Baker Hughes Company (BKR) Earnings Call Transcript & Summary

Hi. I'm Sean Meakim, the Oilfield Services and Equipment Analyst at JPMorgan. Thanks for joining us for our Fifth Annual Energy Conference, the first one in a virtual format. Pleased to welcome back Lorenzo Simonelli. I assume most of the folks tuned in are familiar, but Lorenzo has been CEO of Baker Hughes since the business merged with GE's Oil & Gas division back in 2017. Since then, it's been a busy time. First, working towards integrating these 2 large, diverse businesses, then in effect pivoting towards separation to some degree, as GE sold on its stake in the business. Baker is one of the most defensive and diversified end market exposures across our coverage, with one of the best balance sheets, $15 billion in backlog, led by its LNG levered TPS business. So Lorenzo, great to see you. Thanks for joining us.

Great to be here, Sean. Thanks a lot for the invitation.

So we're going to do a fireside chat format here as we have the last couple of years. To start, I think it's just good to get a little of a level set of what you're seeing out in the field with your teams. Given the unprecedented environment that you're currently trying to navigate, just -- it would be great to hear kind of broadly across the segments, just how operations are going, manufacturing, your ability to work, whether it's a offshore or onshore in the Middle East? How those are trending as the economies are starting to reopen? It'd be great to hear how the team is performing.

Great. And Sean, definitely unprecedented. And so we are really focused on making sure that we execute and execute for our customers. Let me just start by saying congratulations to JPMorgan and yourself for actually hosting the virtual conference. I think it's great that you've been doing this and be able to keep up, like we're doing as well with our customers continuing to keep up operations. Before I go into the business units, maybe what is the operating environment we're in? Clearly, the first thing has been make sure that all of our employees are safe, that our operations are continuing and also that we can provide to our customers what they need over the past few months. I'm extremely proud of what the team's achieved, the level of focus, perseverance through extraordinary set of circumstances. I don't think anybody coming into the year could have predicted the number of black swans, and in particular the impact of COVID-19 as it really went through country-by-country location. So the second part, relative to making sure that we maintain operations, has been in this element of difficulty with COVID-19 and making sure that our supply chain is intact, making sure that we can move people around. In particular, I'm pleased with the way in which our TPS business and also Oilfield Services business has been up and running in every country. We've been able to be designated the strategic significant business. And with that, it's meant that we've got rotations of employees going into our facilities, maintaining production. We've got rotation of field engineers going out offshore and taking the right precautions. And I think that's a key testament to really Baker Hughes in the way in which we work with our customers. We haven't lost a beat. We've navigated, we've managed, and clearly, we've taken the precautions necessary. As you look at the actual business units, maybe let's take one by one. We've been focused on really taking the actions within our Oilfield Services business unit to accelerate the cost out. There's been a number of changes through the business transformation that we're already planning. But what we've done is really work to accelerate those service delivery costs, reduced product costs and other initiatives such as restructuring as appropriate with regards to the demand that we're seeing. And again, as we look at our geographic mix and less exposure here in North America, I'm pleased with the way in which we're executing through this downturn. On the Oilfield Equipment business, we've been able to work off the backlog that we've been able to build over the current years. And significantly now, it is an aspect of cost takeout, self-help, making sure that we're navigating the downturn. Clearly, there's not a lot of activity in the near term. And so we're rightsizing the facilities and focusing on the productivity of our backlog and making sure we execute. TPS, this is a business that coming into the year had a strong backlog. And also, we had the growth in LNG during 2019. So we've been focused on, again, working on the backlog, maintaining our services. And this is a business that, again, has a nice service franchise of onetime service agreements. So main key focus is, really, as we go through the year, mitigate the downturn and look to opportunities to navigate through the transactional decline that we're seeing. And DS, our Digital Solutions business, this is really linked to global GDP. And as you see the impact of global GDP going down, we've had to react and address the levels of economic activity that we've seen with restructuring and really position for when the volume growth returns. So that's one of the businesses that's clearly linked more to GDP. Overall, though, again, navigating well and very pleased with the way the team is executing in this tough environment.

Yes. Thank you for that. That's really helpful. Maybe then just also just to kind of set the table on macro expectations. Maybe just -- we've seen significant disruptions to the oil market, but also a pretty strong rebound relative to maybe somewhere around a month or 2 ago. Just maybe latest thoughts on kind of customer conversations around oil prices, LNG prices and thinking about the translation into customer spending over the next couple of quarters.

Yes. Sean. And it's true. You've seen a bit of a rebound here. I'm not sure that really translates itself into the activity levels yet. So if we look at, in particular, Oilfield Services and you look at North America, we really see the same as what we indicated on our first quarter call that activity will actually be down likely over 50% in the second quarter end. E&Ps are not spending more. I think, as you know, there's a huge decrease in completion activity in the U.S. And as you look at also the rig count and drilling activity, it's likely that the rig activity will be down 50% or more in this quarter and completions down up to 70%. As the year proceeds, we don't see a huge change in the E&P spend. So I'd say 50% versus 2019 is really what we're seeing for the total year. As you look at some of the other activity internationally, we do see that not as impacted. I think as you look at international, we're more on the 10% to 15% decline versus 2019 on the Oilfield Services side. That is where North Middle East and also the aspect of China and Russia being less impacted, but sub-Sahara Africa, Latin America, North Sea being impacted. And a number of those being seen in the second quarter end. For the year, down 10% to 15%, but we are starting to see some pressure that would say also what we're seeing in the Middle East and some of the COVID activity in Latin America that it could be closer to that 15% for the total year versus the 10%. So on your LNG comment, look, we are seeing that LNG is going to continue to be consumed. [indiscernible] picture hasn't changed but, clearly, there's an element of shift out and delay in some of the FIDs. But I think as countries come back on, you'll start to see LNG, in particular, the demand start to come back in the latter part of the year.

And then an interesting debate that's been underway among the investors and, clearly, it's been topical as we're going through the presentations today is thinking about where the incremental barrel comes from next cycle. It was really dominated by shale's most recent expansion, say, '16 through '19. And I'm just curious to get your take on how that could look different next cycle. Do you see potential for more of the operator, the mix of spend to shift towards longer cycle projects? I'm just curious how you see the incremental barrel being delivered between, let's say, short-cycle shale, shorter cycle OpEx within concerned capacity constraints and then the longer cycle projects that IOCs have historically invested in?

Yes. Sean, it's something that we as a team have discussed a lot. We've been active with our customers in. I do see this cycle being different than other cycles. And a key consideration is at the other end of this crisis, the role of North America shale versus other low-cost producers and meeting global demand. I think the natural reflex has always been that North America tends to recover quickly. And I think given what we've seen in the past with now more capital discipline, there's been excess capacity by some of the larger international producers. I think we're going to see a shift where a realistic scenario is North America shale production resets roughly down 2 billion barrels lower than previously. And some of the growth will actually be made up by some of the more OPEC-driven onshore countries. And you'll start to see more investment in digital, automation, and that's where the productivity is going to be driven. So North America is still important, but it won't be the big surge that we've seen in the past with capital being deployed quickly. And I think we're looking at a 2- to 3-year cycle where North America won't be as much of the growth engine, but we'll see it more from the traditional actual oil-producing countries.

That's very interesting. Can we also -- let's maybe shift gears, get more specific to Baker. Can we talk about the cost-out program, so the $700 million, just to get an update in terms of your sense of structural versus variable costs, and just thinking about on a normalized basis, the impact that this cost-out program will have on the margin profile for the business going forward?

Yes. We're progressing very well on the restructuring that we announced, the cost out. Again, we've been focused on continuing to improve the margin rate of this business. And during the downturn, we've got to take out more costs. And as you know, we've got a number of different saving elements that we put in place. The first and the largest relative to the headcount reductions, facilities footprint, the adjustment to the levels of activity and the majority of these savings will come through in Oilfield Services and Oilfield Equipment. If you look at our initiatives, we're accelerating the transformation efforts in global procurement, supply chain. We're shifting consolidating the manufacturing base. We're expanding the use of remote operations of multiskilling on a global basis. And although the volume levels will clearly maybe lower than what we'd initially developed in this plan, we think we're still able to capture a lot of these savings as we go forward. And you won't see the natural return of the incremental cost as volume comes back. We think a lot of this can be maintained. If you look at the third category, simplification across our product lines, you've seen what we've done from streamlining a set of functions. We've taken meaningful steps and also flattening our organization. We've looked at some of the low-performing product lines and we've exited those. You've seen with Lufkin and also some of the announcements we've made. So annualized savings from the restructuring initiatives, around $700 million. And these will be achieved by the late 2020. So we see a positive position as we go forward. And these costs are very much needed and help us organizationally going forward.

And I think the cash flow trajectory is also important to highlight. So a lot of these initiatives this year are going to chew up some cash, but then they don't recur in '21. Maybe you can just talk about free cash flow expectations this year versus how different they can look in '21?

Yes. Just to maybe start, we still believe we can generate a modest amount of free cash flow this year with the visibility that we have from our long-cycle businesses and also our service franchise, which is very important to us. As you know, we will be incurring close to $800 million of cash, restructuring and separation costs. $300 million of that is obviously from the separation cost that we announced with GE and also the restructuring of $500 million that we're undertaking right now. Excluding these onetime cash costs, we would cover the dividend with the free cash flow. And as you look at going forward, it's still early to talk about 2021 in great detail, but you can see that with these moving pieces, we should have a good, free cash flow profile next year once you don't have these onetime cash costs repeating. So we would expect to see free cash flow to rebound to a level where we're covering our dividend as we go forward.

That's very helpful. So let's come back to LNG a little bit. You already alluded to long-term thesis is intact and near term we will see some deferrals and things may slow. I asked you the same thing last year about just the history of feast and famine when it comes to this business. And so you've had a pretty good feast that's going to get underway here from a throughput perspective, but how do you think about the change in as we move towards now execution phase, what's the timing -- or how do you think about timing to returning towards incremental orders? So I guess just thinking about the fundamental progression that gets us back towards where you'll have operators comfortable, place FID in new projects?

So the good thing is, Sean, and I mentioned it to you also last time, I think, when you've been in this industry for a while, and you've seen LNG, you know it's going to be lumpy. And take the good times and then you take the less good times, but with the knowledge that the macro picture doesn't change. And that's very much what we look at when we think about LNG and the demand for LNG and the capacity required of LNG in 2030. Last year, between the end of 2018, 2019, close to 100 million tonnes that were FID-ed, clearly, this year, coming into it, we said that there were a number of projects that may go or may be pushed out. We still see that there's perhaps 1 to 2 medium- to large-scale projects that have the chance to FID later this year. We also think that as we go forward, the LNG projects that have been put on hold will start to come back as you go into 2021, 2022. And the reason why we see that is in speaking to the customers and also the long-term nature of these projects, with the demand still strong in 2030, these projects need to go by the timing of 2021, 2022 to be able to be producing LNG with the demand that will be there. So you've seen us continue executing our backlog, as we've done in other times. That's the nice thing about the TPS businesses. You've got a strong service franchise as well as a strong backlog of unit equipment. And we're able to offer multiple different solutions to LNG customers as they look to go forward with their projects, from modular perspective, which is a solution we're providing to Venture Global's Calcasieu Pass project as well as then largest scale and become very confident that as we go forward, we'll start to see these LNG projects come back. And again, we've seen this before, and it's a trend, it's a cycle that happens.

For sure. I appreciate that. So then just in the near term, happy with the team's performance, you've got a lot of backlog to work through, but there were some disruptions earlier in the year. Just how do you think about margin progression for that TPS business? And what's the process to recouple back towards where things were expected to be before you went through these disruptions?

Yes. I think it's important, and again, you're mentioning TPS business as well. In this environment, we're managing the business for operating income dollars, not margin rates and doing our best to maximize cash flow. I think that said, it's reasonable to think that there's some pressure on margin rates in 2020 versus 2019, even though first quarter was solidly higher on a year-over-year basis. As we indicated on our first quarter earnings call, TPS of income would likely decline on a sequential basis as the services business will be impacted by COVID-related disruptions in 2Q. That's really the ability to get people out to the field. There's more requirements. As you know, governments have put in some restrictions, which we have to navigate, which really means there's dislocations in shipping and accepting of equipment in certain areas. For the second half of the year, margins should improve from 2Q levels as COVID disruption abates and revenues grow as we execute more of our equipment backlog.

I appreciate that. And so North America gets a lot of attention to this conference every year. This year is not really any different. But from your perspective, just given how much of your North American service business is tied to production, it would be great to hear an update as we're now further along in the quarter. We talked about this on the earnings call, but now we're -- mid-June, we've seen production come off-line. In some cases, we're seeing production come back online. Just it'd be great to hear how that flows through into your chemicals and lift businesses in terms of impact near term but also the potential for a bit of a catch-up as things streamline on the production end back half of the year.

Yes. Sean. And you mentioned something very important. Our OFS business is more production oriented. And again, we're fortunate in North America not to be in the pressure pumping side of things. So overall, we would expect our North America revenues to modestly outperform D&C spending trends on a full year basis, but not to the same magnitude as maybe in the last few years. Our view on North America is, as we indicated in our first quarter call, for the full year, we still expect USP -- U.S. E&P spending to be likely down over 50% versus 2019, with the sharpest decline occurring in the second quarter, over 50%. And we believe that our drilling completion business will perform in line with rig count and completion activity. For production chemicals, the relationship tends to be one-to-one. If production in the region is up or down 10%, revenue for our chemicals business should move in a pretty similar fashion. For artificial lift, it's more likely that ESP sales more closely follow the D&C trends near term as operators delay some of the initial lift installations, delay in equipment purchases. And I mean what you've seen in this cycle versus others is the shut-ins that have happened just very quickly. And so we've got a number of wells that are off-line at the moment. But as you start to see those come back online, you'll start to see the orders for our ESPs come back, also the work on the production chemicals side as well. So it's early to say. Every operator is looking at the situation at the moment. But I feel that, again, this will follow through in similar regards that as the production starts to come back, we'll be well positioned with our production side.

I appreciate that. So then let's maybe talk a little bit about the rest of the Oil Services portion of your portfolio. So in the international and offshore markets, a little more stability in the near term, just again, some disruptions, but the spend tends to be less volatile in both directions. Looking out the next couple of years, where do you see opportunities? Where do you see areas are looking to continue to struggle? Maybe that could be on a market basis, but also from a Baker Hughes' perspective.

Yes. I think, again, if you look out a couple of years, and it's very much consistent with the strategy that we're adopting as an energy technology company, Sean. If you look at from the Oilfield Services perspective, again, we see the opportunities from an international activity level. Again, international being more resistant and resilient as it goes through. We also see the Middle East continuing to be a region of importance. As we mentioned before, Russia, as you look at China actually impacted less. Latin America, sub-Sahara in the short term will be challenged. But again, that will come through in the longer term. So still from a standpoint of the international dynamics, we feel good. As you look at also on the competitive dynamics, I think the NOCs will continue to actually execute on their programs over the longer term and so positioning ourselves with those national oil companies. And I'd say there is, overall, a theme around, again, continuing growth in LNG, continued interest in productivity and so we'll start to see much more remote operations, remote drilling. Over 60% of our wells that were drilled year-to-date have been through remote operations. We see that as a trend continuing, also driven by what's occurred with COVID-19. So even through this, a number of opportunities coming through LNG. Our Digital Solutions business coming back from a GDP perspective as GDP comes back. And I think the interesting thing when you consider Baker Hughes is really where we play from an energy transition perspective and the capabilities we have to really help our customers in decarbonizing their energy footprint. And we've got new gas turbines that are lower emitting, have got the best performance from an efficiency standpoint with the LM9000 that we announced last week. We've also got a number of capabilities where we help our customers bring down their CO2 footprint so -- with our Digital Solutions business. So those are some of the growth opportunities as we see going forward.

That's great. And that's one of the -- that's a good transition to talk about energy transition, which is something that I wanted to certainly highlight. One interesting point that, I think, is still up for debate is the degree to which your customer base is going to be willing to pay for a lower carbon footprint. Can we talk about -- just again, strategically, across your portfolio of opportunities, how do you think about the opportunity, the trade-off for your customers between, look, this is a lower cost solution, higher carbon impact, here's a more expensive solution, but also lowers the carbon footprint and what is still relatively constrained cash flow environment for the customer. So how do you think about capturing the value that you can create through these types of new technologies in terms of the value that the customer will strive to a lower carbon footprint.

So I think you've got to look at it in various elements, Sean, and that's because of what's occurring globally in different remix. Some countries obviously have discussions around carbon tax that's going to be imposed. Some people are putting rules and legislation required to reductions in CO2s. We think overall that you can actually go through a transition and actually bring down CO2 by being productive. And you can't just ask the customers to pay more. There's got to be an increase in productivity. There's got to be an increase in benefit. And actually, they have to marry each other. As you look at some of the capabilities, again, as you start to look at stopping the flaring, again, you can bring down the cost because you've got a solution that brings away flaring, you can reutilize the gas to actually run your trucks nearby, you can actually reduce methane, you can help to actually reutilize what's being emitted. If you think of CCUS, finding productive ways of driving CCUS in the future. So I think it's a combination of capabilities. And then also as you look at new forms of the energy mix. So we believe natural gas and LNG is going to continue being a growth area. And as you look at the footprint that the aeroderivative gas turbines as well as the industrial gas turbines provide, it's much lower than if you're on a gen set or a diesel engine. Again, the reduction that you have from a cost saving of not utilizing diesel is very beneficial to our customers. So you've got to marry the aspect of reducing the cost base and yet making it cleaner at the same time. And I think there's a very interesting opportunity in the future around hydrogen. We have a hydrogen gas turbine. We're working on a hydrogen fuel project in Australia, and we think there's going to be considerable discussions around hydrogen as we go forward. So energy transition is not something that's going to go away. It's something that, I think, even through COVID and what the world has seen because of the environmental benefits from lower CO2 emissions is going to become more of a discussion point. And we're very much at the forefront of providing our customers, providing our partners, the capabilities to really lower their CO2 footprint.

Right. Absolutely. And so then if we just come back to traditional Oilfield Services for a second, but still staying in the international offshore markets, competitive dynamics are still pretty robust, particularly around larger tenders. We saw that 2 cycles ago. It's still pretty robust this cycle. But there was a rhetoric around maybe a transition towards more value-based model as opposed to volume among your peers. Clearly, you all were very, I won't say, market share focused, but there was an emphasis on kind of regaining lost share early in the integration with GE Oil & Gas. How do you see that dynamic playing out over the next cycle in terms of the large NOCs being able to extract more value out of the supply chain just through competition? How do you think that could be different or could be similar as we think about the next cycle?

So I think at the end of the day, everybody is going to be focused on the lowest cost per barrel. And from a standpoint of Baker Hughes, again, we're very happy with the positioning and also the commercial intimacy we have with our customers. We did put a big aspect of focus on reentering some areas that were important to us. And as you know, we went into the Middle East. We grew our penetration. We were able to get back into other locations that previously Baker Hughes had exited or lost some market share. I like where we're positioned today. The real focus for us is on margin rates and making sure that we're providing the best technology to drive a lower cost per barrel. And that means that with our customers we're working on new capabilities. We mentioned remote operations. Again, remote operations, actually, once they are up and running and done correctly, you can [ demand ], which provides savings for ourselves if more productive for the customer. As you look at the implementation of digital, when you think of artificial intelligence, our relationship that we have with C3.ai and Microsoft, again, being able to reduce nonproductive time, being able to enhance and really drive production increases. All of this is really a focus on helping the customer deliver a lower cost per barrel, but also retaining our focus on margin rates and an aspect of just going and getting share. We want to have a share that is profitable and margin accretive.

Right. And so as we're coming up on a short time here, I want to make sure we spend a little bit more time on digital. Can we may just unpack that digital strategy a little bit. Why partnership versus internal builds around some of the things -- the capabilities are coming with C3.ai. It'd be great just to kind of see a little bit more about the differentiation of the Baker strategy.

Yes. Look, we spent a lot of time in really assessing how do you become a good digital provider to our customer base. And you can try and home grow, you can try and do it internally. When you're used to doing equipment and services, that's where your knowledge is. And the aspect of software is not that simple. We felt it was much better to actually take our competence, which is the domain experience within the oilfield, within an LNG facility, within a downstream refinery across industrial energy applications and say, okay, what do we do with all this data that we now have. We know what it means. Now how do you marry with the competence of artificial intelligence, which is world-class from C3.ai and Microsoft with a cloud-based Azure and actually give an ecosystem that can provide better outcomes for our customers? And so really the marrying together of our digital strategy is we want to be able to actually help our customers through the journey. We don't claim to be the experts in artificial intelligence. That's why we have C3 that's renowned in multiple industries. We don't claim to be the best in being a cloud provider, but we have Azure and Microsoft. And so we team up together and we go to customers and we use our insights on what's the equipment, the valve, the pump, what's the ESP saying, what's the actual information and utilize that data to create the right algorithms that then allow nonproductive time to go down or our production to go up, reliability to go up. So it's really moving from what used to be time based and to making it much more on a capability of preventative, so you prevent shutdowns taking place. And this partnership is working very well. We've got a number of campaigns with customers. And I think we're only at the start of really understanding the value of the productivity we can generate through reducing silos. And the consortium, the ecosystem we built together between the 3 of us is very powerful.

Absolutely. Well, that about does it for our time here today. So Lorenzo, just want to thank you again. Always great to spend time with you. I appreciate you making time for us. And everyone else, make sure you enjoy the rest of the conference.

Thanks a lot, Sean. See you soon.