The stocks of Baker Hughes, A GE Company (NYSE: BHGE) and Core Laboratories (NYSE: CLB) are both down about 70% from the highs reached earlier in the decade. Their ups and downs along the way have been driven by the highly volatile price of oil, which is what underpins their oil drilling customers' results. Is this painful decline an opportunity to buy one, or both, of these energy services companies or should investors steer clear?
1. Very different business models
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The key takeaway when looking at Baker Hughes and Core Labs is that they do very different things. At a high level, Baker Hughes owns drilling equipment that it then uses on behalf of customers (think companies like ExxonMobil and Chevron) to, hopefully, produce lots of oil. It's a capital-intensive business that faces high costs, which can be a huge headwind when oil prices fall since that generally leads to a dip in demand and pricing.
Core Labs, on the other hand, is focused on helping energy companies maximize the results of their drilling efforts. To simplify things a great deal, it does this by analyzing drilling samples so that it can make suggestions on how a customer can enhance its production. While it needs state-of-the-art equipment to do this, it's a lot different than owning and operating heavy equipment. While an oil industry downturn will hurt, it isn't likely to be as big a hit on the bottom line.
For example, despite a deep oil downturn in mid-2014, Core Labs has remained profitable in each of the last 10 years. Baker Hughes hasn't existed in its current form for very long, after pairing its business up with GE's oil and gas division (more on this below), but before that deal, neither Baker Hughes nor GE's energy business was performing very well.
To put some numbers on this, Baker Hughes business lost nearly $4.50 a share in 2015 and another $6.30 or so in 2016. Shortly thereafter, the complicated merger/spinoff deal with GE was consummated. GE's oil and gas division, meanwhile, never stood on its own, but saw revenue fall 14% in 2015, with profits declining 12%. In 2016, GE's oil and gas business suffered a nearly 22% revenue drop and an even more painful 42% tumble in profits. Putting these two together in 2017 led to a loss of $0.17 a share before the oil upturn allowed the now-larger combined entity to get back into the black in 2018. There's no particular reason to believe that another deep oil downturn wouldn't again lead to red ink at the new Baker Hughes.
2. Different balance sheets
Another important point of differentiation here shows up on the balance sheet, but it needs a little parsing before you make a final call. Long-term debt makes up roughly 25% of Baker Hughes' capital structure, but a heavy 60% at Core Labs. That said, Core Labs has bought back roughly half its publicly traded shares over the past 15 to 20 years, with roughly $50 billion worth of treasury stock on its balance sheet reducing the value of its shareholder equity -- which makes leverage at Core Labs look at little worse than it really is. Pulling treasury stock out of the equation leads to a debt to equity ratio of around 55%.
Looking at leverage differently, Baker Hughes' trailing debt-to-EBITDA ratio was roughly 2.5 times at the end of the first quarter compared to just 2.1 times at Core Labs. Furthermore, Core Labs covered its trailing-12-month interest expenses by over 7.3 times while Baker Hughes covered its interest expenses by a lower 5.9 times or so. In other words, despite higher levels of debt, Core Labs appears easily capable of handling the load. Add in Core Labs' more consistently profitable business model and this is far from a win for Baker Hughes.
3. Different valuations
With that as a backdrop, it is also interesting to look at the valuation of each of these oil services companies. Baker Hughes' forward price-to-earnings ratio is around 23 times and its price-to-book value is roughly 1.4 times. There's not much history to compare this to, since it has only existed in its current form for a couple of years at this point. But when you put these numbers up against Core Labs', a valuation difference stands out.
Core Labs' forward P/E ratio is just under 30. Its P/B ratio is a whopping 14 times. While these two figures are well below the company's five-year averages of 45 and 280, respectively, that doesn't change the fact that, of the two, Baker Hughes is the cheaper alternative.
That said, based on the highly volatile financial performance at Baker Hughes (and its component parts before the merger), the valuation difference here isn't exactly surprising. Add in the fact that Core Labs' operating margin was more than double that of Baker Hughes over the trailing 12 months, and it's easier to see why investors would be willing to pay a premium for Core Labs.
4. A different type of headwind
There's one more difference here that's worth highlighting: Baker Hughes is still tied up with General Electric (NYSE: GE) in a big way. At the end of the first quarter, GE owned roughly half of Baker Hughes. However, GE has a stated intent to sell that stake off. That's likely to be a headwind to a higher stock price, since it represents additional shares that could, at least theoretically, hit the market at any time. Although the end result of GE selling its stake is likely to be a net positive, allowing Baker Hughes to truly stand on its own, until GE is out of the picture there's an unusual crosscurrent that investors have to worry about.
A winner, if you have to choose
All in, Core Labs appears to have a more stable business model. That allows it to handle a heavier debt load and helps underpin its higher valuation. Add in Baker Hughes' remaining ties to General Electric and investors would likely be better off owning Core Labs at this point -- if they had to choose between just these two companies. Most investors, however, should think carefully before jumping into the often-volatile energy services sector. If exposure to oil and gas drilling is what you're after, you would probably be better off considering other alternatives, such as a well-diversified and integrated energy company like Exxon or Chevron.
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