Oil prices have plummeted in 2020, leaving a wake of destruction in the broader energy sector. Baker Hughes (BKR -1.00%) and Schlumberger Limited (SLB -0.89%) have been no exception. What should investors be thinking about these two energy services companies now, and is one a better option than the other?
Oil: Lower for longer
There was already a supply glut in the oil market before COVID-19 and the OPEC/Russia price war. The main reason for the oversupply was the increasing prominence of onshore U.S. drilling. As the U.S. pumped more and more oil, the normal dynamics in the global industry started to shift. OPEC attempted to deal with this, and keep oil prices up, by cutting its production. That, however, wasn't enough, because U.S. oil simply replaced the disappearing barrels.
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Eventually Russia grew tired of this approach and decided it would no longer play along with OPEC's efforts. That led to a price war between the two that pushed oil prices sharply lower. On top of that, COVID-19's spreading impact has squashed demand as countries curtail economic activity and travel in an attempt to minimize the damage from the virus. Oil prices have fallen even further.
The lingering problem is that much of the oil being produced today isn't needed. Oil is now being put in storage for use at a later date. Thus, even when economic activity picks up again from what is likely to be a global recession, there will be a supply overhang to work through. So oil prices don't look like they are heading higher anytime soon.
Extra painful for service providers
This is bad for oil drillers, most of which are now trying to cut back on their drilling efforts. When the problem was just U.S. oil, the hardest-hit area was onshore U.S. drilling. In fact, Schlumberger has been pulling back in that sector for a couple of years because of weak performance. Sales in the company's U.S. segment were down 10% in 2019, but higher throughout the rest of the company's business. Baker Hughes, meanwhile, specifically highlighted weakness in North America as a trouble spot when discussing its fourth-quarter 2019 financial results.
The issue for both companies is that they provide services to oil and natural gas drillers. When their energy industry customers pull back, demand for Schlumberger and Baker Hughes services falls. The situation hasn't improved so far in 2020, with the global rig count down about 8% year over year in February. That drop was driven by falling U.S. rig counts, and doesn't include the likely hit from the OPEC/Russia price war or COVID-19. More pain is on the way for services companies like Baker Hughes and Schlumberger.
Muddling through
At this point, investors should be focused on how well Baker Hughes and Schlumberger can weather the coming demand hit, noting that it could take a long time for things to improve. On that note, Schlumberger had roughly $33 billion in revenue in 2019, and ended the year with around $2.2 billion in cash. Baker Hughes generated about $24 billion in revenue in 2019 and ended the year with $3.2 billion in cash. When times get tough, cash is king. And Baker Hughes appears to be in better shape on the cash front.
Leverage is also different, with financial debt to equity at Schlumberger sitting at around 0.29 times at the end of 2019 versus 0.17 times for Baker Hughes. Again, Baker Hughes' balance sheet looks better positioned. To be fair, Schlumberger isn't exactly over-leveraged, and it is highly likely that both companies get through this downturn. But it appears that Baker Hughes is better positioned financially going in.
A broader business may help, too
That said, there's another point of difference that could be important today: diversification. Both companies are large and globally diversified. However, Baker Hughes' business serves more end markets than those of any of its peers, offering products and services to the upstream (drilling), midstream (pipeline), and downstream (refining and chemicals) sectors. Schlumberger is largely focused on the upstream segment. That gives Baker Hughes a bit of an advantage in dealing with a downturn, since its eggs are spread across more baskets.
That said, when times eventually get better -- which is likely to happen eventually in this highly cyclical space -- Baker Hughes' diversification could work against it. As oil drillers start to ramp back up, it is Schlumberger that will likely see the biggest boost from demand.
The winner is?
The oil industry looks like it is headed for more pain ahead because of a difficult mix of oversupply and falling demand. At the very least, the hit that the energy industry is taking today is going to linger for a while longer. In this scenario, Baker Hughes looks better positioned.
That said, despite massive price declines, most investors should probably stay on the sidelines for the moment when it comes to both Baker Hughes and Schlumberger. Times are tough right now, they are likely to get worse, and there's no clear end in sight. That's not going to be particularly good for either of these companies.
