Baker Hughes Earnings Call Insights: Margin Gap Analysis and Normalized Margins

Baker Hughes Inc. (NYSE:BHI) recently reported its second quarter earnings and discussed the following topics in its earnings conference call.

Margin Gap Analysis

James West – Barclays Capital: Martin, as you think about North America in the second half of the year, you obviously highlighted a lot of traction, a good traction in your pumping business in terms of utilization. We got the new ESP that you just mentioned and went through the technology there. You also got some strength in product chemicals things like that. It looks like your estimates, at least our estimates and other estimates out there have a pretty wide margin gap between yourself and some of your peers. Admittedly, we haven’t seen one of your peers numbers just yet we’ll see those on Monday, but how quickly do you think, or I guess two things – I guess, one, do you think that there is a structural gap between kind of your margin potential and theirs. Two, if not how quickly do you think you can close that margin gap?

Martin Craighead – President and CEO: That’s great question James. Thanks for asking it. First of all, there is not a structural impairment, as we’ve highlighted before, our – one of our largest product line in North America is operating at differentially low performance economically. That all said, it’s making – it is the product line with the most momentum in terms of the improvement across the globe for us right now. So it’s a locomotive that is starting to churn out and it’s – it made some very nice improvement. As I highlighted two quarters in a row, in this particular quarter, the slope of the curve is picking up even more. So it’s really starting to come together. That is the only issue that I believe we have in North America. We like our portfolio, both in terms of product line and in geographies, highlighted the diversifications going on in Canada, the strength in the Gulf of Mexico, our mix with our ships versus our peer group and the non-pressure pumping businesses are performing extremely, extremely well. In that particular business, if you remember about a year ago, a little over year ago, we highlighted the issues that we were facing. One of the most critical at that time was the people utilization and action was taken and realignment made. The customer mix is pretty much where we wanted to be and the big issue there was having the right customers in the right locations and being able to get on 24 operations and that’s behind us. I think the issue still lies around the – some issues around the transportation and logistics, and those are things we are still working through. So, no structural and in terms of timing, I don’t want to put my finger on that because it’s a volatile business as you know. But for us, we don’t expect any more price erosion going forward. We did experience a little from one to two, but I think that’s behind us. So you know it’s upward and onward from here.

James West – Barclays Capital: Okay. The transportation issues that you highlighted – I mean those don’t seem like – I’m not trying to (putting) down too much on timing, but they don’t seem like that’s an issue that’s going to take years to progress. I mean it seems like the couple of quarter or something where you can kind of fix those issues. Is it not a fair assessment?

Martin Craighead – President and CEO: That’s a fair assessment.

James West – Barclays Capital: Then, just one last follow-up for me. You’re over 50% utilization, I believe, or 50% 24-hour operations on pumping today that originally was the goal I believe for yearend, so what’s the new goal now?

Martin Craighead – President and CEO: Well, I’ll tell you this, this time next year I’m hoping that it starts with a seven, but we are not at 50%. We hit 50% a couple of times in the quarter, the high midweek times, but it’s really averaged around 45%. I just want to calibrate it a little differently here.

 

Normalized Margins

Bill Herbert – Simmons & Company: Sort of tackling the North America margin question a little bit differently. In a world in which we have relatively arranged our commodity prices and a continued positive delta between well count and rig count and E&P capital spending moving methodically higher. What do you think is a reasonable expectation for targeted normalized North American margins? What should – what do you think in that kind of world in which we’re growing, but not melting up and we continue to prosecute the North American growth story, yet the rate of change remains relatively methodical. What should be the normalized margin after you make all these adjustments which have (played due) from a sort of operational standpoint, logistical standpoint, supply chain standpoint, et cetera?

Martin Craighead – President and CEO: Well, if you also factor in which you did mention, that hopefully capital discipline that begins to permeate the service sector as much as it has permeated our customers, I’d say if that’s sustainable and pretty much around the pressure pumping business once the cost of capital, we also start earning our cost of capital again. I’d say mid-to-high teens is probably a fair expectation, assuming no sharp swings in the market…

Peter Ragauss – SVP and CFO: Bill, this is Peter. Don’t forget, you still got an overhang on that pressure pumping capacity somewhere circa 20% and that’s kind of an unnatural position for the industry to be in. So if that overhang melts away through attrition, which we expect it will with, like you said, well count increasing, then I think what Martin said is easily achievable. But, again, that’s going to take quite some time to get that overhang out of here.

Bill Herbert – Simmons & Company: Right. Peter, don’t worry, I’m not going to go high-teens margins right away, but I hear you and that is a valid point. Martin, with regard to yearend, is it unrealistic or unreasonable to expect – I mean, you’re going to get a seasonal recovery in the third quarter with regard to Canada. We’ve got the new frac vessel being deployed in the Gulf of Mexico. We got ongoing utilization gains domestically. Is it unreasonable to assume that North American margins by year end kind of get to somewhere approaching the low-teens?

Martin Craighead – President and CEO: I don’t know if that’s unreasonable, but I think that’s maybe on the optimistic side of where we think. Again, the big part is the recovery in the pressure pumping business. Remember, the follow-up on your first point, correct, in 2 to 3 in Canada. 3 to 4 in Canada is obviously nowhere near as dramatic. So that’s a big factor as well.

Bill Herbert – Simmons & Company: Understood, and that’s what I’ve got modeled, but essentially low-teens ambitious but doable is what I’m hearing for year end, is that correct?

Martin Craighead – President and CEO: Ambitious is definitely correct.

Peter Ragauss – SVP and CFO: Yes, I’d probably box in a little bit more. I’d say it’s ambitious to be in low-teens, it’s possible certainly to be double digits.

Bill Herbert – Simmons & Company: Then secondly, with regard to Latin America, I’m not sure if my math is all that crisp, given all the adjustments that we made, but I get to kind of after you back out the bad debt provision, something around a 1.2% or 1.3% margins for the second quarter, something like that. Then you guys mentioned a high-single-digit margin hopefully by year end. What should we assume for the third quarter just as a guess? Moreover revenues for second half of the year in Latin America, is it reasonable just to assume that we’re going to be flat – flattish with the second quarter? So help me on top line as well as for second half year in Latin America and margins for the third quarter?

Peter Ragauss – SVP and CFO: Revenues for the second half, we’ve got new projects starting up. I would say, we tend to view Q2 as pretty much an anomaly in terms of revenue and, certainly, in terms of costs. So revenues ought to be up a little bit second half with new projects. We are expecting improvement in Q3 over Q2 after adjusting out the bad debt. So it may not be exactly linear between what we said our exit rate would be, but certainly an improvement from here.

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