BHI Equity Valuation

BHI

Baker Hughes stock is trading at an unusually low valuation. The shares
have been badly hurt, along with the rest
of the group and stocks in general, by
fears of a global recession. So far, the impact
on business of the credit crunch and
sharply lower oil and gas prices has been
marginal. The domestic rig count peaked
at the end of August, and we expect it to
be down about 10% by yearend. If it were
to hold there, prospects would be relatively
bright, because there is still a substantial
amount of international oil activity getting
under way. With the stock changing hands
at its lowest price-earnings ratio in
memory, any sign that the oilfield services
business will stabilize, rather than decline
rapidly, would point to value here.
The company is prepared to deal with
a deeper slide, if it comes. The estimated
10% drop in the North American
rig count amounts to about 200 rigs. A
falloff of that magnitude wouldn’t be too
bad, but the loss of an additional 200 rigs
on top of that would be painful. Under
that scenario, Baker Hughes would stop
hiring, ship inventory to busier areas, and
focus more on the collection of accounts
receivable. Even more drastic measures,
such as reducing headcount and consolidating
facilities, could be taken, if need
be. But it may not come to that. A normally
cold to colder-than-average winter
would allow natural gas inventories to be
burned off, and put a floor under drilling.
A couple of underpinnings are already
in place. More than 50 newly built
rigs are set to join the industry fleet in the
next three years, and another 90 are under
construction. Baker Hughes stands to
get its share of business providing the
services required by those capacity additions.
Moreover, long-term demand for oil
is expected to recover once economic issues
clear up. Since most oil projects are multiyear
in nature, little slowdown in spending
for oil-related ventures is likely.
This neutrally ranked stock has
plenty of room to run once the backdrop
for oil and natural gas demand
turns favorable again. Investors currently
appear to be anticipating the worst.
But the company was turning away business
in North America as recently as the
third quarter of 2008.
Robert Mitkowski, Jr. November 14, 2008