Energy equipment and services company Baker Hughes (BKR -0.43%) delivered a solid, if unspectacular, set of fourth-quarter results this week, but they were enough to confirm the investment case for the stock. It's easier to engineer structural changes in a business when end markets are positive, and it's a lot easier to invest in growth businesses when the core business is growing and generating earnings and cash flow. Those are the favorable conditions facing Baker Hughes right now, and the stock is attractive for investors.
Earnings momentum
While ongoing strength in energy prices -- despite recessionary talk, the price of oil is still $82 as I write -- is encouraging investment in the industry, the oil majors are only cautiously opening the spending tap. There's a desire not to get caught out again as they were in 2014 when the price of oil slumped, and there's also the longer-term question of the future of fossil fuels in light of growing environmental regulation and the emergence of renewable energy trends.
That's good news for Baker Hughes as it speaks to the potential for a long cycle of investment in the industry and the avoidance of the usual exaggerated boom-and-bust cycle of excess supply creation leading to collapsing energy prices.
As you can see in the chart below, the oil majors are not spending anywhere close to 2014 levels.
Data by YCharts
However, energy companies are spending more, and it's showing up in Baker Hughes' earnings. For example, revenue of $5.9 billion was up 8% in the fourth quarter on a year-over-year basis, with adjusted operating income up 21%. Meanwhile, orders in the fourth quarter increased 20% year over year to $8 billion.
The guidance for 2023 implies ongoing growth in both segments. The company is forecasting:
- Oilfield services and equipment (OFSE) revenue of $14.5 billion to $15.5 billion in 2023, compared to $13.2 billion in 2022.
- Industrial and energy technology (IET) revenue of $9.5 billion to $10.5 billion in 2023, compared to $7.9 billion in 2022.
- OFSE earnings before interest, taxation, depreciation, and amortization (EBITDA) of $2.4 billion to $2.8 billion in 2023, compared to $2 billion in 2022
- IET EBITDA of $1.35 billion to $1.65 billion in 2023 compared to $1.3 billion in 2022.
- Total company revenue of $24 billion to $26 billion in 2023, up from $21.1 billion in 2022, and adjusted EBITDA of $3.6 billion to $3.8 billion, up from $3 billion in 2022
Restructuring actions
Baker Hughes hasn't always executed as well as it could, and in light of that, management's restructuring actions make sense. In a nutshell, the segments discussed above -- OFSE and IET -- are actually new segments created by combining the former oilfield services and oilfield equipment segments together, and the turbomachinery and process solutions segment with the digital solutions segment. The idea is to remove leadership layers and cut costs accordingly. The company's aim is to cut annual costs by at least $150 million. There's no guarantee management will achieve this aim, but it helps that its orders and revenue outlook is excellent; it's easier to cut costs when profits are growing.
Meanwhile, the earnings and cash flow from traditional fossil fuel activity allow management to invest in new energy growth initiatives like carbon capture, utilization, and storage (CCUS), liquefied natural gas (LNG/midstream already comprises 42% of IET revenue), hydrogens, and clean power. Finally, the strong equipment orders will likely translate into more higher-margin services revenue in a few years as equipment gets used -- raising the long-term margin profile.
An energy stock to buy for 2023
Wall Street analysts have Baker Hughes growing revenue at a double-digit rate for the next few years, with EBITDA growing at a mid-teens rate. Trading at a forward price-to-earnings ratio of less than 19, Baker Hughes looks undervalued and could provide a double-digit return for investors looking to get exposure to energy.
