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Better Buy: Baker Hughes vs. National Oilwell Varco

By Reuben Gregg Brewer - Feb 21, 2020 at 7:33AM

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Of these two oil services companies, is one in a better position than the other today? It looks like it, but there's more to this comparison.

Oil prices are suffering through another period of weakness, this time led by the impact of COVID-19. Investors have once again pushed anything related to oil lower, including oil services companies like Baker Hughes (BKR -1.46%) and National Oilwell Varco (NOV -1.56%). That said, investors looking to invest when others are fearful might be taking a closer look at this cyclical industry, wondering how these two names match up. Here's what you need to know.

1. Similar but different

Baker Hughes as it exists today is the amalgam of the old Baker Hughes and General Electric's (GE -3.32%) energy services business. It offers products and services across a huge spectrum of the energy sector, covering the upstream (drilling), midstream (pipeline), and downstream (refining and chemicals) areas. National Oilwell Varco, meanwhile, has a tighter focus on drilling services, engaging with customers primarily in the upstream sector. 

A man with a notebook in front of oil well

Image source: Getty Images

Investors looking for a diversified energy services investment should favor Baker Hughes here. Those looking to bet on a drilling upturn would be better off with National Oilwell Varco. That said, there's a scale difference, as well. National Oilwell Varco is a big company, sporting a roughly $9 billion market cap. However, Baker Hughes is more than twice as large, with a market cap of around $23 billion. Larger and more diversified, Baker Hughes gets the point here.

2. A rough patch

With low oil prices, investors have been pulling away from energy services names. The stocks of Baker Hughes and National Oilwell Varco are down around 14% and 8%, respectively, so far in 2020. Over the past year they are down 15% and 23%, respectively. Over the past three years they are down 64% and 42%, respectively. Basically, these two stocks haven't seen much love from Wall Street for a while. Weak oil prices, which tend to lead to a reduction in drilling activity, are the core reason for that.

This is, in the end, one of those periods where an oil services company simply needs to retrench and just muddle through. Things like cutting costs and improving efficiency become paramount in the larger effort to keep operations in the black. On that front, Baker Hughes has been doing a better job. It's operating margin fell slightly into negative territory in 2016, but has been positive and rising in each of the last three years. National Oilwell Varco's operating margin has been in the red in three of the past four years, including in 2019.

Baker Hughes gets another point. 

3. A unique obstacle

That said, there's a complication here that deserves mentioning. GE agreed to merge its energy services operations with those of Baker Hughes in 2016. The early days of that union were difficult, but Baker Hughes has clearly started to prove that the thesis here was sound. However, a lingering problem is that GE has a significant ownership stake in Baker Hughes -- at one point GE owned so much of the company that it was named Baker Hughes, a GE Company.

This is a problem because GE is struggling through a wrenching makeover. Selling Baker Hughes stock has been a way for it to raise much-needed cash, but this creates an overhang on Baker Hughes, because investors expect any uptick in price to result in more GE stock sales. GE's ownership interest is well below 50% today, but it still has a big stake in Baker Hughes. This will likely keep a lid on the upside at Baker Hughes, even if the company produces solid financial results, until GE's position is materially reduced.

National Oilwell Varco doesn't face this odd complication, which is a point in its favor.

4. The foundation

While Baker Hughes is working through a big merger during a difficult market environment for energy services firms, it is doing so with a pretty solid balance sheet. For example, its financial debt to equity ratio is a very solid 0.17 times. It covered its interest expenses by more than 6.5 times.

National Oilwell Varco's financial debt to equity ratio is pretty close here at 0.20 times. However, red ink has left it with negative interest coverage. It would not be appropriate to suggest that National Oilwell Varco is a deeply troubled company, but it doesn't appear to be quite as financially strong as Baker Hughes right now. 

NOV Financial Debt to Equity (Quarterly) Chart

NOV Financial Debt to Equity (Quarterly) data by YCharts

5. Returning some value to investors

The next point up is dividends. Baker Hughes offers investors a sizable 3.2% dividend yield. National Oilwell Varco's yield is a miserly 0.9%, which is even lower than the S&P 500 Index's roughly 1.8%.

However, there's another difference here worth looking at. National Oilwell Varco's cash dividend payout ratio, which looks at dividends in relation to free cash flow, is an easily manageable 16%. Baker Hughes' cash dividend payout ratio is about 85%, which leaves much less cash for other purposes like investing in the business. That said, Baker Hughes appears to be doing just fine coping with this long industry downturn, and there's no particular reason to be overly concerned about a dividend cut. All in all, Baker Hughes gets another point.

6. Cheap and cheaper

The last thing up for examination here is valuation. Examining price to earnings is out because National Oilwell Varco is in the red right now. So looking at metrics like price to sales, price to book value, and price to cash flow are the valuation fallbacks. The company is below its five-year average on two of those metrics, and above on one (price to book value). On the whole, it appears relatively cheap today. Because of the GE merger, Baker Hughes doesn't have five-year averages on these metrics. That said, its current price to sales, price to book value, and price to cash flow metrics are below those of National Oilwell Varco. So it looks like the better value of the two options. Again, a point for Baker Hughes. 

And the winner is...

When you put all of the pieces here together, Baker Hughes looks like the clear winner. That's not to suggest that National Oilwell Varco is a bad company, it just doesn't look quite as desirable today. Before you run out and buy Baker Hughes, though, you'll want to keep in mind the ongoing entanglement with financially troubled GE. While Baker Hughes appears to be a better option than National Oilwell Varco, it is hard to suggest that Baker Hughes is a buy, since GE's intention to sell more of its stake is likely to remain an overhang on the stock price in the near term.

So, all in all, neither of these two oil services names looks like a great opportunity right now.

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Stocks Mentioned

General Electric Company Stock Quote
General Electric Company
$63.69 (-3.32%) $-2.19
National Oilwell Varco, Inc. Stock Quote
National Oilwell Varco, Inc.
$17.05 (-1.56%) $0.27
Baker Hughes, a GE company Stock Quote
Baker Hughes, a GE company
$29.63 (-1.46%) $0.44

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