Baker Hughes: Compelling Valuation Relative To Its Competitors

Jul.23.12 | About: Baker Hughes (BHI)

Baker Hughes (BHI), the supplier of oilfield services for the worldwide oil and natural gas industry announced its second quarter results on Friday. Investors were pleasantly surprised by the report, sending shares 9% higher on the day.

Second Quarter Results

Baker Hughes reported second quarter net income of $439 million, or $1.00 per diluted earning per share. This compares to first quarter profits of $0.86 per share and second quarter earnings per share in 2011 of $0.77. Revenues rose 12% on the year to $5.33 billion and were down 0.5% on the quarter. The results came in much better than expected. On average, analysts expected the company to earn $0.77 per share on revenues of $5.26 billion.

Martin Craighead, CEO of Baker Hughes said:

We achieved 2 percent sequential growth in operating income despite challenging market conditions in North America. Our international business delivered improved revenue and operating profit, driven by outstanding performance in Europe and the Middle East.

Outlook

The company is cautiously optimistic about the market outlook for the remainder of the year. If commodity prices stay at current levels, the activities in the onshore of the US should remain stable with improvements in the Gulf of Mexico and in its international activities.

Valuation

Baker Hughes ended the first half of 2012 with $792 million in cash and equivalents and operates with $5.0 billion in short and long term debt, for a net debt position of $4.2 billion. The company generated $10.7 billion in revenues in the first six months of this year, on which it reported $818 million in net income, or $1.86 per diluted share. It spend $1.4 billion in capital expenditures, roughly double the annual depreciation amount, a sign that the business prospects remain good.

The company is on track to generate approximately $22 billion in annual revenues on which it can earn between $1.6 billion and $1.9 billion. This values Baker Hughes at merely 0.9 times annual revenues and around 10 to 12 times annual earnings. Investors value Baker Hughes at a discount compared to the 2.1 times annual revenues multiple for Schlumberger (SLB) and 2.0 times for National-Oilwell Varco (NOV). Both competitors trade at 17 and 13 times earnings, respectively.

Currently, Baker Hughes pays a quarterly dividend of $0.15 for a dividend yield of 1.3%

Investment Thesis

Shares of Baker Hughes have fallen 6% year to date including Friday's gain of 9%. Shares have fallen roughly 40% after peaking at $80 per share in July 2011 to levels around $45 at the moment. The shale boom in North America allowed the company to double its revenues in merely two years. The higher cost of drilling for natural gas and oil in those regions makes projects vulnerable as crude prices have corrected recently amidst fears about the prospects of the global economy.

Friday's results confirm that North American margins are holding up better than expected and we might be closer to the bottom than anticipated. Given the extreme discount in valuation compared to some of its larger competitors, and the overall absolute valuation, I would consider a long position in Baker Hughes.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in BHI over the next 72 hours.