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Morningstar | BHGE Updated Forecasts and Estimates from 12 Oct 2018

No-moat Baker Hughes posted a solid quarter with 3% sequential revenue growth and adjusted operating margins improving to 5.2% from 4.2% previously. Most of the improvement in both top- and bottom-line performance was driven by the oilfield services segment, as we expected given the recent increases in overall oilfield activity levels. We expect to retain our fair value estimate of $32 per share.

The oilfield services segment (essentially consisting of the former Baker Hughes entity) derived broad-based support for its improved results. North American revenue growth of 7% is in line with peers and rising activity levels, but the 8% international revenue growth rate will likely best peers’ results for the quarter. We don’t expect this outperformance to become a trend--for one thing, Schlumberger has several incoming contracts that will be ramping up throughout the second half of the year. Nevertheless, this is an encouraging result for a business that has struggled since the post-2014 oil and gas downturn.

We were disappointed to see that the turbomachinery and process solutions segment is still bleeding revenue with a 5% sequential decline in the second quarter, as the long-anticipated increase in contractual services revenue has not yet replaced declining new equipment sales for liquefied natural gas and other upstream oil and gas end markets. Nevertheless, excluding a one-time expense, margins actually improved sequentially and are set to improve further as management drives extraneous costs out of the business.

The biggest weak spot for the company overall remains the oilfield equipment segment, but the segment impressively hauled in over $1 billion in new orders in the quarter, pushing the trailing 12-month book/bill ratio over 1.1 times. This slate of new orders, combined with ongoing cost-cutting, should allow the segment to finally return to solid operating profitability.

Perhaps the most noteworthy event for Baker Hughes during the quarter was the announcement by its parent GE that it would seek to divest its majority ownership of Baker Hughes after the lockup period ending in July 2019.

This announcement hasn’t fundamentally affected our assessment of Baker Hughes, largely for two key reasons. First, in business lines where Baker Hughes is currently quite dependent on the GE parent entity (essentially the TPS segment), we expect the requisite agreements over intellectual property and other areas to be put in place to preserve the existing value of these businesses. Second, we had never ascribed significant value creation to initiatives seeking to enable Baker Hughes’ other business lines to tap into the GE parent’s technologies or capabilities, in spite of management’s ebullient enthusiasm about these prospects in the earlier days of the merger. Therefore, the imminent termination of these initiatives due to the full separation of the companies does not present significant downside with respect to our base-case forecast.