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Baker Hughes Inc Eyeing Mid-Teens Margins by Year-End

Baker Hughes (NYSE: BHI  ) , similar to its peer Halliburton (NYSE: HAL  ) , is well positioned to benefit from the unfolding North American recovery and robust growth in the Eastern Hemisphere.

The company reported first quarter operating EPS of $0.84, beating consensus estimates of $0.78 by 8%. The headline EPS of $0.74 was adjusted for $41 million in after-tax charges ($0.10 per share) related to severance and a royalty agreement. Stronger than expected North American results largely drove the beat. Strong activity in Canada in the peak winter drilling season and a better mix of sales in the Gulf of Mexico both helped the North American results.

North American margins increase
Despite the negative impacts of cold weather in the first quarter, the company was able to increase North American margins by 200bps quarter over quarter to 10.8%. These margins represent not only the highest level since 3Q12, but also narrow the North American margin gap vs. the company's peers.

The increase in margins can be attributed to the company's self-help initiatives. Baker Hughes has largely completed infrastructure improvements and will now focus on logistics and customer mix optimization. Baker Hughes is expected to increase margins to mid-teens by year-end.

Better pricing and new technology to drive higher margins in 2H14
Baker Hughes expects a 10% increase in the average Permian Basin rig count in 2014, which should drive an overall gain in the U.S. rig count of 4%. The company remains optimistic about the U.S. oil services market and expects prices to improve by year-end. As mentioned earlier, the company expects margins to be in the mid-teens in the second half of 2014, largely due to efficiency gains across the supply chain and new technologies such as FracPoint, FlexPump and ProductionWave, and Kymera drill bits. These new technologies sell for significantly higher margins than the products they replace.

Baker bought back $200 million worth of stock (3.4 million shares) in the first quarter. This comes after the company spent $350 million in buybacks in 4Q13. These buybacks are a further evidence of the company's growing confidence in its business prospects. Baker Hughes is now left with $1.45 billion in its current buyback program. The company expects to produce more free cash in 2014 and 2015 as cash generation grows and capex demands remain more modest than in recent years.

Subsea alliance with Aker Solutions
Following its quarterly results, Baker Hughes also announced the formation of a production partnership with Aker Solutions. The alliance will merge Aker's subsea production and processing capabilities with Baker Hughes' well completion and artificial lift expertise.

This is the second partnership of its type and follows a similar move by Cameron International (NYSE: CAM  ) and Schlumberger (NYSE: SLB  ) , which teamed up in 2012 to create a joint-venture OneSubsea.

Deepwater recovery rates significantly lag those of onshore wells, and there is great opportunity in being able to unlock incremental production offshore. The alliance aims to develop technology that will boost output and recovery of offshore wells and ultimately reduce the cost of developing subsea fields.

The alliance is positive for Baker Hughes and shows the confidence that the company has in its technological advances. Baker Hughes, long known as a premium manufacturing company, has now completed its capability suite required of a high-end, integrated service company.

After a decade of large capital spending programs, the oil industry has entered a new age of capital efficiency. The companies are cutting down their spending programs as oil prices have leveled out. This new world of energy is more focused on returns than ever, and Baker Hughes' alliance with Aker Solutions has a clear long-term vision of creating value for customers by developing integrated system that aim to lower the per barrel cost of production. In this new world of energy, companies with the technological means to lower costs while at the same time maximizing production will continue to be winners.

Bottom line
Baker Hughes has proven its ability to execute on its turnaround, and now things are coming together nicely. The company offers investors accelerated growth opportunities in North America, but its international business is also beginning to pay off after years of investment. The company will be a major beneficiary of an expected improvement in the pressure pumping market in the second half of 2014.

This is Baker Hughes' sixth consecutive quarter of improving margins, and the company remains confident in its ability to generate mid-teens margins by year-end. A number of factors are driving margin increases, including improvement in Gulf of Mexico operations, a favorable revenue mix shift, an expected increase in well count and well intensity, continuing improvement in pressure pumping, and finally absorption of high-margin new technologies, as the focus on well efficiency continues.

In terms of international operations, both China and the Middle East offer opportunities for revenue growth in 2014. Finally, the company's financial position remains healthy. Baker bought back $200 million worth of shares in the first quarter, and keeping in mind its strong cash flow position, the company is expected to continue buying back shares at this rate.

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  • Report this Comment On May 14, 2014, at 7:42 PM, stevebry56 wrote:

    Baker Hughes’s North America segment covers oilfield services and equipment operations in the US and Canada, and is by far the largest contributor to the company’s overall revenues because

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Jan-e- Alam

Jan-e-Alam writes mostly for the Motley Fool energy and materials sector. He has been writing for several financial media websites for a few years now and other than materials/energy sector also covers financials and industrials. He holds an undergraduate degree from Loughborough University and is a CFA Level III Candidate. He has also worked for a bulge bracket bank in the past.

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