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Morningstar | BHGE Posts Unsurprising 1Q Results; Outperforming on OFS Growth, but We Are Worried About Pricing

Baker Hughes posted sequentially down first-quarter results following a windfall fourth quarter. Revenue fell 10%, driven most strongly by the turbomachinery segment, where revenue fell 27% sequentially following a 28% increase in the fourth quarter. Adjusted operating margin fell to 4.9% from 8% in the prior quarter, driven mostly by turbomachinery but with declines also in oilfield services and digital solutions. Our fair value estimate and no-moat rating are unchanged.

In oilfield services, Baker Hughes' performance has been impressive on the top line in recent quarters. First-quarter revenue was down 2% sequentially, as the slowdown in U.S. shale activity finally hit Baker, causing a 6% decline in North America revenue. However, this bested peers Halliburton and Schlumberger, which posted 3%-4% declines overall.

On a year-over-year basis, Baker Hughes' oilfield services revenue was up 12% thanks to a 6% increase in North America (compared with 3%-7% declines for peers) and an impressive 16% increase in international markets (compared with 3%-11% increases for peers). The North America performance is chiefly attributable to Baker's lack of a pressure pumping business, which has heavily weighed on peers' results. Internationally, management has touted a plan to regain market share lost during the company's turmoil, which resulted in strong contract wins in 2018 that are now beginning work.

However, we are somewhat worried that the increase in international market share is coming at the expense of pricing. Indeed, peers have alluded to this, and Halliburton recently called out the Middle East as a difficult pricing market, which is one market where Baker appears to be gaining share. We were disappointed that oilfield services' adjusted operating margin fell to 5.9% versus 7.3% in the prior quarter, which could be the product of weaker pricing (management also cited project startup costs). However, on a trailing 12-month basis, segment operating income incrementals are at 35% (probably in line with peers), which suggests that it's premature to call this a trend for now. That said, we will be watching the segment's profitability closely in coming quarters.

In the turbomachinery segment, management is still guiding for a strong second half, which should allow for overall 2019 results to be roughly in line with last year. Orders were down 12% year over year, which is slightly disappointing given the large Golden Pass and Tortue liquefied natural gas awards. However, LNG orders should remain very strong in 2019, and management has guided for a recovery in non-LNG orders as well. Thanks to new orders, high-margin LNG equipment is set to return as a large share of segment revenue starting in 2020, which should drive segment margin improvement. We expect segment operating margins to reach 13% in 2021 (versus 10.3% in 2018), which is conservative relative to management's medium-term target in the "mid- to upper teens."