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While Baker Hughes (NYSE:BHI) has struggled recently, near-term visibility is improving and will drive multiples expansion. The Street currently rates shares a "buy" versus a "strong buy" for Schlumberger (NYSE:SLB). While Schlumberger is preferred on the Street, I prefer Baker Hughes due to the bar being set low despite strong fundamentals and low valuation ratios compared to historical levels.

From a multiples perspective, Baker Hughes is by far the cheaper of the two. It trades at a respective 12.6x and 8.6x past and forward earnings while Schlumberger trades at a respective 22.3x and 13.7x past and forward earnings. Baker Hughes' current PE ratio is 69% of the 5-year average despite a strong ROIC of 9.1%. Both firms are highly volatile with betas of 1.4 or greater.

At the fourth quarter earnings call, Baker Hughes' CEO, Martin Craighead, addressed particularly weak domestic performance:

"In North America, our results were disappointing as very strong performance in drilling systems, completions and artificial lift were more than offset by Pressure Pumping, where we've experienced a variety of cost and efficiency challenges associated with ramping demand. These cost challenges come in 3 categories. First, we experienced inefficiencies associated with our freight, fuel and other logistical operations. Second, there are significant shortages of specific sizes and qualities of proppant, gel and other materials. These shortages shifted the supply and demand curves; and as a result, our product costs escalated. In addition, these shortages adversely impacted operational efficiency. Third, we incurred incremental costs associated with adding new crews in the fourth quarter in anticipation of growth in 2012".

Fourth quarter EPS came out $1.22, 8.3% below consensus. North america issues are less of a concern going forward with improving economic costs and quick changes to the logistical issues. The firm has solid fundamentals and with international margins are strong at 16%, Baker Hughes is capitalizing on emerging market demand at an opportune time. Furthermore, ROE is trending towards a 260 bps improvement to 14.1% in 2013 as net debt stays relatively flat.

Consensus estimates for Baker Hughes' EPS forecast that it will grow by 18.8% to $4.99 in 2012 and then by 17% and 18.2% in the following two years. Assuming a multiple of 12.5x and a conservative 2013 EPS of $5.74, the rough intrinsic value of the stock is $71.75, implying 43.8% upside.

Schlumberger, on the other hand, modestly beat consensus estimates for the most recent quarter. Demand continues to be strong both international as seismic improves. With natural gas pricing at disappointing levels, investors stand to benefit from environmental regulations on more pollutive energy sources. Even still, the firm has a low free cash flow yield (12 months forward) below 5% at the same time that rig count will decline on put pressure on margins. Haynesville and Fayetteville will particularly be the scene of the margin story with utilization rates heading towards 80% and greater dry-to-wet switching by the second quarter.

Consensus estimates for Schlumberger's EPS forecast that it will grow by 28.4% to $4.70 in 2012 and then by 21.7% and 20.3% in the following two years. Assuming a multiple of 17.5x and a conservative 2013 EPS of $3.65, the rough intrinsic value of the stock is $98.88, implying 26.1% upside.

Source: Why Baker Hughes May Fly 44%, Outperforming Schlumberger