSE: SLB ) still trade at discounts to the S&P 500. For example, Baker Hughes trades at a forward P/E of 13.4 and Schlumberger trades at a forward P/E of 15 while the S&P 500 trades at a forward P/E of 17.
The oil service companies should also continue to grow at healthy rates going forward because overall oil industry capital expenditures should continue to increase whether oil prices remain range-bound or rise.
If oil prices remain range-bound, total industry capital expenditures should increase simply because it will become harder and harder to extract oil. Schlumberger, for example, expects total worldwide well-related capital expenditures to grow by 6% for 2014, a year that has seen Brent range-bound between $100 and $120.
If oil prices were to rise, total industry capital expenditures should increase because many of today's marginal projects are very capital-intensive. Once those marginal projects get the green light, total capital expenditures will increase and Baker Hughes will realize more revenue.
The only way for oil service companies to disappoint would be if oil prices were to fall significantly. This scenario is unlikely given emerging market demand. The per capita vehicle count in China, for example, is only 85 vehicles per 1,000 people versus 797 vehicles per 1,000 in the U.S. The number of vehicles in China will only increase going forward, and with it demand for oil.
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