Baker Hughes Starting to Look Slick

NEW YORK (TheStreet) -- If you ever doubted that the Street is prepping for an oil services recovery, consider that shares of Baker Hughes (BHI) jumped more than 3% on management's reduced guidance. That rarely happens in today's market, much less within a commoditized industry like oil.

Despite Baker Hughes' struggles with weak oil prices and soft rig counts, the Street always wanted to love this company. And the entire sector, including market leaders Schlumberger (SLB) and Halliburton (HAL), is posting better-than-expected third-quarter earnings results.

There's no denying that this industry is on the rebound. Given the evidence of improved business conditions in North America, investors have even more reason to be optimistic.

Although it has always been the third wheel to Schlumberger and Halliburton, Baker Hughes has been no laggard. In fact, Baker Hughes' shares have outperformed Schlumberger over the past year, at 24% vs. 22%, respectively. It seems as if management is finally ready to take steps to produce the results that the Street covets.

That's why the stock jumped last week even with management's reduced guidance. Astute investors understand the reasons for the reduction have little to do with the company's fundamentals. Baker Hughes' long-term growth potential remains intact. Management now projects earnings per share to be in the range of 60 cents to 62 cents, down sharply from previous estimates of 78 cents to 80 cents.

But Baker Hughes receives the benefit of the doubt. Investors remember that the company's profits surged 22% in the October quarter. In the guidance reduction, management also cited last November's shutdown of the company's Iraq operations, which occurred due to protests by local residents at the Basra facility. Schlumberger also experienced similar distractions in that region.

With Baker Hughes due to report fourth-quarter earnings Tuesday, management must affirm what the Street already assumes to be true: If and when the energy market does fully recover, Baker Hughes will regain its status as a strong oil producer. That is much preferred to the company's natural gas performance, which has suffered considerably more.

On Tuesday, management will also need to make investors feel better about the fracking business, which had weakened due to the natural-gas surplus.

In short, I don't believe Baker Hughes management deserves the skepticism they have faced, particularly since both Schlumberger and Halliburton were forced to make similar adjustments to grow profitability.

Baker Hughes exceeded expectations, especially give its decision to switch to shale. Shale is not only less efficient, it also comes at a higher cost. To that end, the 22% profit surge is no small accomplishment. On Tuesday, management will need to demonstrate continued momentum in North American operations.

North America has been a pleasant surprise, growing almost 7% sequentially in the October quarter, and margins have also been impressive, soaring 10%.

While some analysts were quick to criticize management's decisions to switch to shale, these same analysts also discounted that Baker Hughes was outperforming both Halliburton and Schlumberger. This despite Baker Hughes' capital deficits, or the fact that the company is not as deep-pocketed as its rivals. That didn't matter.

Investors should also pay attention to what management says about international growth. Schlumberger and Halliburton are both catching up outside of the U.S. and, in some cases, widening their gap. And they've begun to use their deep pockets more for international expansion. The good news, though, is that Baker Hughes did well in the October quarter, posting 14% growth outside of North America.

So although Halliburton and Schlumberger are doing what they have to do to capture market share, the Street remains impressed with what Baker Hughes has been able to accomplish and the path on which management has placed the company for long-term growth. Investors are wise to not take this company for granted. And on the basis of improved business conditions in North America and international expansion, fair market value for Baker Hughes should approach $65 a share by the second half of 2014.

At the time of publication, the author held no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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