There are two key reasons to buy the stock of energy equipment and services company Baker Hughes (BKR -1.38%). The first reason is its play on the medium-term outlook for spending in the energy industry. The second is a value investing opportunity based on the company playing catch-up with peers like Halliburton and Schlumberger and, in doing so, releasing a significant amount of value for investors. Here's the lowdown.
Baker Hughes in 2022
It's been a good year for the energy industry and energy services companies. The chart below shows the performance of three of the leading companies in the industry compared to the benchmark S&P 500 index. All three are up, but Baker Hughes' underperformance is notable.
Data by YCharts.
The company's underperformance stems from a combination of factors, including charges taken concerning suspending activities in Russia, component shortages and raw material price inflation, and a disappointing performance in two of its four segments.
Baker Hughes currently reports data for four business segments. As you can see in the table below, the oilfield equipment (OFE) and digital solutions (DS) businesses are being carried by oilfield services (OFS) and turbomachinery and process solutions (TPS) right now.
|
Baker Hughes Third Quarter 2022 |
Revenue |
Segment Income |
Orders |
Description |
|---|---|---|---|---|
|
Oilfield services (OFS) |
$2,842 million |
$330 million |
$2,832 million |
Products and services for onshore and offshore oil wells to enable evaluation, drilling, and completion |
|
Oilfield equipment (OFE) |
$561 million |
($6) million |
$874 million |
Products and services for onshore and offshore oil wells to enable hydrocarbons to flow from the well to the production facilities |
|
Turbomachinery and process solutions (TPS) |
$1,438 million |
$262 million |
$1,810 million |
Equipment and services that enable mechanical, compression, and power generation across various industries, including oil and gas, LNG, refining, petrochemicals, heavy industries, etc. |
|
Digital solutions (DS) |
$528 million |
$20 million |
$547 million |
Software, hardware, and analytics that connect energy assets enabling monitoring and inspection |
Data source: Baker Hughes presentations.
Restructuring plans
In response to the disappointing performance at OFE and DS, management announced a major restructuring in early September. The key points are as follows:
- The company will now comprise just two reporting segments: oilfield services and equipment (OFSE), which will incorporate OFS and OFE, and industrial energy and technology (IET), which will include TPS and DS.
- Overall corporate structure will be streamlined, resulting in $150 million in annual cost reductions.
The annual cost reduction of $150 million is equivalent to around 0.7% of estimated 2022 revenue. It might not sound like much, but bear in mind that Wall Street analysts expect Baker Hughes' operating margin to be just 8.66% this year, so an extra 0.7% helps. With it, the company can begin chipping away at the difference between its margin and that of its peers.
BKR Operating Margin (TTM) data by YCharts
More margin opportunities
It's somewhat unfortunate that Baker Hughes is having issues with DS. After all, the whole purpose of General Electric (GE 0.68%) agreeing to merge its oil and gas business with Baker Hughes a few years ago (ultimately creating the Baker Hughes we know now) was to add GE's oil and gas technology to Baker Hughes' oilfield services businesses. The big idea was that creating a full-service provider sprinkled with GE's digital capability's stardust would add value for customers.
Still, according to management on the earnings call, merging DS with TPS will cut costs (at least $50 million by the end of 2023). Moreover, a large part of the problems this year came from an inability to secure components (chips, etc.), and Baker Hughes is undoubtedly not alone in facing that issue. When the supply chain issues ease, the new IET segment should benefit.
Similarly, at OFE, management is aiming for cost cuts and downsizing facilities while conducting an operational review of its poorly performing subsea business.
A stock to buy
It all speaks to a company with plenty of self-help opportunities to expand its profit margin. Moreover, despite the recessionary talk, the price of oil still stands well above $80 a barrel, and there's no shortage of interest in LNG as a potential replacement for Russian pipeline gas. History suggests it's a lot easier to restructure a company when it's in favorable end markets, and hopefully, Baker Hughes is on the right track.
