Smart Money Analysis: Choppy results weigh on Baker Hughes

By Braden Reddall

SAN FRANCISCO (BestGrowthStock) – Equity analysts have been showering love on Baker Hughes Inc (BHI.N: ), the world’s No. 3 oilfield services provider, but some top hedge funds are still afraid the stock might take a bath.

Wary of a U.S. drilling slowdown and tired of waiting for Baker’s restructuring to pay off, some of the savviest hedge fund managers, including Andreas Halvorsen of Viking Global Investors and Eric Mindich of Eton Park Capital, dumped their entire stakes in Baker during the third quarter.

That made the stock the most popular “sell” in the quarterly “Smart Money” survey of 30 of the largest stock-picking hedge funds, conducted by Thomson Reuters.

Sellers were likely scared off by disappointing second-quarter results that Baker reported in August. That was followed by stronger third-quarter numbers, which typifies the choppiness investors have come to dread.

“The hedge fund community, unfortunately, is tasked with the issue of timing,” said David Havens, oilfield services analyst at Sterne Agee in New York, citing Baker’s volatility.

The hedge fund sales came despite the fact that 18 analysts have recently raised their profit estimates for Baker, according to StarMine data.

“Going all the way back to 2006, (Baker Hughes) has shown quarters of brilliance, and they’ve shown quarters of material disappointment,” Havens said. “It’s been pretty hard to predict.”

Now, with natural gas prices so depressed, no one expects a repeat of the surprise U.S. growth that gave the recent boost to Baker and rival Halliburton Co (HAL.N: ). Three of the four Smart Money hedge funds that sold Baker in the third quarter also exited Halliburton.

Dinakar Singh of TPG-Axon Capital Management and Brookside Capital, a hedge fund run by private equity giant Bain Capital, were the other Baker Hughes sellers among the Smart Money 30.

GLOBALLY LAGGING

Some analysts argue that the slow, steady production growth expected outside North America, particularly in deepwater fields and Iraq, will leave room for all the big players, including industry leader Schlumberger Ltd (SLB.N: ) and No. 2 Halliburton, to eventually make money.

In theory, Baker Hughes could offer more upside than its rivals, as it has more room to raise margins. The company promises a sharp improvement in its international margins from about 5 percent now to 15 percent at the end of 2011.

But the Houston-based company finds itself playing catch-up internationally, and therefore may not be as comfortable a place to park money while waiting for all the oilfield services companies to reap the fruits of their heavy investment abroad.

Its stock also looks expensive compared with Halliburton, which demonstrated smoother results over the past year, even while the work Halliburton performed on the blown-out BP (BP.L: ) well left it vulnerable to scrutiny and panic selling.

Halliburton and Baker Hughes, along with No. 4 player Weatherford Ltd (WFT.N: ), have all expanded beyond North America in expectation of better growth outside their home market.

CEO’S ‘TOUGH HAND’

Chad Deaton, a Schlumberger man for 25 years who became Baker president six years ago and then chief executive in 2008, has had a tough battle in overhauling the company.

“He was dealt a fairly difficult hand of cards in that his predecessor was tasked with cutting costs,” Sterne Agee analyst Havens said. “They were building while everybody else was earning money.”

In May 2009 Deaton laid out his plan to sell services through a “geomarkets” structure, which sliced the world into 19 divisions and sought to build better client relationships, instead of having a variety of managers selling their own products around the globe.

Company spokesman Gary Flaharty said that while the overhaul had cost more than initially planned, the first year went well. He said Baker is confident its international margins will improve next year because half the gains will be through “self-help,” like integrating BJ Services, a $6.8 billion acquisition.

But the selling of Baker shares is not confined to hedge funds that are unwilling to wait for the company to shape up internationally.

Dodge & Cox let its Baker stake drop to 5.7 percent at the end of the third quarter from 9.1 percent at the start of 2010. Over the same period, the San Francisco-based fund raised its Schlumberger stake, its top holding at 4.75 percent of its portfolio.

Dodge & Cox was previously Baker’s No. 2 investor; now it’s No. 3.

“They have more confidence in the management team at Schlumberger,” said Kurt Hallead, co-head of global energy research at RBC Capital Markets. “Ultimately, that’s probably what the differences come down to.”

Havens said such differences grow more stark when investors are highly uncertain.

“Do you go with someone that’s tried and true?” Havens said. “Or do you go with someone where there’s upside but it could be rocky as hell?”

(Reporting by Braden Reddall; editing by Aaron Pressman and John Wallace)

Smart Money Analysis: Choppy results weigh on Baker Hughes