Earnings Preview: Baker Hughes (BHI) 2Q To Show North American Weakness

Baker Hughes Incorporated (NYSE: BHI), one of the world's largest oil services companies, is expected to report a slight decrease in profit for the second quarter on a seasonal slowdown in the company's Canadian operations.

Analysts polled by Thomson Reuters expect the Houston-based company, which reports Friday before the market opens, to report earnings of 77 cents per share on 5.28 billion in revenue. That consensus estimate has dropped from 82 cents per share three months ago. Last year in the second quarter Baker Hughes earned 93 cents per share on 4.74 billion in revenue.

Baker Hughes expects a profit decline in the second quarter due to seasonality and continued price deterioration in the pressure pumping product line, according to Peter Ragauss, the company's senior vice president and chief financial officer.

CEO Martin Craighead said the projected seasonality is most pronounced in Canada, according to the Wall Street Journal.

In response to lower prices, the company has been cutting costs by moving roughly 500,000 manufacturing hours out of the United States to cheaper locations such as China and Russia, but does not expect those cuts to be realized until the third quarter.

Morningstar analyst Stephen Ellis believes Baker Hughes' success in cutting internal costs, like manufacturing, could surprise investors.

Through the use of lean manufacturing techniques, Baker Hughes has been able to achieve lower costs and higher productivity while locating facilities closer to customers, thus shortening delivery times, Ellis wrote in a June 14 note.

Ellis believes that revenue declines in pressure pumping, particularly a push to moving beyond simple brute-force approach of throwing large amounts of equipment at today's tight shale wells, could plague the company until 2013. Pressure pumping is a key operation for Baker Hughes that boosts oil and gas production from wells.

Major pressure pumping companies such as Halliburton Company (HAL) and Schlumberger Limited (SLB) have faced falling revenues due to rising prices of guar, which is necessary for fracking. Guar, primarily harvested in India, has seen its value jump from $1.50 a kilogram to $25 a kilogram in just the last 18 months, significantly cutting profits of oil service companies dependent on it.

In addition to pressure pumping declines, Baker Hughes also expects to see revenue declines in Europe and Africa due to product mix and favorable conditions in Q1 that won't repeat in Q2. Baker Hughes had stronger-than-expected revenue in those regions in the first quarter, in part due to especially strong activity in Africa. Ultimately, it expects revenue from outside the U.S. to slightly increase in the second quarter.

Revenue increases have been the norm for Baker Hughes for the past year. It has averaged 26.9 percent revenue growth year-over-year over the last four quarters. Despite the revenue increases, rising costs has caused profits to fall in each of the last two quarters.

Higher prices have also been a problem for Baker Hughes off the Gulf of Mexico, according to the company's chief executive officer.

Margins are improving, but remained challenged due to higher operating costs, slow startup on new Deepwater rigs and the Deepwater shelf mix, Martin Craighead said in an April 24 investors call.

Baker Hughes has also revised its estimate for growth in the 2012 average rig count to 8 percent from 11 percent annual growth rate that it estimated in the first quarter. Rig count growth is important for Baker Hughes because it ties to gas exploration, a major component of the company's service offerings. With rising costs in the industry and smaller than expected rig growth, it could indicate that companies are instead focusing more on oil exploration, which could create operation and logistical challenges for oilfield services firms such as Baker Hughes, according to Trefis Forecasts.

In June the company announced that the worldwide rig count was 3,484 rigs, up from 3,335 in May. In the U.S. the company's average rig count dropped to 1,972 from 1,977, but the company made up for it with growth in countries such as Iraq, which added 79 rigs.

Stock Performance

After dropping for months from the company's last quarterly earnings announcement, Baker Hughes has seen its stock steadily rise in the days leading up to its second-quarter earnings call. After opening at $39.21 on Monday, the stock rose to $41.68 by Wednesday afternoon.

Eleven out of 21 analysts rate Baker Hughes shares as a Buy -- 52.4 percent of the group -- which ranks far below the mean analyst rating of its nearest 10 competitors, which average 83.2 percent Buy ratings, according to Forbes.