It's been a bit of a roller-coaster year for energy services giant Baker Hughes, a GE Company (NYSE:BHGE) and its shareholders. After the stock rallied around 30% at the start of 2019, it has since fallen over 20% from its highs. For the year it is up in the low single digits, but still off some 40% from the highs it reached in late 2017. That's an important date for any investor considering buying Baker Hughes today. The business looks better now than it did back then, despite the steep price decline, but there's still some big issues to contemplate here.
When everything changed
In late 2017, General Electric (NYSE:GE) merged its oil and natural gas operations with Baker Hughes. It was a fairly complex deal that left GE with a 62.5% stake in the combined entity, effectively giving the industrial giant control of Baker Hughes, a GE Company. The marriage of the two got off to a little bit of a rocky start, but that's not unexpected when dealing with such a large and complicated transaction. What was so intriguing about the deal, however, was the broad portfolio of services that Baker Hughes is now able to offer. It calls itself the first and only "fullstream" provider, with services across the upstream (drilling), midstream (pipeline), and downstream (chemicals and refining) spaces.
In fact, there is a compelling story behind the combined Baker Hughes and GE businesses. First, the merger offered up the chance to pull some costs out of the company. Strategically, meanwhile, it is now capable of being a one-stop shop for customers around the world. And, perhaps more important, it can adjust within its broad suite of offerings to highlight those businesses most in demand and that are most profitable.
On the cost side, Baker Hughes has actually been running ahead of scheduled cost savings. Often these synergies, as they are called, don't pan out as expected. But in this case, the energy services company was able to exceed its 2018 target by $100 million and remains on track to hit its 2019 goals. As for the business, there were no major operational hiccups, though oil prices have remained volatile and have been a bit of a headwind on the demand side of the equation for all energy services companies.
That said, Baker Hughes has been seeing some success despite a difficult market. For example, orders were up 10% in 2018, and through the first half of 2019 they increased another 9%, year over year. Revenue advanced 5% and 6%, respectively, in those two periods. Notably, the company's book-to-bill ratio was 1.1 in the second quarter, which means that it inked more new orders than it completed. That, in turn, suggests that there is more growth ahead for Baker Hughes. The strength here is highly related to the company's ability to offer a wide and varied portfolio of products and services.
The company's success on the bottom line is a bit harder to see because of ongoing integration efforts. For example, Baker Hughes lost $0.02 a share in the most recent quarter under GAAP accounting rules. But if you pull out one-time expenses, it would have earned $0.20 a share. A lot of the one-time costs the energy services specialist is facing relate to the ongoing integration process. So, all in, Baker Hughes appears to be doing reasonably well today and the outlook is for more good things to come -- even in a difficult oil market.
The problem with this picture
Before buying Baker Hughes, a GE Company, however, investors need to step back and look at the bigger picture. And that means considering the situation at General Electric, which isn't nearly as positive as the situation at Baker Hughes. GE is working on yet another turnaround effort under its third CEO in as many years. There are high hopes this time around, but so far it has been tough going.
Most notably, GE's balance sheet remains weak. That traces back to the deep 2007 to 2009 recession, when the company's push into the financial space turned into a huge liability. It has been trying to get out from under this issue ever since. That's included multiple rounds of restructuring, write-offs, asset sales, and dividend reductions. None of these efforts has come from a position of strength. At this point, some market watchers fear that GE is getting desperate. For example, GE sold down its position in Baker Hughes to around 50% in late 2018 despite the massive drop in Baker Hughes' stock price. And it recently agreed to sell a portion of its healthcare business, which is one of its best-performing divisions.
Moves like these have bought the company some breathing room, to be sure. But it is not out of the woods yet, which is a concern given the cyclical nature of GE's industrial focus. Most of its recent problems have come during an economic expansion; what will happen when a recession hits? There's a very real chance that it will be forced to dump Baker Hughes stock on the market, putting downward pressure on the share price. The fear that this could happen, meanwhile, is likely to remain a cloud over Baker Hughes until GE is finally out of the picture.
In other words, GE's position in Baker Hughes is a headwind that has nothing to do with how well Baker Hughes performs as a company. And there's nothing that Baker Hughes, or its shareholders, can really do about it.
Wait on the sidelines
Baker Hughes, a GE Company is a well-run and highly diversified energy services company. It has been executing well on a large and complicated merger. Unfortunately, GE's controlling stake in the company remains a wild card that is hard to quantify. Most investors would be better off monitoring Baker Hughes than owning it today. Once GE is out of the picture, however, Baker Hughes could quickly become a lot more attractive.