Baker Hughes

Iran-backed Houthi rebels have taken control of the Bab al-Mandeb strait, according to several news reports. Also, last week, drone attacks damaged the critical East-West pipeline, forcing Saudi Arabia to shut it down.

Why it matters: The Bab al-Mandeb Strait is another critical Middle Eastern maritime chokepoint, aside from the Strait of Hormuz, while the East-West pipeline is a critical artery that crosses Saudi Arabia and connects it to the Red Sea. Saudi Arabia used both as a workaround to the current crisis. Before the war, roughly 4%-7% of global liquids moved through Bab el-Mandeb, though EIA estimates have shown that figure rose during the second quarter. Houthi control of this strait disrupts one of the world's major suppliers and heightens the risk of escalation. While we previously flagged that recovery was quicker than expected following the now-failed earlier Memorandum of Understanding between the US and Iran, we now believe something akin to our prior bear case scenario is more likely and that the disruption of flows will persist into 2027.

The bottom line: We aren't changing our $65 per barrel Brent midcycle oil price estimate, as stated in real terms, but we're far more concerned about near-term supply disruptions than we were previously. While Saudi Arabia can keep loading crude, it must rely on a thin storage cushion. How quickly flows normalize will depend on how fast Saudi Arabia can restore the pipeline. We've read that the country could partly restore the pipeline through one of its two lines, even as full repairs could take multiple weeks. But even so, Houthi control of the Red Sea will still hurt flows. We continue to model oil price futures in our next two-year assumptions as we have no edge over markets here. Long-term, however, we see greater opportunity in the gas supply chain in names such as Expand, Antero, and Baker Hughes, particularly as cheap Permian supply hurts gas companies.

We raise our fair value estimate to $73 from $60. The primary driver of our raise is based on the long-term orders we think Baker Hughes can capture on power systems tied to data centers and LNG liquefaction equipment and favorable pricing. Its industrial and energy technology's segment book/bill ratio sits at 2.2 times as of the second quarter, indicating outsize demand, and backlog continues to grow both year on year and sequentially, especially in gas technology equipment. Additional revenue from gas technology equipment should drive further EBITDA margin expansion in the industrial and energy technology segment, and for Baker Hughes overall, from operating leverage.

We also like the Chart Industries acquisition. While Baker Hughes purchased Chart at a premium to our stand-alone valuation of Chart of $200, which excludes deal-related effects, we think cost synergies look readily achievable and fully incorporate them. We think Chart had a history of uneven execution, so there's plenty of room for improvement. Still, we award no credit for revenue synergies.

We continue to like the company’s operational improvements and portfolio moves. We value the stock at roughly 13 times and 11.5 times on a 2026 and 2027 enterprise value/adjusted EBITDA basis.

As a provider of equipment and services to the energy and industrial markets, Baker Hughes is differentiated from its oilfield services peers. We think this business helps the overall company’s long-term growth, which we expect will be midsingle digits organically, versus the typical flat to low single digits we expect from other services firms we cover. Baker Hughes also has an advantage in that it's more exposed to international offshore projects than a peer like Halliburton. These projects enjoy far lower breakeven pricing than US shale; therefore, Baker Hughes' oilfield revenue should be less sensitive to near-term commodity pricing headwinds.

On a segment basis, we're very bullish on IET, but we suspect we're more bearish relative to the market on the OFSE segment. We think IET's revenue, which we model at an organic 9% compound annual growth rate during our forecast, will be driven by data center and LNG-related demand for IET products (turbines, compressors, and electrical equipment) and new energy wins. On average over the long term, we think IET can maintain incremental EBITDA margin in the mid-30s. Aside from strong volume-related leverage, we think IET’s margins will expand as it converts high-margin backlog, introduces new digital products, and continues its lean journey (supply chain, design, improved cycle times). By our midcycle year, we believe IET can improve its EBITDA margin by over 700 basis points, from 18.5% today.

For OFSE, we model a low-single-digit five-year outlook, driven positively by international markets on production and completion-related revenue. We believe producers will mostly focus their spending on improving production (maintenance spending) rather than on exploring and developing new basins (capital spending). From this standpoint, OFSE is well-positioned, as its portfolio is strongly positioned in specialty chemicals and artificial lift. Finally, we expect there's still more productivity and efficiency that Baker Hughes can extract from OFSE's near-term margins, which we expect will dip below 18% in 2026. Longer-term, however, we believe that volume leverage will primarily support this business, though we think OFSE's current profitability is close to what it can maintain through the cycle.

On a consolidated basis, we assign Baker Hughes a no-moat rating.

We think Baker Hughes' industrial and energy technology segment is a much stronger, moatworthy business relative to the oilfield services and equipment business. That's evident to us from both a qualitative and quantitative basis. But when incorporating goodwill in the capital base and the cumulative impact of impairments, Baker Hughes has never cleared its firmwide WACC as it's currently constituted.

Oilfield Services and Equipment Segment Has No Moat

Following the paradigm shift toward producer capital discipline and consolidation in North America, the oilfield-services industry now appears to require suppliers to hold either first or second position to generate through-the-cycle economic profit. At roughly 5% of the global oilfield-services market, Baker Hughes' OFSE segment holds the number-three spot, behind Big Three peers SLB and Halliburton. We think having a first or second share is needed to dig a moat, because the cost advantage from economies of scale and scope partly underpins our ratings for SLB and Halliburton. Services firms have large, fixed cost bases, evidenced by their inherently high operating leverage. These fixed costs include equipment, technology, and facilities. So, service firms require high utilization rates to earn economic profit.

As a global service provider, Baker Hughes achieves good utilization by supplying a wide range of producer clients that value its service breadth, including national oil companies, major integrated firms, and independents focused on US shale. But Baker Hughes partly improved its position with key customers through a transformative M&A that inflated its invested capital base and would never have derived the full benefit of these global customer relationships without its combination with GE's oil and gas assets in 2017.

Industrial Energy and Technology Segment Has a Narrow Moat

We think the IET segment benefits from switching costs (primarily) and intangible assets. While IET is organized along five product lines, we compartmentalize it as three separate businesses: gas technology equipment and services, industrial products and solutions, and climate technology solutions. We believe gas technology and the industrial business earn a moat from switching costs and intangibles, with gas technology having the stronger intangibles and moat, given the complexity of the equipment, in our view.

We consider gas technology to be a razor-and-blade business, with its large installed base of equipment benefiting from intangible assets and the services side of the business benefiting from switching costs. Among other pieces of critical equipment, Baker Hughes manufactures aeroderivative (smaller, more compact) gas turbines for oil and gas applications through a 50/50 joint venture with GE Vernova. Baker Hughes sells heavy-duty gas (or larger-scale) and steam (or coal-powered) turbines through a supply agreement with GE Vernova and GE Aerospace, as well as manufactures other smaller industrial turbines, compressors (used to transport natural gas through pipelines), pumps, and electrical equipment. Its gas tech equipment is highly engineered and complex. Success in the industrial and energy markets this business serves depends on a long, successful record, strong intellectual property, and adherence to regulatory standards.

Gas equipment sales earn Baker Hughes lower margins relative to service revenue. The company sells equipment at comparably low levels of profitability, but substitution risks are low. IET works closely with its customers in the design, testing, and installation process, and equipment product cycles may last up to 10 years. Once installed, IET earns back far higher-margin, recurring aftermarket parts and service revenue (repair, upgrades, and monitoring) that frequently spans over two decades.

Baker Hughes' content isn't a significant amount of customer project spending, but its solutions represent the most mission-critical part of that outlay. Roughly half of Baker Hughes' gas technology service revenue is secured by either contractual or long-term service agreements. For instance, most of Baker Hughes' content in LNG liquefaction plants (commonly referred to as LNG trains), where LNG is converted into a liquefied form for transport, has contractual service agreements that span anywhere from 5 to 20 years.

However, even in situations where critical equipment isn't secured by a contractual relationship, customers tend to buy parts from the original equipment manufacturer. This reliance on an OEM like Baker Hughes mostly stems from the associated high cost of failure of the equipment. Mechanical failures from a faulty pump could mean more than just additional maintenance costs and production losses—they can lead to unplanned downtime, catastrophic to a customer's operations and, in turn, their bottom line. Baker Hughes' digital, remote monitoring solutions can identify potential faults early and improve the real-time performance of equipment, which, in our view, only reinforces IET's switching costs.

As for IET's industrials business, Baker Hughes' final control valves (valves that respond to a control system that regulates the flow of liquids or gases in an automation process) and vibration sensors are held in high regard by field experts based on reputable industry surveys. These are differentiated solutions that support intangible assets. These instruments also provide real-time data to operators that monitor asset quality, which we believe also creates switching costs because they prevent failures, optimize efficiency, and lower monitoring costs.

Baker Hughes will grow far faster than its oilfield peers. Investors don’t fully appreciate the growth opportunities in its IET portfolio and a rerating through the successful integration of Chart Industries.

Exposure to international projects and strong positioning in productivity-related solutions mean Baker Hughes’ revenue is much more defensive than that of its peers.

The company has far more levers it can pull to drive further margin and return improvements; a 20% EBITDA margin is merely part of its journey, not its destination.

Baker Hughes is priced for perfection; bulls assign it an inflated multiple relative to peers that either is not justified by its returns profile or assumes no midcycle reversion.

Baker Hughes is trapping value in its current structure, and despite multiple portfolio reviews and outside investor pressure, has indicated it intends to keep this structure intact.

Macroeconomic-related and commodity weakness from oversupply of oil and other factors has led to a pullback in capital spending that will negatively affect the entire oilfield-services industry.