3 Energy Stocks to Buy on Market Drop

BOSTON ( TheStreet) -- The "risk-off" trade, which has pummeled the stock market, has led to the outperformance of defensive sectors, including telecommunication, utility and health-care stocks. Still, energy, the most profitable sector so far in 2011, is holding up well.

S&P 500 oil-and-gas stocks have delivered a median gain of 9.3% in 2011. Crude oil is hovering around $100 a barrel, a sweet spot for producers -- expensive enough to generate lofty margins, but not costly enough to cannibalize demand for energy.

On Tuesday, addressing vocal concerns about elevated commodity prices, Federal Reserve Chairman Ben Bernanke reiterated his stance that the recent price rise would prove transitory. He also dismissed the notion that speculators are driving up the cost of fossil fuels, noting that emerging-markets demand has long outstripped supply, a trend expected to continue, or perhaps amplify, in coming years. In consideration of this market fundamental, energy investments are looking attractive from a long-term perspective. Three energy stocks, in particular, are worth considering now.

3. Baker Hughes ( BHI) is the third wheel to energy-services brand names Schlumberger ( SLB) and Halliburton ( HAL), but its margin upside and growth potential is superior. Morningstar ( MORN) recently added Baker Hughes to its five-star stock list, citing demand growth and margin expansion as catalysts for the equity. Sell-side researchers have a favorable view of Baker Hughes, as well. It receives "buy" ratings from 77% of analysts.

Baker Hughes sells services and parts to drillers, including directional drilling assistance, field chemicals, drill bits and advanced pumping systems. 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 a solid 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. Two weeks ago, Goldman Sachs ( GS), 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 and its stock will climb, perhaps faster than peers'.

Last quarter, its operating profit margin extended from 9.3% to 14%, boosting net income. That margin has room to widen, 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. Goldman has the highest target on Wall Street, expecting Baker to gain 39% to $102. Macquarie isn't far behind, at $102. And, Jefferies values Baker at $96.

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