It's always encouraging when a company beats Wall Street's earnings estimates as Baker Hughes, a GE Company did this past quarter, but that doesn't necessarily mean that everything's peachy. While it is hitting some important milestones in its integration, BHGE's tepid growth rates in what has been a fast-growing period for oil services has to have some investors a little concerned.
Let's take a look at the company's most recent earnings results and try to figure out why BHGE may be slow to react to the upswing in oil services companies.
By the numbers
|Metric||Q1 2018||Q4 2017||Q1 2017*|
|Revenue||$5.39 billion||$5.76 billion||$5.32 billion|
|Operating income||($41 million)||($92 million)||$39 million|
|Free cash flow||$226 million||($367 million)||N/A|
BHGE's results have something in them for both the bulls and the bears. On the bullish side, the company continues to grow its oil field services business and expand margins. Also, the company was able to maintain a book-to-bill ratio of 1 for the quarter, which means that it is securing the same amount of work coming in the door as going out. This is quite a feat because much of BHGE's business is tied to selling equipment that typically only gets ordered in times of heavy investment. Over the past few years, producers haven't signed off on many new major capital projects that would require this kind of equipment.
On top of that, the company is making progress on the integration of the two businesses, finding ways to cut costs, and offering what it calls a full-stream service contract. These contracts involve providing both services and equipment to the same customer. This hasn't traditionally been the way the oil industry has worked in previous years (producers would select services and equipment separately using a competitive bidding process), but the merger of BHGE and the tie-up of Cameron and Schlumberger has created these integrated service companies that can provide full-service packages. A lot of BHGE's future success is going to be tied to signing these full-stream contracts, so seeing another one on the books this past quarter is encouraging.
As for the bears, there was plenty to be concerned about as well. One thing that really stands out is BHGE's low operating income margins. Also, even though the company has been able to secure a sufficient amount of orders to replace revenue, its growth rates are falling behind its largest competitors, as both are going through rapid growth phases. Here's how BHGE's results stacked up against its peers in terms of revenue growth and operating income for the most recent quarter.
|Company||Revenue Growth (YOY)||Operating Income Margin Q1 2018|
Again, this could be a product of BHGE's big-ticket-item segments being lumpier businesses that could rise as new major capital projects get the green light. For now, though, it looks like both Schlumberger and Halliburton are taking market share at the expense of BHGE.
What management had to say
According to CEO Lorenzo Simonelli, it seems as though he thinks it's all a matter of timing for BHGE. As companies start to invest in the next wave of projects, BHGE will benefit immensely, he said:
Market fundamentals remain supportive, as crude oil prices are relatively rangebound, providing stability to customers as they evaluate projects. The gas market continues to grow, and strong [liquefied natural gas] demand supports the view that new capacity will be required in the early to mid-part of the next decade. BHGE is uniquely positioned across the oil and gas value chain, and well placed to benefit from the long-term industry trends.
Simonelli also went out of his way to highlight some of the progress management has made on the integration of the two businesses and the value it intends to create for shareholders, stating: "We continue to make progress on the integration. In the first quarter we delivered $144 million of synergies and our 2018 total year commitment of $700 million remains firmly on track."
Considering how weak its operating margins are compared to its peers', it's imperative that BHGE gets its costs under control.
Not off to the strongest start
The combination of Baker Hughes and GE's oil and gas business has created a unique oil services company. While oil producers have increased their spending levels lately, there has been a noticeable lack of final investment decisions for larger projects that would require the kind of equipment that BHGE supplies. Management seems to think that as we see new projects get to final investment decision stage, especially new liquefied natural gas (LNG) facilities, BHGE will see a considerable uptick in orders.
For investors, though, it's hard to watch its peers grow at double-digit rates while BHGE is still mired in the middle of restructuring and not capturing more work. It's still way too early to say whether this merger can be considered a success or not, but it's understandable if investors are slightly uneasy right now. The most important thing to watch in the coming quarters will be any announcements about new major LNG facilities and BHGE's ability to capture orders for those facilities. Management has gone all-in on this particular market, so a lack of orders from this business could cause investors lots of headaches.