Capital spending is the lifeblood of energy services companies. With oil trading at historically low levels, exploration and production (E&P) companies have pulled back hard on spending plans. That's left services companies like Baker Hughes (BKR 6.30%) and Core Laboratories (CLB 10.16%) reeling as revenues dry up. Investors have been fleeing, leading to deep price declines. Is this an opportunity for long-term investors in either company?
Ups and downs
If there is one thing that is consistent in the energy sector it is that the commodity-driven business is highly cyclical. Supply and demand routinely get out of whack, with prices rising and falling in often large and swift moves.
Today, oil is down and out. There are normal patterns that occur when this happens, the most notable of which, for services companies like Baker Hughes and Core Labs, is that E&P companies pull back on their capital spending plans. That basically means less revenue for services companies. So it's not surprising that Baker Hughes stock is down roughly 40% so far this year, with Core Labs off by nearly 50%.
On the positive side, the reduction in spending by E&P companies that typically occurs during periods of weak energy prices has historically helped to rebalance supply and demand. So, if history is any guide, the pain today should help set up higher oil prices and increased demand for Baker Hughes and Core Labs in the future. It doesn't change the painful share price declines, but it suggests that investors looking at this pair today could be getting in at -- or at least near -- a bottom for the industry. Notably, Baker Hughes has highlighted large decreases in the industry rig count, with the biggest drop coming in the U.S. onshore space.
That's an important factor here, because over the past decade or two U.S. oil production has materially increased. That flood of oil has upended the normal supply/demand dynamics in the industry. Although the demand drop from the world's effort to slow the spread of COVID-19 is the immediate cause of the industry's oversupply, U.S. onshore production is a key factor underpinning the problem. With the U.S. rig count hovering at record lows, however, there are early signs that things could eventually change for the better for Baker Hughes and Core Labs.
Positioned to benefit
Core Labs and Baker Hughes are both energy services companies, but they take very different approaches. Baker Hughes is something of a jack of all trades, providing products and services to the industry all along the chain, from drilling (upstream) to pipelines (midstream) to refining and chemicals (downstream). While that provides it with a fair amount of diversification, this downturn has hit the industry from top to bottom. So there's been no place to hide.
Core Labs, on the other hand, provides data services to drillers, helping them maximize the amount of oil they find and produce. There isn't much diversification going on in that model. For investors who prefer to spread their bets, Baker Hughes gets the point here.
The two also differ materially when it comes to their balance sheets. Baker Hughes' debt to equity ratio is around 0.6 times. After taking a large one-time write off in the first quarter (a move that trimmed shareholder equity by roughly 60%), Core Labs' debt to equity ratio is a hefty 4.6 times. Even before that write-off, however, Core Labs made greater use of leverage, ending 2019 with a debt to equity ratio of about 1.7 times. Investors looking for a fiscally conservative name would probably prefer Baker Hughes.
Dividend investors will also like the story at Baker Hughes more today. Despite the current headwinds, the company has maintained its dividend at $0.18 per share per quarter. Core Labs, on the other hand, has trimmed its dividend to just $0.01 per share per quarter in an effort to conserve cash. That's nothing but a token payment largely meant to allow institutional investors with a dividend mandate to remain shareholders. Again, Baker Hughes wins, noting that its cash dividend payout ratio, which looks at dividend relative to free cash flow, is a reasonable 55% or so despite the troubles facing the energy sector.
Almost an easy call
When you take a closer look here, Baker Hughes appears to be a better investment choice than Core Labs for most investors. That said, Baker Hughes counts General Electric is a major shareholder. GE, working through a difficult turnaround, has openly stated it wishes to sell its remaining stake in Baker Hughes. That means GE could start selling shares as Baker Hughes' stock recovers, potentially dampening the upside here for a bit. Although the current low price may adequately discount this fact, long-term investors should go in realizing that GE is a headwind outside of the oil patch troubles that Baker Hughes is dealing with today.
In the end, more conservative types would probably be better off avoiding Baker Hughes, too, at least until the situation with GE is settled.