Baker Hughes CEO Lorenzo Simonelli. Source: Barron's
Baker Hughes (NASDAQ:BKR) reported Q1 revenue of $5.43 billion, Non-GAAP EPS of $0.11 and GAAP EPS of -$15.64. BKR is down over 40% Y/Y as the free fall in oil prices has taken a toll on oil-related names. In Q1, the company's revenue was off 15% sequentially, but things could be looking up.
Headwinds In North America E&P
E&P in the North America land drilling market has been facing headwinds for a while. Pricing power for oil services companies has also waned. This has come in spite of OPEC supply cuts over the years. Saudi Arabia and Russia recently agreed to additional production cut. After the pandemic ends, demand for oil should rise, driving prices and E&P higher. This should benefit Baker Hughes. Brent oil is currently sub-$30 on fears over a lack of storage capacity and weak demand.
For now, Baker Hughes will likely face headwinds in North America land drilling. Baker Hughes, Schlumberger (SLB) and Halliburton (HAL) dominate the sector, which makes their operations particularly vulnerable.
The company's Q1 total revenue of $5.4 billion was off 15% Q/Q and down 3% Y/Y. Oilfield Services and Digital Solutions represent the company's short cycle businesses and are a proxy for exposure to North America land drilling. They generated a combined $3.6 billion in revenue, down 8% Q/Q. They represented 67% of total revenue, up from 62% in Q4. Oilfield Services was hurt primarily from a decline in international pressure pumping, artificial lift and completions. Digital Solutions revenue declined across most businesses as a result of the coronavirus.
Combined revenue from Turbomachinery and Oilfield Equipment was $1.8 billion, down 25% Q/Q. Revenue from Turbomachinery declined over 30% due to lower equipment and services revenue in addition to the disposition of certain business lines. Oilfield Equipment revenue fell 7% on lower volume in Subsea Production Systems and Flexible Pipe products. Oilfield Equipment orders fell 55% sequentially, implying future revenue for the segment could be dismal. With oil sub-$30, several subsea projects may not be economical. Oilfield Equipment could be the company's weakest segment going forward.
Costs Containment Efforts
Management is identifying opportunities for cost savings and efficiency gains. In Q1, Baker Hughes recorded restructuring and impairment charges, including inventory impairments and separation charges of $1.5 billion. The company will continue to rightsize the business, with the largest reductions in headcount and facilities footprint coming from Oilfield Services and Oilfield equipment.
Q1 gross profit was $755 million, down over 40% sequentially. Gross margin was 14%, down over 600 basis points versus Q4. SG&A costs of $675 million were down 10% Q/Q, yet the decline was not enough to offset the diminution in revenue. The fall out was that EBITDA of $435 million was off 52% Q/Q. EBITDA margin of 8% was down 600 basis points versus Q4. Management must step up cost containment efforts in order to maintain margins. Of the big three oil services firms, Baker Hughes has the lowest margins. Halliburton and Schlumberger delivered Q1 EBITDA margins in the 17-18% range. I expect management to address its margin erosion over the next few quarters.
Ample Liquidity
Heft and liquidity could become highly important amid stagnant E&P in the oil patch. Baker Hughes has $3.0 billion in cash and over $4.0 billion in working capital. Its Q1 free cash flow ("FCF") was $160 million, up from an outflow of $440 million in the year-earlier period. This came despite a $62 million increase in capital expenditures. I look for management to make deep cuts to capital expenditures going forward.
Baker Hughes must squirrel away capital in the face of a serious decline in the economy. The last downturn in the oil patch saw pricing power dissipate, making it difficult for smaller oil services firms to survive. The company's debt of $6.5 billion is at 2.3x last 12 months ("LTM") EBITDA. Baker Hughes must ensure its credit metrics do not deteriorate further. Its strong balance sheet is a competitive advantage, yet it appears Halliburton and Schlumberger have gotten out in front of cost containment measures. Baker Hughes must play catch-up.
Conclusion
BKR trades at 6.2x LTM EBITDA, low by historical standards. When the economy reopens, oil markets and E&P should rebound. This represents a chance to get into the stock at a low valuation. Buy BKR.
