BHI’s return and key drivers
Oilfield equipment and services companies such as Baker Hughes (BHI) are affected by crude oil and natural gas rig counts and energy prices. Crude oil prices started to slump in June 2014 after they reached a multiyear high of $110 per barrel.
Since the beginning of 2015, West Texas Intermediate (or WTI) crude oil prices have dropped ~24%. As crude oil prices fell, the number of active rigs also started to fall. The sharp fall in rigs in 1H15 prompted the market to believe that production would fall soon. This brought about some support for crude oil prices and rig counts shortly after that. However, prices started falling again in July and continued to stay weak until November 2015.
The effect of a falling US rig count
Year-to-date (or YTD), the US rig count has dropped nearly 60%. The fall in active rigs indicates a fall in exploration and production activity by upstream oil and gas companies. This, in effect, reduces oilfield services companies’ revenues, which in turn push oilfield service (or OFS) companies to take lower contract terms or day rates in order to save on costs. This has a negative impact on OFS companies.
What is Baker Hughes’s return?
Since the beginning of 2015, Baker Hughes stock has returned -11% until December 8. Year-to-date, the VanEck Vectors Oil Services ETF (OIH) has returned -18%, while the SPDR S&P 500 ETF (SPY) has returned a positive 2% during the same period. SPY provides investors exposure to the broader market through investing in the S&P 500 Index. BHI’s peer Core Laboratories (CLB) has performed in line with BHI, producing a negative 5% return since January 4, 2015.
How did Baker Hughes beat the industry?
BHI’s year-to-date returns have not only been higher than OIH, but its stock has held up much better than the primary drivers such as crude oil with a fall of 24% YTD and the US rig count with a fall of 60% YTD.
BHI has been able to outperform its industry drivers and peers despite the ongoing energy market downturn. This is due to the valuation premium it receives from its proposed merger with Halliburton (HAL).
Under the terms of the proposed merger, each BHI stockholder will receive 1.1 HAL share against one BHI share plus $19 in cash for one BHI share. BHI’s merger implied price is at a premium to its current price.
What also benefited BHI is its presence in the downstream energy sector. Despite shrinking income from upstream companies, higher earnings from its Industrial Services segment has helped BHI’s earnings. The segment caters to the downstream industry.