Baker Hughes is likely undervalued

The evolution of Baker Hughes (NYSE: BHI) share price can be predicted quantitatively. Energy category of the S&P 500 list contains many companies linked to various types of energy production and services. BHI supplies oilfield services, products, and technology services and systems to the oil and natural gas industry worldwide.  As for other energy related companies, we assume that BHI share price is driven by the change in some energy-related prices. There are two opportunities: consumer prices and producer prices. In our previous article, we found that Noble Energy (NBL) is rather driven by the PPI of natural gas. On the other hand, many companies are deeply involved in consumer markets and might likely depend on consumer prices.  
Our concept assumes that a BHI share price can be represented as a weighted sum of two individual producer or consumer price indices selected from a predefined set. We split the overall set into two pieces. There are five producer price indices (all borrowed from the Bureau of Labor Statistics): the overall PPI; the PPI of electric power, EL; of natural gas, GAS; of coal, COAL; and the PPI of oil, OIL.  There are nine  CPIs: the headline CPI, C; the core CPI, CC; the CPI less energy, CE; the CPI of energy, CC; the CPI of motor fuel, MF; the CPI of household energy, HHE; the CPI of fuels and utilities, FU;  the CPI of food and beverages, F; and the CPI of housing, H.
All PPIs, CPIs and the monthly closing price are available now through March 2012. Our model seeks for the best pair of PPIs (CPIs) which minimizes the RMS error since 2003. We also allow both defining indices to lead or lag behind the modeled share price. Additionally, we introduced a linear time trend and an intercept term. The best fit model is obtained with the pair C and F:
BHI(t)= 4.409C(t-0) – 4.174F(t-6) 4.797(t-2000) – 50.84; sterr=$6.73
where BHI(t) is the (monthly closing) share price in U.S. dollars. We allowed both time leads to vary between 0 and 12 months. In the best model, the CPI of food leads the share price by 6 months and the headline CPI evolves in sync with the share price.  The model standard error for the period from July 2003 to March 2012 is $4.75. We report only on reliable models which do not change over eight to twelve months in a row. Thus, the above model is valid and reliable since the middle of 2011.  

Figure 1 shows how the model predicts the current BHI price.  As for many energy companies, there were two major fluctuations in the first half of 2010 and in the fourth quarter of 2011 (see Figure 2 for the model residual error). Both ended on the fundamental price curve.  In November 2011, we would estimate the BHI price as an undervalued one. The closing price of March 2012 is undervalued by $15.  We expect the price to return to the fundamental level as defined by the model, i.e. by the CPIs.

Figure 1. The observed and predicted monthly closing prices for BHI between July 2003 and March 2012.

Figure 2. The model residual error.

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