Since the U.S. Department of Justice effectively shut down the Halliburton Co. (NYSE: HAL) and Baker Hughes Inc. (NYSE: BHI) merger announced in November 2014, both companies have been introspective about their future.

So, too, has Moody’s Investors Service. On June 3, Moody’s downgraded both companies’ credit, though Baker Hughes received a $3.5 billion break fee from Halliburton. The credit tensions for both companies appear more connected to how, individually, they will deal with diminished markets for their services.

Both companies have made it clear they will be cutting costs, but Moody’s ratings suggest for now their efforts won’t be enough to buoy them in the short-term.

Moody’s review of Halliburton’s $12.8 billion in debt began in October. The rating service concluded that the company’s use of debt to finance the merger is a detriment and the further erosion of a weak oilfield services environment will strain profitability and cash flow, said Andrew Brooks, Moody’s vice president.

“Depending on the pace of a broader energy market recovery, HAL’s debt leverage should peak in 2016, subsiding in subsequent years but is unlikely over the next several years to fall inside the 2.0x debt/EBITDA level that prevailed prior to 2015,” Brooks said.

Halliburton’s rating downgrade is based, in part, on the expectation that it will see a significant increase in its debt leverage to more 5x debt/EBITDA in 2016.

The severe downturn in the oilfield services market “is likely to drive 2016's EBITDA down as much as 70% from 2014's record high,” Moody’s said.

Moody’s sees Halliburton’s debt leverage dropping near 3.5x in 2017.

“The duration of the downturn in oilfield services demand and pace of the eventual recovery in Halliburton’s earnings and cash flow is inherently uncertain,” Moody’s said.

In May, Halliburton said it would turn to cutting costs with a goal of whittling down $1 billion in expenses. The company is also positioning itself for a recovery led by the North American market. The company cut its capex to about $800 million in 2016, about half of what it spent last year.

“Cost savings are expected to drive earlier-than-expected margin growth in 2016, with the company expecting $1 billion in annualized savings achieved by the end of 2016,” said Marc Bianchi, analyst for Cowen and Co.

Bianchi said second-quarter 2016 margins would be the “trough” for Halliburton and in the second half of 2016 a less brutal turn for the company.

“Despite the $3.5 billion breakup fee and a $2.5 billion debt clawback, Halliburton’s cash balance is expected to remain at more than $2.8 billion by the end of 2017,” Bianchi said.

Notably, Halliburton’s eastern hemisphere and Latin American guidance in early May was up, largely due to assets previously held for sale being reclassified as continuing operations, Bianchi said.

“These assets accounted for approximately $500 million of revenues and $124 million of operating income in fourth-quarter 2015,” he said.

Baker Hughes

Similarly, Baker Hughes was knocked for its elevated leverage and developing business model underpinned by the “current oilfield services segment weakness and the failed Halliburton merger,” said Terry Marshall, Moody’s senior vice president.

In first-quarter 2016, Baker Hughes’ revenue fell by $1.92 billion to $2.67 billion, a 42% decrease compared to first-quarter 2015.

Moody’s review of Baker Hughes encompassed the company’s $3.9 billion in debt.

“BHI plans significant cost cutting and restructuring measures that will improve EBITDA and leverage in 2017, which will support” the new rating.

In May, Baker Hughes strategy was clear cut: it would reduce costs by $500 million it was unable to implement for the past 16 months due to the Halliburton merger, Moody’s said.

Following a $1.5 billion share buy-back and $1 billion debt repurchase, Baker Hughes will be left with about $500 million of after-tax proceeds from the $3.5 billion Halliburton termination fee.

Baker Hughes should end 2016 with about $2.7 billion in cash, a portion of which resides outside of the U.S. and may not be readily available, Moody’s said.

While Baker Hughes’ strategy has been applauded on those fronts, many investors “have understandably expressed discomfort with the lack of details regarding the shift to an asset-light strategy with a more simplified organizational structure,” said J. David Anderson, analyst at Barclays Equity Research.

Baker Hughes plans to “pare back” certain product lines in countries that did not achieve adequate returns even during the 2009-2014 growth period, Anderson said. About two-thirds of the company’s revenue comes from outside North America.

“BHI is still committed to a full-service model with a global, albeit somewhat leaner, footprint,” he said.

Darren Barbee can be reached at dbarbee@hartenergy.com.