Baker Hughes' Big News: Is It a Smart Buy or a Risky Sell?

Energy equipment and services company Baker Hughes' (BKR -1.38%) second-quarter results produced a mixed reaction among investors. Just like its peer, Halliburton, Baker Hughes served notice that lower oil and gas prices were curbing upstream and shale spending in North America.

However, there's a lot more to Baker Hughes than that, and the company beat estimates for the quarter and also raised the midpoint of its full-year guidance. What's going on, and is now the time to bail out of the stock or buy more?

A cyclical industry, but all cycles are different 

It's no secret that the energy sector is a cyclical industry. High prices induce investment, which often causes overcapacity in the sector leading to a collapse in energy prices. A slump in investment follows, which causes under-capacity, and ultimately prices start rising again, so the cycle begins anew.

Image source: Getty Images.

As such, it's no surprise to hear both Halliburton and Baker Hughes' management talk of market softness in North America this year as the price of oil has trended lower over the last year. While that's obviously a concern, there are plenty of reasons to believe the stock is attractive. 

A lot more than upstream U.S. activity 

First, as CEO Lorenzo Simonelli noted on the earnings call, about 70% of its oilfield services and equipment (OFSE) business is international "and around 40% exposed to offshore." He expects weakness in U.S. onshore spending to be "more than offset by strength in international and offshore markets." 

Indeed, a review of management's updated guidance shows Baker Hughes upgraded its full-year OFSE revenue expectations, alongside upgrading the midpoint of its total revenue and adjusted earnings before interest, taxation, depreciation, and amortization (EBITDA) guidance. 

Data source: Baker Hughes presentations. 

A different cycle

In a sense, the softness in spending in the U.S. -- coming in response to slightly weaker energy prices -- supports the case for Baker Hughes stock. It's not great news over the near term, but it suggests oil majors are disciplined in their spending plans. That's likely to lead to a cycle that Simonelli describes as being "more durable and less sensitive to commodity price swings relative to prior cycles."

If Simonelli's right, then the boom and bust cycle will be much less extreme, and Baker Hughes' earnings aren't about to collapse anytime soon. 

New energy orders growth

The fear that fossil fuels will be slowly phased out of the economy (something that's also holding back oil capital spending) is well-known in the industry. As such, companies like Baker Hughes must make themselves relevant in the clean energy transition. 

I've previously discussed how Simonelli sees "new energy" (hydrogen, CO2 compression, carbon capture, utilization, storage, etc.) orders reaching 10% of gas technology orders over the next few years. The good news is Baker Hughes is well on its way.

Management upgraded its estimate for overall industrial and energy technology (IET) orders in 2023 by $1 billion to a range of $11.5 billion-$12.5 billion. As for new energy orders, it came in at $440 million in the first half compared to $400 million for the whole of 2022, and management expects it to come in at $600 million to $700 million for the full year 2023.

LNG orders remain strong

Speaking of the energy transition, there's a strong case for natural gas and liquefied natural gas (LNG) playing a key role in the transition and beyond as a base energy source alongside renewable energy, which tends to be intermittent. Indeed, Baker Hughes' LNG-based orders remain strong, with $900 million in awards in the quarter.

Due to the strength in LNG and new energy orders, management believes the IET segment could report orders "near the updated 2023 guide for the next couple of years." Given that the midpoint of the IET outlook for 2023 is $12 billion and the midpoint of the revenue outlook is $10 billion, that assumption implies revenue will have to grow 20% from 2023 to 2025. 

Ongoing cost cuts

Another critical aspect of the investment case for the stock is the $150 million in planned cost cuts by the end of 2023 as a result of the reorganization of the company. The good news is the actions to achieve the $150 million target have now been taken, and management held out the prospect of a "much larger" process coming to fruition over the next couple of years. CFO Nancy Buese promised more detail on how that will translate into margin expansion in the future -- something to look out for ahead.

Data by YCharts

A stock to buy?

While the 19% rise this year means the stock is no longer a screaming buy (see chart above), there's enough value to support buying the shares as part of a diversified portfolio. Moreover, Baker Hughes is an excellent option if you are specifically looking for some energy exposure. As such, the stock could be worth picking up after a dip.