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Better Buy: Baker Hughes vs. Core Laboratories N.V.

By Reuben Gregg Brewer - Feb 3, 2020 at 11:31AM

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These two energy services companies both come with warts, but they're on different trajectories.

Oil and natural gas prices are low today, and that's been a major headwind for energy companies, which in turn is bad for energy services companies like Baker Hughes (BKR -1.92%) and Core Laboratories (CLB -0.74%). That's because energy producers tend to pull back on spending when energy prices are low.

However, there's more to know if you are considering these two key industry players. And at the end of the day, one looks a little bit better positioned for 2020 than the other right now. But you don't need to rush in and buy either name at this point, so take your time and understand what's going on. Here's a quick primer.

1. Similar, but different

The first thing to understand about Baker Hughes and Core Labs is that they both serve the energy industry, but they do that in different ways. Core Labs is largely an asset-light business that uses technology to help its customers find and extract oil and natural gas more efficiently. It does this by offering high-tech data processing services to exploration and production companies around the world. The model affords the company impressive operating margins, which were recently in the mid-teens. 

An offshore drilling rig

Image source: Getty Images

Baker Hughes, meanwhile, does some stuff with data, but it's more about building physical assets that energy companies use. What sets it apart from its peers on this front is that its suite of products spans the entire energy landscape, including the upstream (drilling), midstream (pipelines), and downstream (refining and chemicals) spaces. Like Core Labs, it operates on a global scale. Its operating margins have been in the low- to mid-single digits of late (more on this below).

There's no win or lose takeaway here, but it's important for investors to understand that this pair serve the same industry in vastly different ways.

2. Strong foundations

Baker Hughes and Core Labs are also on close to equal footing when it comes to their balance sheets. Financial debt to equity for Baker Hughes is a very reasonable 0.25 times, even though that's higher than the 0.15 times at Core Labs. Both companies cover their interest expenses by more than six times, and have debt to EBITDA ratios of around 2.5 times. If you had to give one company an edge here, it would be Core Labs, but the difference is really not that material -- both are financially strong companies. 

3. Getting better, getting worse

Baker Hughes just turned in a pretty solid year, with revenue up roughly 4%. Two of its four divisions turned in growth, and two shrunk a little. However, all four saw year-over-year order growth in 2019. Still, the company painted a mixed picture for 2020 outlook during its fourth-quarter 2019 conference call. So don't go in expecting a standout year.

But that's only half of the picture here. 

Baker Hughes merged its business with General Electric's (GE -1.02%) energy industry operations a few years ago. The deal got off to a rocky start, with a bit of red ink as the two companies tried to integrate the combined business. Management has been working to get back on track, with a key goal being improving profitability. It has been achieving its aim, and gotten the company back into the black.

It's worth noting that its operating margin has steadily improved since the GE merger. To ensure that investors are rewarded for its ongoing success, Baker Hughes has paid a $0.72 per share annual dividend for two years running. That provides a 3.3% yield today, and with strong cash generation, there's no particular reason to expect this payment to be at risk in 2020. 

That highlights a key difference in the outlook here. Core Labs just announced an over-50% cut in its dividend because it expects 2020 to be a difficult year. The big problem is the onshore U.S. market, where demand has been falling off because low oil and gas prices have led to a pullback in drilling activity. Although that's part of the reason for Baker Hughes' mixed outlook for 2020 as well, Core Labs is obviously pretty worried about its business in the States. It cited the need to increase its financial flexibility when it announced the dividend cut. For all of 2019, Core Labs' revenue was down 9%, so it looks like it does, indeed, have more to worry about than Baker Hughes right now. 

4. No need to move fast

On the whole, Baker Hughes appears to be in a better position today than Core Labs. Its business is improving rather than faltering, as appears to be the case at Core Labs. That's also apparent in Wall Street's view of the two companies, with Baker Hughes down around 7% over the past year and Core Labs off by a painful 45% or so. 

CLB Chart

CLB data by YCharts

The thing is, both companies will continue to feel the effect of low oil and natural gas prices, especially in the U.S. space. That's a trend that isn't likely to change until there's a sustained uptick in the price of oil. Investors really don't need to rush in. And before you start thinking that Core Labs is a value play here, its forward P/E ratio of nearly 21 times is slightly higher than Baker Hughes' roughly 19.5 times figure. Add in the poor outlook for 2020, and Core Labs doesn't look like much of a bargain. 

That said, there's a not-so-minor wrinkle with Baker Hughes. General Electric owns a huge slug of the shares (around 37%), which it ultimately wants to get rid of. Since investors know those shares are likely to hit the market at some point, GE's ownership is likely to remain a headwind to any stock advance -- if the stock heads higher GE might flood the market with shares and push the price right back down. Core Labs doesn't have that negative sitting over it, but that doesn't really offset the visual provided by a massive dividend cut. 

Better, but maybe better to wait

If you are looking at Baker Hughes and Core Labs right now, Baker Hughes appears to be better positioned for the year ahead. While it is warning that 2020 will be filled will challenges, Core Labs' decision to cut its dividend to preserve cash suggests that it is battening down the hatches in preparation for a really bad year.

That said, even though Baker Hughes appears to be the better option, most investors should probably wait until GE's stake in the company is notably lower than it is today before jumping aboard. It's not that Baker Hughes is a bad company -- it is, in fact, doing a very good job of setting itself up for better days. The problem is that investors are likely to keep a lid on the stock so long as it knows GE is looking to get rid of its 36% ownership position. 

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Stocks Mentioned

General Electric Company Stock Quote
General Electric Company
$75.62 (-1.02%) $0.78
Core Laboratories N.V. Stock Quote
Core Laboratories N.V.
$24.29 (-0.74%) $0.18
Baker Hughes, a GE company Stock Quote
Baker Hughes, a GE company
$34.48 (-1.92%) $0.68

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