Baker Hughes Outperforms its Peers

Prospects for oil services company Baker Hughes   are never really going to be divorced from the outlook for energy prices. However, the company has made great strides in operationally adjusting to flattish energy markets over the last year. Alongside companies such as Halliburton  and General Electric's  energy segment, it's been forced to innovate to generate growth and develop its international business. The good news is that its plans are working.

Baker Hughes innovates
The following chart demonstrates the relationship between Baker Hughes and the U.S. Rotary rig count (data compiled by Baker Hughes).

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Baker Hughes Equity Research

As ever when looking at oil services stocks like Halliburton  $HAL  and Baker Hughes $BHI , your long-term outlook will be defined by your view on the future of oil prices. While this rule still applies, there are also many changing trends within the oil services market, which Baker Hughes has positioned itself to benefit from. If you are bullish on oil, then Baker Hughes looks particularly well placed.

A bifurcated market in oil services
The biggest story in oil production in recent history is the wide-scale adoption of fracking technology in energy production in the U.S. -- the result of which has been the reversal of a seemingly inevitable decline in U.S. crude oil production.

US Crude Oil Production data by YCharts

The good news for the oil services companies is that production has gone up over the last two years, but the bad news is that oil prices have been relatively flat. Moreover, the most wildly followed barometer of the U.S. oil and gas services industry (rotary rig counts) has been in decline over the last couple of years.

WTI Crude Oil Spot Price data by YCharts

All told, the result has been to bifurcate the global oil services market into good growth in emerging markets versus weaker growth in the U.S. Moreover, if oil prices fall then some current U.S. production will prove commercially unviable.

What the industry is saying
Indeed, some of the underlying issues were touched on in General Electric's  $GE recent conference call. When questioned by an analyst on the outlook for GE's oil and gas segment, CEO Jeff Immelt articulated the bifurcation in oil and gas services prospects between North America and the rest of the globe:

"If you look at the national oil companies versus the integrated oil companies, our view is that the NOCs really haven't backed off at all...the place that we still think is reasonably weak is maybe around North America, some of the drilling and surface stuff"

It was a similar story from Halliburton. Its North American revenue declined 4.9% in 2013, while outside of North America its revenue increased 13.5%. Halliburton's management sees the current North American market as "driven by increased drilling and completion efficiencies with a relatively flat overall rig count and industry overcapacity."

Putting these elements together, a picture is emerging of a bifurcated market that is seeing U.S. oil services companies being challenged in their core domestic market. In addition, North American subsea/deepwater operations are outperforming vertical onshore drilling. Meanwhile, increased usage of fracking has enhanced productivity, which further contributes to overcapacity in North America.

How Baker Hughes is adjusting
Baker Hughes' last earnings report was quite impressive, not least because it highlights the adjustments that the company is making to deal with changing conditions. There are four key factors:

• Baker Hughes' share of total pre-tax profits from North America was only 43.7% in 2013. Latin America was weak, but the other segments (Europe/Africa/Russia, Middle East/Asia Pacific, and industrial services) saw pre-tax profits grow 14.9%

• Its North American pressure pumping business (heavily reliant on fracking activity) is seeing improved profit margins as the company takes action to overhaul the business in response to overcapacity

• The company sees itself as a deepwater specialist, a sector that is outperforming most of the oil industry

• Management has taken impressive measures to decrease working capital and increase cash conversion,  the result being a record $1.5 billion in free cash flow

Where next for Baker Hughes?
Looking ahead, Baker Hughes' management sees the U.S. onshore rig count as being "essentially flat," while Halliburton expects a modest increase. However, recall that Baker Hughes is taking measures to improve margins, and its forecast for the onshore well count is for a 5% increase. In addition, U.S. offshore rig count is expected to increase 5%. Conditions appear to be getting better.

Meanwhile, its international operations are forecast to receive a boost due to an estimated 10% increase in the international rig count. Add in the improved operational efficiencies and increased cash flow generation, and the stock is starting to look attractive. In fact, analysts have it on a forward P/E ratio of less than 14 times earnings, as I write. If you are bullish on the outlook for oil, then Baker Hughes is well worth looking at for 2014.

GE Earnings Takeaways

Whenever a bellwether like General Electric $GE gives results investors will want to analyze them in great detail to see what they mean for other stocks in other sectors. GE's latest earnings were solid enough, but there were many interesting subplots to the story. The global economic recovery has been pretty uneven and inconsistent since 2009, and this theme was further confirmed in its fourth-quarter report.

General Electric's fourth-quarter earnings
GE generated around a third of its segmented profits from its capital division in 2013, but what about the industrial side? The following chart demonstrates the most important industrial sectors for GE.

Source: Company presentations.

GE ended the year strong in its power and water segment with profits up 9% in the fourth quarter, but for the full year the segment's profits actually declined 8%. Of the other three largest segments, oil and gas profits grew 13% in 2013, with aviation up 16% and health care rising only 4%.

The company's order book was up 8% in the fourth quarter, and when discussing the results on the conference call, GE's management guided toward "double digit industrial earnings growth similar to the second half of '13" and "4% to 7% organic growth with expanded margins".

In short, GE looks set for another solid year, and this portends well for the industrial sector, but what are the key takeaways from the results?

Power and water, oil and gas
Gas turbine orders came in at 65 in the fourth quarter versus only 26 in last year's fourth quarter. This was somewhat surprising, because Alcoa  $AA had already estimated that its industrial turbine end market would decline 8 to 12% in 2014. However, the difference in the outlooks may be because Alcoa's forecast is based on production while GE's positive news concerns its orders. If this logic is correct then, provided GE's orders continue to strengthen, investors might expect Alcoa's industrial turbine business to improve in future.

There was mixed news in the oil and gas segment. There are fears over capital spending plans of the major integrated companies, but on the conference call, CEO, Jeff Immelt argued, "If you look at the national oil companies versus the integrated oil companies, our view is that the NOCs really haven't backed off at all, and that's where we see a ton of activity." However, he also said that activity around North American drilling and surface was work was still "reasonably weak" and this tallies with the Baker Hughes  $BHI  US oil and gas rotary rig count.

US Rotary Rigs data by YCharts

Baker Hughes is a leading oil services companies and its North American operations contributed nearly 44% of its segmental operating profit before tax in its first nine months. However, North American segment profits decreased 8% in its third quarter, but strength elsewhere ensured that Baker Hughes' overall segmental profit grew 8%. If GE's commentary is accurate, then that pattern is likely to continue for Baker Hughes.

Home appliances and lighting
As the first graph above outlines, the home and business segment isn't hugely important to GE, but what it says about the segment is useful for shareholders in a white goods company like Whirlpool  $WHR . GE's appliances and lighting revenue grew 6% with its appliance revenue up 9%. Indeed, its appliance sales saw a marked pick-up in the second half:

	Q1 2013	Q2 2013	Q3 2013	Q4 2013
GE Appliance Sales Growth	3%	8%	11%	9%

Source: Company presentations.

This is good news for Whirlpool, because its outlook for North America has tended to match what GE is saying about its appliance business. In fact, in its first quarter Whirlpool estimated its full-year 2013 industry demand to grow at 2%-3%. This figure was raised to 6%-8% in the second quarter, and then 9% in the third. In the light of what GE just reported, is Whirlpool likely to upgrade estimates for 2014 at its next set of results?

The bottom line
On the whole, GE delivered a solid set of results with some interesting puts and takes in the sectors it covers. The following article will cover the health care, transportation and aviation segments. As for the segments covered in this article, there was some good news. Power and water prospects are improving and, internationally at least, oil and gas remains solid. Meanwhile, appliance and lighting sales continue to benefit from the housing recovery.

Time to Buy Roper Industries

Industrial conglomerate Roper Industries (NYSE: ROP  ) serves end markets as diverse as toll roads, water handling systems,oil & gas drilling, and medical imaging. But Roper underperformed the market this year, rising less than 10%, and also recently cut its full-year guidance. Despite those setbacks, however, its management has successfully continued its long tradition of integrating acquisitions, while squeezing every last penny of profit from its ongoing businesses. Let's review five key reasons why the stock's current slump could actually be a buying opportunity.

Roper Industries lowers guidance
The company started the year expecting 13% to 17% in EPS growth, and 8% to 10% in revenue growth. But analysts have now downgraded their full-year expectations to 13.1% and 8.5% respectively. Essentially, Roper was forced to guide the market lower due to a combination of weaker-than-expected performance at its nuclear business, Zetec, and some weakness in oil & gas drilling activity in the US. The market didn't like these developments, but in the long run, Foolish investors just might.

Five reasons to buy Roper Industries
First, Roper's order book and backlog is in excellent shape. Orders grew 18% in the quarter, and with a backlog of more than $1 billion, there should be plenty of growth to come next year.

Second, the weakness at Zetec is due to some unexpected nuclear plants being shut down, and a corresponding lack of orders for its testing equipment. Roper's management expects these issues to continue into the fourth quarter, this part of the company could easily bounce back in 2014.

As for the weakness in US oil & gas drilling, the best way to gauge industry conditions would be to look at the oil services company Baker Hughes' (NYSE: BHI  ) North American rig count data. This metric is the most widely followed indicator of North American drilling activity. In other words, if Baker Hughes is reporting strength, then Roper could expect to see some future improvement, too.

Source: Baker Hughes presentations

The count seems to be stabilizing, and Baker Hughes believes it will only decline 2.5% in the next quarter. However, companies can still generate growth if they innovate, and Baker Hughes actually saw record revenues for its North American drilling services thanks to "innovative products and services".  In a similar vein, Roper has a new drilling product called DuraTorque, which is "doing very well" according to Roper's CEO, Brian Jellison. DuraTorque has good chances to succeed, because it's aimed at an area of the market (larger-sized directional drilling) that thus far hasn't lived up to Roper executives' expectations.

Third, Roper's most profitable segments are outperforming the rest of the company. Here is a breakout of its operating profits for the third quarter.

Source:company presentations

In the third quarter, energy operating profit declined 4% and its industrial technology profit was flat. On the other hand, RF technology saw profit rising 15% while its medical and scientific unit recorded a 64% increase in operating profits. The latter was helped by contributions from Sunquest, which makes medical information software. Nevertheless, organic revenue growth remained at 3%. As for its RF technology segment, Roper forecasts double-digit organic growth in the fourth quarter.

Fourth, a lot of Roper's other end markets are seeing strong growth. Medical imaging solutions and RF technology (particularly for toll roads) are forecast to have "solid growth" in 2014, according to Roper's management.

Moreover, if housing starts continue to climb, then Roper's metering and water handling solutions (industrial technology segment) should see some upside in 2014.

One of its peers, Watts Water Technologies (NYSE: WTS  ) , recently gave an outlook which I would only describe as being cautiously optimistic. Watts generates 60% of its sales from residential & commercial flow control products, so just like Roper's water handling systems, it relies on construction activity for its growth.

The increase in new US housing starts in 2013 has been a strong support to Watts' residential business, but housing starts have stalled to around 900,000 (annualized rate) due to interest rate increases in the US. Watts is predicting that starts will return to 950,000 by year end , and that "the anecdotal evidence we're seeing suggest that the nonresidential construction market is likely to turn sometime next year." If Watts is right, then Roper could see some, upside too .

And finally, Roper's management has managed to improve its operational performance, despite having to reduce guidance. For example, its cash flow conversion has gotten even better, enabling the company to keep its full-year operating cash flow guidance at $800 million. In addition, the Sunquest acquisition that Roper made in 2012 has bedded in well. Given Roper's acquisition history and current cash flow generation, you can expect more deals to come in 2014.

Where next for Roper Industries?
Roper's valuation doesn't look cheap in relation to some of its peers.

ROP P/E Ratio (TTM) data by YCharts

However, analysts have 12% earnings growth forecast for 2014. In other words, if it ends 2014 on "fair value," then the stock price will be up 12%, and there may be upside to these estimates.

Looking forward, Roper will want to see a snap-back in nuclear activity in 2014, some stabilization in US oil & gas drilling, and a pickup in US construction activity. All three look like decent assumptions. Roper expects the nuclear plants to be reopened, the Baker Hughes data is suggesting conditions are bottoming, and housing construction continues to grow.

There's a strong argument that Roper's current dip makes the stock attractive. At least, I hope so -- because I bought some.