The oilfield services sector has yet to bounce back from the oil market downturn that bottomed out in early 2016. While crude oil prices are more than twice as high now as they were three years ago, service stocks as a group remain down by about 25% as measured by the Dow Jones U.S. Equipment & Services Index. One of the hardest hit stocks in the sector has been Weatherford International (NYSE:WFT), which lost more than 86% of its value over that time frame.
However, as intriguing as Weatherford International might be as a bounceback candidate, especially after it generated free cash flow for the first time in years during the fourth quarter, it remains way too risky an investment given its perilous financial situation. Because of that, investors looking for options in this sector would be better off forgetting about Weatherford, and instead should consider Baker Hughes (NYSE:BHGE).
The case for and against Weatherford International
Admittedly, there is an interesting investment case to be made for Weatherford International. The beleaguered oil services company hired former Halliburton CFO Mark McCollum in early 2017 to help engineer a turnaround. While it has taken some time, McCollum has been slowly selling assets and cutting costs to improve the company's financial profile. Those efforts finally started paying dividends at the end of 2018, when it generated $65 million in free cash flow, ending a multiyear drought. Meanwhile, management believes the company will be free cash flow positive in 2019 -- a situation which, along with improving earnings, will help reduce its net debt-to-EBITDA ratio by one-third compared to where it was at the end of last year.
However, while Weatherford International appears to finally be heading in the right direction, it has a long way to go before it's back on solid ground. It still had more than $7 billion of net debt at the end of last year, which is significant and concerning, considering its $8.2 billion enterprise value. To further put that leverage into perspective, even if the company achieves its ambitious goal of adding $1 billion to its annualized EBITDA by the end of this year -- boosting it to $1.75 billion -- its debt-to-EBITDA ratio would still be more than 4, which is high for an oilfield service company. And if market conditions deteriorate, that level of debt would significantly impair the company's ability to hit its leverage and profitability goals.
The case for and against Baker Hughes
While Weatherford International is finally starting to show signs of progress on turning around its financial profile, Baker Hughes is already solidly profitable and has a strong balance sheet. During Q4 2018, for example, Baker Hughes generated nearly $500 million of adjusted operating income and more than $875 million in free cash flow, boosting its full-year total to over $1.2 billion. Further, its revenue rose 8% year over year during the quarter, while Weatherford's continued to decline due to asset sales. Thanks to its improving earnings and cash flow, Baker Hughes has a strong balance sheet: It ended last year with $3.7 billion in cash and just $3.4 billion in net debt, which is a very manageable level for a company with an enterprise value in excess of $48 billion. That strong financial position allowed it to return $3.3 billion in cash to investors last year via its dividend and share-repurchase program.
If there's one knock on Baker Hughes, it's that beleaguered industrial giant GE (NYSE:GE) still owns a 50% stake in the company. That could continue to weigh on Baker Hughes' valuation, since GE has demonstrated that it's willing to sell shares to raise cash even in the midst of oil market turmoil. If GE gets desperate again, it could unload more stock at an inopportune time, which could undermine Baker Hughes' share price. However, GE eventually expects to exit its position, so this is a short-term concern.
Not worth the extra risk
While Weatherford's low stock price and early-stage turnaround might look tempting, investors are better off avoiding it because of its high debt load. At rival Baker Hughes, the turnaround is well underway, and it's in a much stronger financial position. That makes it a less risky way to play the eventual rebound in the oilfield services sector.