Shares of Weatherford International Ltd (NYSE:WFT) surged to multi-year highs following the news of a solid quarter. The oilfield services firm has long been pressured by disappointing results and struggling operations, but the management team might finally be focused on the right metrics.
The key to the turnaround is a focus on improving operations and trimming the fat. Weatherford is in the middle of a cost-cutting program that will eliminate 7,000 employees, though the company suggests that the cut is only eliminating duplicated functions and operations. When complete, the move will save the company $500 million annually. The company's recent results suggest that it is working.
Due to these cuts, the company forecast a substantial increase in operating margins going forward, with a goal of approaching 20% by the fourth quarter. The company agreed with an analyst on the earnings call that the earnings run rate would approach $2 if those operating margins are achieved. The question is whether these operating margin levels are attainable based on the margins of larger and stronger competitors like Schlumberger Ltd (NYSE:SLB) and Baker Hughes Inc (NYSE:BHI).
The incredible story with Weatherford is the large losses produced by the non-core segments. During the first quarter, Weatherford produced a negative operating margin on the non-core assets of nearly 6%. These assets currently generate around $680 million of quarterly revenue, as compared to the $2.9 billion of revenue generated by core operations. In addition, core divisions including the Formation Evaluation and Stimulation have abnormally low margins, contributing to the overall weak margins of the oilfield services firm.
The Latin America results were a prime example of the new focus on strong operating margins. The company reported a substantial decline in revenues while at the same time generating a huge increase in margins.
Weatherford reported a $118 million, or 19%, sequential decline in revenues for the region, but the operating margins improved 782 basis points. The main culprit was the ending of a low-margin contract in Mexico and more work in higher-margin countries of Argentina and Brazil.
Both Baker Hughes and Schlumberger have larger operations that generate stronger profits, but the margin picture is mixed with these two oilfield service majors. Baker Hughes only generated a 12% operating margin in the first quarter, and that was a solid improvement over the 10% in the prior quarter. During the first quarter, Schlumberger generated exceptional operating margins of 21.2% in the seasonally weak period with the international margins at a very strong 22.8%.
Weatherford didn't change its 2014 guidance from that provided in the fourth quarter earnings report, but the company's stock soared due to it hitting and maintaining those targets. Weatherford guided toward earnings per share of $1.10 to $1.20. Combined with earnings in the first quarter of $0.13 and guidance of $0.21 to $0.22 in the second quarter, it requires the company to earn up to $0.80 in the second half.
The good news for investors is that a substantial portion of the earnings gains are due to the workforce cuts. In total, the company forecast a $0.30 improvement in earnings from the reduction in force and the closing of up to 50 facilities.
Weatherford appears to have turned the corner from years of disappointing results. It helps that the sector is seeing an improved operating environment. Investors need to be cautious regarding this company hitting its targets of operating margins approaching 20% considering the margins of Baker Hughes and Schlumberger. Regardless, Weatherford is likely to continue showing investors better numbers going forward.
Mark Holder and Stone Fox Capital clients own shares of Weatherford International Ltd.. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.