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BOSTON (TheStreet) -- Value-focused Morningstar (MORN) - Get Free Report tends to recommend stocks that are out-of-favor and in the bargain bin, not those that have surged 78% in just 12 months.

But, for

Baker Hughes


, the company is making an exception. Morningstar, known for its star-rating system, upgraded the oil-services company's shares to five stars, the highest, a week ago.

Baker Hughes sells services and parts to drillers, including directional drilling assistance, field chemicals, drill bits and advanced pumping systems. Morningstar is particularly bullish on Baker Hughes, relative to a field of competitors that includes


(HAL) - Get Free Report



(SLB) - Get Free Report

, because of Hughes' top market share in drill bits, completions, pumping systems and field chemicals. Despite these stalwart businesses, Baker Hughes' $34 billion market value renders it smaller than Halliburton, at $45 billion, and Schlumberger, at $115 billion.

In 2009, the company was largely product-, rather than, market-focused, so to compete better with larger peers, Baker Hughes merged with

BJ Services

in a deal valued at over $5 billion. The move proved accretive to earnings. Baker has tripled trailing 12-month net income. Last quarter, the company doubled adjusted earnings to 87 cents, exceeding analysts' consensus projection by 12%. Sales, up 78%, also beat consensus. But, business is abnormally cyclical and currently benefiting from elevated crude oil prices. Should that trend reverse, Baker's outlook would drop precipitously. This week,

Goldman Sachs

(GS) - Get Free Report

, in a bullish move, bumped its 12-month oil forecast to $130.

Continued price momentum in crude isn't guaranteed as a slowdown in resource-hungry China, the end of the Federal Reserve's QE2 and a strengthening dollar could catalyze a price drop, as the commodity is priced in U.S. currency. On the other hand, if the recovery continues and oil remains above $100 a barrel, Baker will cash in on higher profit spreads. Last quarter, its operating profit margin extended from 9.3% to 14%, boosting net income. That margin has room to run, as it ranked in just the 67th industry percentile. Baker held $1.4 billion of cash and $3.8 billion of debt at quarter's end, for a 1.8 quick ratio and a 0.3 debt-to-equity ratio.

The balance sheet is well-managed, though recently debt has been on an upswing, rising 90% as the company focused on overseas expansion. Morningstar says oil-services companies "are still in the early days of a multiyear international upcycle" with "substantial near-term margin expansion -- which should lead to increasing earnings per share estimates and higher stock prices." It values Baker Hughes at $100 a share, suggesting upside of 37% to fair value. That valuation is equivalent to 25-times Morningstar's 2011 earnings estimate.

Wall Street has a comparable view of the stock. Currently, 27, or 77%, of researchers in coverage rate Baker Hughes "buy," seven rate it "hold" and one ranks it "sell." The stock has a median 12-month target of $93.75. Goldman Sachs has the highest projection on Wall Street, forecasting a gain of 40% to $102 in just six months. Energy-focused


concurs with Morningstar's $100 valuation. Morningstar is optimistic about Baker's expertise in "liquids-rich production in onshore shale plays, more offshore drilling, which is very services-intensive, and oil and gas companies seeking to boost recovery rates from old or mismanaged wells."

However, Baker Hughes faces stiff competition from the more-established Halliburton and Schlumberger as it attempts to gain incremental market share overseas. Management is targeting a 15% international operating margin by year-end and hopes to be margin-competitive with Halliburton and Schlumberger by 2012. Halliburton's trailing 12-month operating margin is 17% and Schlumberger's is 16%. Both are above Baker's spread, illustrating the room for improvement. Goldman's thesis is similar to Morningstar's.

The Wall Street bank, encouraged by the quarterly international operating margin expansion to 12%, which exceeded its forecast of 8.2%, reiterated its "buy" rating. Going further than Morningstar even, Goldman stated that Baker's "15% margins by the fourth quarter could prove conservative." It expects "15.4% with risks to the upside." Goldman is also encouraged by a recent contract win in Angola, a critical drilling site that "could become an important source of upside as deep water activity there accelerates in 2012 and beyond."

-- Written by Jake Lynch in Boston.


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