EFTA00301083.pdf

J.P. Morgan North America Equity Research 12 June 2014 Overweight Halliburton HAL, HAL US Price: $66.94 Few Holes in a Story That Keeps Getting Better A Price Target: $78.00 Previous: $77.00 We spent last week on the road in Europe with CFO Mark McCollum, which Oil Services and Equipment reinforced our view that the bull case on Halliburton continues to strongly J. David Anderson, PE, CFA AC outweigh any of the bear arguments, of which there are few. With the North American pressure pumping market tightening, HAL is going to be testing pricing in the coming months, providing upside to margin targets. We edged up Bloomberg JPMA ANDERSON <GO' 2014/2015 EPS above consensus to $4.00/$5.20, with an additional $0.15/$0.35 in William S Thompson EPS upside from share buybacks. Our detailed note begins on Page 2. • With the North America market tightening, HAL is starting to push Samantha Hoh, CFA pricing...will they put Tier 2 players in their place with new capacity? With only 10-12% excess industry capacity and 80% of HAL's hp on 24 hrs, the time is now to start pushing pricing. If successful, HAL likely starts adding capacity J.P. Morgan Securities LLC in addition to accelerating the Q10 pump rollout, which should make the tier 2 Price Performance players nervous in light of HAL's considerable cost advantage. 70 • Few concerns about an IOC slowdown, emerging IPM opportunities with NOCs. A lot of talk about IOC capital discipline, but Halliburton isn't seeing a * slowdown in the offshore market, nor do they see excess service capacity. NOCs are getting more creative in looking to fund activity with service Asia 10.13 Neal INM4 Me company balance sheets, creating a growing opportunity set for HAL that must — HAL sten Oa (0.1 be balanced against higher project risk. StP500 (teemed) YID 1m 3m 12m - Swirling currents in Latin America. The one soft spot is LatAm where Ate I 33.9% SA% 20.1% 59.2% Rel I 234% 2S% 16.2% 39.2% margins should appreciably improve in 2015. Petrobras has agreed to re-tender the drilling contracts on lower activity levels, with costs right-sizing by 2Q15. Mexico reform is getting close and onshore service contracts could materialize in 2H14 followed by IOC offshore tenders in 1H15. Even Venezuela is improving with a recent agreement on receivables and additional activity. • Raising EPS estimates slightly, more upside from buybacks. We raised 2014/2015 EPS to $4.001$5.20 from $3.9515.10 primarily on modest tweaks to our NAM margin and revenue progression, but could see upside on buybacks. We expect HAL to raise its dividend in the coming quarters (we model +20% to 50.18/qtr in 4Q14) to stay within 10-15% of net income but with plans to distribute 30-35% of operating cash flows, we could see -$2bn in buybacks in 2014 (would add —$0.15 to our '14 EPS) and another 42.5bn in 2015 (adds —$0.35 to our '15 EPS). Haillburton Company (HAL;HAL US) FYE Dec 2013A 2014E 2014E 2015E 2015E Company Data (Prey) (Cuff) (Prey) (Cuff) Price ($) 66.94 EPS (S) Date Of Price 11 Jun 14 01 (Mar) 0.67 0.73A 0.73A 1.12 1.14 52-week Range ($) 67.35-40.12 02 (Jun) 0.73 0.91 0.91 1.22 1.24 Market Cap ($ mn) 62,321.14 03 (Sep) 0.83 1.13 1.13 1.32 1.35 Fiscal Year End Dec 04 (Dec) 0.93 1.18 1.23 1.44 1.48 Shares 0/S (mn) 931 FY 3.15 3.95 4.00 5.10 5.20 Price Target ($) 78.00 Bloomberg EPS FY (s) 3.10 3.98 5.10 Price Target End Date 31-Dec-14 Source: Company data. Bloomberg. J.P. Morgan estimates. See page 11 for analyst certification and important disclosures. J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. www.jpmorganmarkets.com EFTA00301083 J. David Anderson, PE. CFA North America Equity Research 12 June 2014 J.P.Morgan Halliburton on the Road After spending last week on the road in Europe with Halliburton CFO Mark McCollum, our conviction as one of the top names to own in services has only grown stronger. North America market may be tighter than you think. Not surprisingly, most investor questions centered on the state of the North American land market, which is clearly showing improvement across the board. Considering the U.S. onshore rig count at 1,787 (+6% Y-Y) is where they thought it would end the year (as did we), higher E&P spending in the Permian is the obvious driver. In March volumes pumped were 30% higher y-y on a 15% increase in the number of frac stages; however, the increased service intensity is limited to the Bakken, Eagle Ford, and Niobrara with the Permian in an earlier stage of development. Figure 1: US Land Rig Count Figure 2:US Frac Stages (L-Axis) & US Wells Frac'ed (Rash Forecast 2.500 ti Hor Oil Veil Oil 85% 600.000 Frac Stages —Wells Frac'ed 35,000 lHor Gas to Dir Gas 2000 —%Hor/Dir 80% 500.000 30,000 25,000 1.500 75% 400.000 20,000 1.000 70% 300.000 15,000 200.000 500 65% 10,000 100.000 1 5,000 0 60% C' Oa. 41# 0 .O .O 4% 4. 0 1 1 I 0 # # I # I& I I I / 1 2011 2012 2013 2014E 2015E 2016E Source: Baker Higbee and J.P. Megan. Source: PecWesl andJ.P. Phnom Mr. McCollum estimates the pressure pumping market has about 10-12% excess Despite its forecast for moderate capacity currently, cut in half from the 22% overcapacity seen a year ago. Notably, +3% CAGR growth in wells spud this contrasts the more bearish analysis from PacWest Consulting that estimates and wells frac'ed in NAM from utilization at 81% in 2014, with the difference in views likely coming from two 2013-2016, PacWest forecasts +12% CAGR in total stage sources (see our June 4th note "Consultants Provide Frac Market Update: Modest counts driven by a continued Pricing Increases Offiet by Cost Recovely"). First, customers are demanding more shift to horizontal drilling horsepower on site from the second tier pressure pumpers. Second, while true (forecasts +12% CAGR for horsepower attrition levels may have been overstated historically pressure pumping horizontal wells fracied), fleets require an overhaul every 2 to 3 years. Therefore, with an estimated 6.8mm net increased lateral lengths, and decreased stage widths. HHP in capacity added in NAM during the 2010.11 timeframe, effective capacity may be quite a bit less than the 17mm HHP is stated industry capacity. 2 EFTA00301084 J. David Anderson. PE. CFA North America Equity Research 12 June 2014 J.P.Morgan Figure 3: North America Pressure Pumping Capacity (Million HHP at Year End) 25 "•6.8mm HHF, was added in 2010-2011 20 or 1/3 of current capacity 15 10 5 0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014E Source: PacWesl ardJ.P. Morgan. With promising pricing signs, will HAL put the Tier 2 players in their place? In describing the North American market, Mr. McCollum depicted a more stable pressure pumping market than in the past. While he does expect the market to overbuild again, it won't get to the point of 3O% overcapacity as in the past. This is partly because pricing increases won't be the "hockey stick" that drove the flurry of capacity additions from the smaller players, but it may also be a result of greater manufacturing capacity on pumps. But rather than showing concern about recent announcements of capacity additions (PacWest estimates 1.1mm of net HHP in NAM to be added in 2014), the company is more perplexed at the rationale behind the orders. Noting that Halliburton is the low cost operator in the market, the company is generating returns marginally above cost of capital (11%) on the current —15% EBIT margins. In other words, without substantial pricing increases, the market is adding capacity at sub-cost of capital returns, which could snuff out pricing improvements before it even takes hold. Figure 4: North America Operating Margins by Company SLB HAL BHI WFT —CJES 40% 35% 30% 25% - 20% 15% 10% 5% 0% 2006 2007 2008 2009 2010 2011 2012 2013 2014E 2015E Source: Company rapoils and J.P. Morgan esamales. With this backdrop, would it make sense for Halliburton to start adding material capacity to disincentivize the smaller players from adding more capacity? The answer may be yes. Until now, Halliburton hasn't been adding net capacity, instead replacing existing pumps with the new QIO design, which requires 30% less maintenance with a 2-1Ox longer wear life than competitor designs (PacWest estimates pumps generally last for about 5,000 hours). Currently, 20% of the fleet is outfitted with the Q 10, but now plans to reach 50% by year end 2015 may be 3 EFTA00301085 a David Anderson. PE. CFA North America Equity Research 12 June 2010 J.PMorgan accelerated. While this is lowering HAL's operating costs and increasing effective capacity by reducing downtime from maintenance, larger scale capacity additions are now being considered. Over the next month, the company plans to start testing higher pricing as contracts roll over, with success likely resulting in new capacity additions. Signs are clearly pointing towards pricing moving higher in 2H 14 as Halliburton's utilization improved to 80% on 24-hour work in 1Q14 from 75% in 4Q13, and all of its horsepower is committed through October. The company indicated three signs for contractual pricing to move higher: • Cost recovery from customers. On the majority of contracts, Halliburton is now able to pass through higher labor and logistics costs. • Improvement in the transactional market. They are starting to see spot pricing moving higher — not only are we hearing it from the second tier players (CJES), but our quarterly survey of US E&Ps also confirms the trend. • Calendar leverage. When Halliburton starts to control the calendar and telling customers when they can schedule the job instead of being told, then pricing leverage is clearly taking hold. We're not there yet. Halliburton is wrestling with this question: can they add capacity but still benefit from pricing increases or at least hold pricing steady? From an internal standpoint, as long as returns remain above cost of capital, capacity should be built and market share should be gained. But looking more broadly at the market, would it be prudent for Halliburton to seek to drive the smaller players out by adding capacity and putting pressure on their returns? The risk is if it backfires because the Tier 2 players don't seem to care about returns in the first place and cheap financing is at their fingertips allowing them to build without recourse. Confident in hitting margin targets. Halliburton's analyst day last November was notable for the aggressive North American margin targets set for 2014 and over the next 3 years. Mr. McCollum acknowledged this year's targets were a bit of a stretch when first announced (and then reiterated on the following earnings conference calls), but they now appear to be well in hand. Notably, none of the 200bp Y-Y margin improvement by 3Q14 assumes any pricing improvement, instead accomplished through costs and supply chain: I. About half of the improvement is from improved supply chain, primarily guar pricing and potentially sand; 2. Realized cost savings from the internal mobility project that streamlines back office functions in the field; and 3. The ongoing Q10 pump rollout that reduces maintenance costs by 30% (all expensed). Keeping in mind 1Q14 NAM results included 75bp of price degradation as contracts rolled over, any pricing increases in 2H will immediately result in higher incremental margins. Additional margin upside could come from Halliburton's ability to negotiate better proppant costs with suppliers. 4 EFTA00301086 J navirlAndprgnn PF CFA North America Equity Research 12 June 2014 J.P.Morgan Figure 5: Halliburton's North American Operating Margins 30% 25% 20% 16.3w ISIw 15:1% 15% 10% I 11 5% 1012 2012 3012 4012 1013 2013 3013 4013 1014 2014 3014 4014 1015 2015 3015 4015 Source: Company reports and J.P. Morgan esamales. The rest of the 300bp non-pricing margin improvement by 2016 will come from internal measures derived from the Frac of Future and Battle Red initiatives. As the US land market moves further into development mode, we expect superior logistics to play an increasing role in improved margins. According to Mr. McCollum, Halliburton had the fifth largest logistics operations in the United States (behind Coca Cola, Pepsi, and WalMart), with plans to expand significantly over the next several years. Halliburton currently owns 3,500 rail cars to transport proppant to well sites, which will double to 7,000 cars, while 2/3rds of the 18,000 new hires globally this year will be in North America. We believe this gives the diversified service companies (which includes Schlumberger and to a lesser extent Baker Hughes) a distinct advantage over the smaller players. In an isolated example, a customer in the Marcellus stopped using Halliburton over pricing, but struggled to replicate operations and had to hire 7 smaller companies instead. Not a lot of concerns about IOC slowdown. The biggest concern investors consistently voiced was the impact from the "capital discipline" mantra that many 10Cs have repeated over the past 6 months. Despite 20-25% of total revenue generated from 10Cs, Halliburton continues to forecast low double digit spending growth out of the Eastern Hemisphere this year (consistent with our forecast) and has yet to see a reduction in spending or activity levels offshore. In fact, the deepwater market is progressing about how they thought it would: slow and steady. The company believes that most of the overcapacity in the deepwater rig market can be traced back to Brazil, which some had expected to reach 70 deepwater rigs by now. While there is a chance that Brazil could pick up the slack and start growing again in 2016, Halliburton continues to model modest offshore growth the next several years and does not see excess service or equipment capacity in the market, other than rigs. Increasing 1PM opportunities with NOCs. One of the more compelling growth opportunities for Halliburton over the next several years is pursuing integrated project management (1PM) work outside the U.S. With one project underway (Malaysia), another poised to begin (Humapa in Mexico), and third under negotiation (Ecuador), national oil companies are getting creative, looking to use the large cap service companies' strong balance sheets as a means for funding activity. Mr. McCollum appeared comfortable that increases in working capital won't be onerous to Halliburton's balance sheet (will have to keep a close eye on receivables), but is clearly aware of the multitude of risks that 1PM projects bring. Risks that include commodity prices, currency, sovereign, reservoir, and environmental, each of which 5 EFTA00301087 J David Anderson PE. CFA North America Equity Research 12 June 2010 J.P.Morgan need to be properly compensated in contracts and justify a measured pace. Perhaps the most challenging aspect of these contracts is establishing a base-line for measuring the incentive portion of the contract. In other words, assuming a field increases production, how much credit goes to Halliburton for the increased production versus what would normally be achieved? Another issue is establishing the base-line for environmental risk to assure the company is only responsible for what takes place under their scope and not taking on legacy environmental risk. Swirling currents in Latin America. Latin America is arguably the one "soft spot" in the Halliburton story as margins have disappointed in recent quarters. But while we believe the issues have been ring-fenced, the major countries in the region face unique sets of issues that will take some time to resolve. Brazil is the biggest concern with activity substantially below what was agreed upon when the drilling contract was signed in 2012. Recently, Petrobras has agreed to retender the contracts, but the timing is in question. Assuming the contracts are re-tendered in 2H14, Halliburton should see margin improvement by 2Q15 as costs are right-sized. The big issue will likely be around price as Halliburton presumably priced the initial contract lower based on the higher expected activity levels. With reforms waiting for secondary laws to pass over the next month or two, Mexico will be a growing opportunity for Halliburton, particularly if service companies are the first to be offered contracts in unconventional work. We note that our understanding was the offshore market would be the first to be offered with 1OC's partnering with Pemex in both shallow and deepwater. Lastly, Venezuela may be showing some signs of improvement with the recently negotiated deal with PDVSA. Together with Schlumberger and Weatherford, $2bn in work has been agreed upon, which will include payment on receivables. Many Options with Balance Sheet and Cash Flow. We believe free cash flow generation is becoming the defining topic among large cap service companies, and has contributed to the re-rating of the stock over the past 6 months (in addition to oil prices and North America, of course). Last fall, Halliburton recapitalized the balance sheet with a $3.0bn debt offering and subsequent $3.3bn share buyback, but with net debt/cap at 29% as of 1Q14, investors shouldn't expect a repeat re-cap this fall. Instead, share buybacks will be coming from operating free cash flow, essentially paying out anything in excess of the $1.5bn in cash needed to run the business. As of 1Q14, Halliburton reported $2.1bn in cash on the balance sheet, with $1.2bn of it set aside for a Macondo settlement, which is expected to be resolved within the next 12 months. Mr. McCollum noted that the dividend currently paying out the low end of a stated 10-15% of net income, suggesting investors should expect an increase in the coming quarters (we model +20% to $0.18/qtr in 4Q14), with excess cash going towards share repurchases. With the company targeting 30-35% of operating cash to be paid out in total, this implies over $2bn in buybacks in 2014 (34/.32mm shares at $70) and another 42.5bn in 2015, which would add --$0.15/sh to 2014 EPS and $0.35/sh to 2015. Mr. McCollum expects capex to remain relatively flat over the next several years. He indicated North America is still the best place for the incremental dollar of spending for growth, but even if they dialed up pressure pumping capacity, it would only raise capex by 10% or so. Interestingly, one of his bigger balance sheet concerns is having available room for M&A, which would either focus on technologies or product lines 6 EFTA00301088 J. David Anderson_PE_CFA North America Equity Research 12 June 2014 J.P.Morgan that complement the mature field business around artificial lift (ESPs or PCPs) or chemicals. That said, there was a sense of frustration that more deals haven't presented themselves...then again, with the business outlook as strong as its been in years (if not as long as we've covered the company), Halliburton doesn't need much external help. 7 EFTA00301089 J. David Anderson. PE. CFA North America Equity Research 12 June 2014 J.P.Morgan Fi ure 6: Halliburton Model Summa Revenue North America $16.004 $3.706 $1802 $3.1131 $3.823 $15.212 $3.901 54.097 $4.191 $4.167 $16.356 $17.665 Latin America 3.694 945 944 1.002 1.018 3.909 859 906 992 1.140 3.897 4.483 EuropWAIricalCIS 4.510 1.187 1.299 1,340 1.399 5.225 1.299 1.455 1,447 1.567 5.768 6.202 Middle EasVAsia 4,295 1.136 1,272 1,249 1.399 5.056 1.289 1.437 1,511 1.679 5.916 6.804 Total Revenue $m,ses $8,974 $7,317 $7,472 $7,639 $20402 $7,348 $7,895 $8,142 $8,553 $31,938 $35,154 Rev oleo Consensus 28.243 6.879 7.246 7.498 7.557 : 243 7.863 8.285 8.65' Completion 8 Produclon 17,380 4.100 4.363 4,501 4.542 17,506 4.100 4.405 4.543 4.772 17.821 19.615 Drilling 8 Evaluahon 11,123 2,874 2.954 2,971 3.097 11,898 2.874 3,490 3.599 3.781 13.744 15.539 COGS ($23,741) ($6.000) ($6.191) (56.230) ($t363) ($24,784) ($6.303) ($6.619) (*fiat) ($6,891) ($26.413) ($28237• SG8A (21S) (72) (87) (60) 194) (333) (75) (87) (90) (94) (345) (387: Total Costs & Expenses ($24,016) ($6,072) ($6.278) ($6,310) ($6,457) ($25,117) ($6,378) ($6,706) ($6,690) ($6,985) ($26,759) ($28,623) Total D&A ($1,628) ($448) ($474) ($481) ($497) ($1,900) ($510) ($525) ($540) ($555) ($2,130) ($2,420) EBIMA $6,115 51.350 $1.513 $1.643 $1,679 $6,185 $1,480 $1,715 $1,992 $2,123 $7,310 $8,951 EBITDA Consensus 6.027 ti24 1. '59 6,174 1.483 1.714 1.953 Operating Income North America $2,980 $605 $666 $891 $651 $2,613 $602 $716 $859 $854 $1031 63.66E Latin America 607 109 101 159 157 526 100 109 144 171 524 760 EuropelAlricatiS 593 121 161 207 209 698 146 204 246 282 878 1.105 Middle East/Asia 667 187 219 207 264 877 211 259 295 353 1.117 1.353 Total Operating Income $4,487 $902 $1,039 $1,162 $1,182 $4,285 $970 $1,190 $1,452 $1,568 $5,180 $6,531 North America Margins 18.6% 16.3% 17.5% 17.8% 17.0% 17.2% 15.4% 17.5% 20.5% 20.5% 18.5% 20.8' Lalin America Margins 16.4% 11.5% 10.7% 15.9% 15.4% 13.5% 11.6% 12.0% 14.5% 15.0% 13.4% 17.6' EuropWAIricatIS Margins 111% 10.2% 12.4% 15.4% 14.9% 13.4% 11.2% 14.0% 17.0% 18.0% 15.2% 17.8" Middle East'Asia Margins 16.0% 16.5% 17.2% 16.6% 18.9% 17.3% 16.4% 18.0% 19.5% 21.0% 18.9% 19.8' Total Operating Margins 15.7% 12.9% 14.2% 15.6% 15.5% 14.6% 13.2% 15.1% 17.8% 18.3% 16.2% 18.6% Income Taxes ($1,355) ($191) ($276) ($312) ($278) ($1,057) ($229) M3101 ($384) ($417) ($1,341) ($1.681 Tax Rale 33% 23% 29)6 29% 26% 27% 27% 29% 29% 29% 28% 28% Net Income $2,561 ($13) $677 $707 $798 $2,189 $623 $774 $961 $1,044 $3,403 $4,424 Dluled Shares (Avg) 928 931 928 894 854 902 853 850 850 850 851 850 EPS (Adjusted, Diluted) $3.00 $0.67 $0.73 $0.83 $0.93 $3.15 $0.73 $0.91 $1.13 $1.23 $4.00 $5.20 EFS Consensus 2.97 0.57 0.72 0.82 0 En 0.91 1.11 Dv Bend • r Share $0.36 $0.13 $0.13 $0.13 $0.15 $0.53 $0.15 $0.15 $0.15 $0.18 $0.63 $0.72 Tolal Working Capital Changes ($1,026) ($864) (f219) $108 $538 (5437) l$172) ($116) ($492) $548 (6232) ($376) Cash from Operations $3,654 $349 $1,122 $1,078 $1,898 $4,447 $954 $1,183 $1,009 $2,147 $5,294 $6,468 Capital Expendtures ($3,586) ($685) ($711) ($679) ($859) ($1934) ($643) ($750) ($773) ($813) ($2,979) 43252, Cash from Investing ($3,688) ($651) ($540) (9876) ($1,003) ($2,870) ($674) ($750) ($773) ($813) ($3,010) ($3,252) Increase (decrease) in LT ChM SO $0 SO $2.968 SO $2,968 $0 $0 $0 $0 $0 $0 Cash from Financing ($172) ($145) ($1,184) ($338) ($87) ($1,754) ($514) ($127) ($127) ($152) ($320) ($609) Cash at End of Period $2.484 $2,029 $1,412 $7.491 $2,356 ,2$ 356 $2,123 $2,429 $2,538 $3,721 $3,721 $6,328 Prosody. Pant & Equip. (Nei) 10257 10.509 10.753 10.949 11.322 11.322 11.463 11.688 11.922 12.179 12.179 13.011 Total Assets $27,410 $27.684 $27,418 $27,948 $29,223 $29,223 $29,256 $30,178 $30,970 $32,090 $32,090 $36,353 Long-term Debt, Net of Current 4,820 4.820 4,820 7,816 7,816 7,818 7,816 7,816 7,816 7,816 7,816 7,816 Stockholder Equity 15.765 15.710 15.337 12.788 13.581 13.581 13.725 14,372 15.207 16.099 16.099 19.914 Cash Flow Metrics Free Cash Flow $88 ($336) $411 $399 $1,039 $1,513 $311 $433 $236 $1,335 $2,315 $3,216 FCF/share (diluted) $0.09 $0.361 $0.44 $0.45 $1 .22 $1 .68 $0.36 $0.51 $0.28 $1.57 $2.72 $3.78 • ratin Free Cash Flow $1193 $741 $634 $859 ($182) $2,052 $598 $932 51.226 $369 $3,124 $4,255 Men* et '17 ,P7.11 - a a Book Value (per stare) $16.98 $16.87 $16.53 $14.30 $15.90 $15.06 $16.09 $16.91 $17.89 $18.94 $18.92 $23.43 Net Debt $2.336 52.791 $3,408 $6,325 $5,460 $5,460 15.693 15.387 $5,278 $4,095 $4,095 $1,488 Tolal DebtCapital 23.4% 23.5% 23.9% 37.9% 36,5% 36.5% 36.3% 35.2% 33.9% 32.7% 32.7% 28.2% Nel Debblevital 12.9% 15.1% 18.2% 33.1% 28.7% 28.7% 29.3% 27.3% 25.8% 20.3% 20.3% 7.0% Return on equ0y 19.2% 15.9% 17.4% 21.2% 24 2% 19.4% 18.3% 22.0% 26.0% 26.7% 22.9% 24.6% Return on capital (Net Debt) 17.9% 14.8% 15.6% 17.1% 18.39. 1&6% 14.4% 17.2% 20.4% 21.8% 18.7% 22.6% Source: Company reports. Bloomberg. J.P. Morgan estrnams. 8 EFTA00301090 J. David Anderson, PE, CFA North America Equity Research 12 June 2014 J.PMorgan Investment Thesis, Valuation and Risks Halliburton (Overweight: Price Target: $78.00) Investment Thesis We believe HAL is exhibiting its pressure pumping cost advantage with a fleet that is 85% on long-term contracts and 75% working on 24-hour operations. With 2014 earnings revisions likely to the upside going fonvard, we expect multiple expansion with more investors looking toward the considerable growth in 2014/2015 EPS amid conservative assumptions. We also think there is a free option for gas recovery, which could dramatically improve frac utilization and pricing. Valuation We continue to rate Halliburton Overweight but raised our Dec 2014 price target slightly to $78 (from $77) as we maintain our 15.0x target. Our target multiple is close to where HAL traded mid-stage last cycle. HAL currently trades at 12.9x our 2015E EPS, a 19% discount to SLB and a 6% discount to BH1. Our target multiple for HAL is an 17% discount to SLB but a 5% premium to our target multiple for BH1 as we expect HAL to see continued relative multiple expansion given its strong international growth and superior North America operations. Furthermore, expect the company to continue to buy back shares as free cash flow ramps, but don't include buybacks in our model. Risks to Rating and Price Target Potential liabilityfrom involvement in Macondo blowout Halliburton performed cementing services on the ill-fated Macondo well that led to one of the largest oil spills in history. While we continue to believe that Halliburton acted properly throughout the well construction process, Halliburton faces civil penalties resulting from its involvement in the disaster. Our expectation is for a settlement in the S300.500mm range. The possibility ofa large acquisition couldpressure shares In the wake of the Smith and RI acquisitions, M&A discussions naturally shifted to Halliburton. We do not believe Halliburton needs to get bigger, and it is unlikely to make a significant acquisition, but it could see shares under pressure on this thesis. We believe smaller, technology-focused acquisitions are more likely, particularly in artificial lift (ESPs) and well testing. EFTA00301091 J David Anderson PE CFA North America Equity Research 12 June 2014 J.P.Morgan Halliburton: Summary of Financials Income Statement • Annual FY134 FY14E FY1SE FY16E Income Statement • Quarterly 10144 2011E 3011E 1014E Revenues 29.402 31.938 35.154 37.087 Revenues 7.348A 7.895 8.142 8.553 Cosl of products sold (24.784) (26.413) (28.237) (29331) Cost of prcducls sold (6.303)A (6.619) (6.601) (6.891) Gross profil 4.618 5,525 6.917 7.756 Gross profit 1.045A 1.277 1.541 1,662 SOU (333) (345) (387) (408) SGSA (75)A (871 (90) (94) DO8A (1.900) (2.130) (2.420) (2.740) DMA (510)A (525) (540) (555) Other cperafing expenses Other operating expenses Operafing Inane 4.285 5.180 6,531 7.348 Operating Income 970A 1.190 1.452 1.568 EBIT 4.285 5.180 6.531 7.348 EBIT 970A 1.190 1.452 1.568 EBITDA 6,185 7,310 8251 10.088 EBITDA 1.480A 1.715 1.992 2,123 Net interest inutile/ (expense) (331) (372) (368) (360) Net interest income! (expense) (93)A (931 (93) (93) Income applicable to minority interests (10) (3) (12) (12) Income applicable to mbaity bterests 6A 131 (3) (3) Pretax income 3,911 4.747 6.119 6,944 Pretax income 846A 1,087 1.349 1,465 Taxes (1.057) (1.341) (1,683) (1.875) Taxes (229)A (310) (384) (417) Tax rate (%) 27.0% 28.2% 27.5% 27.0% Tax rate (%) 27.1%A 28.5% 28.5% 28.5% Reported net interne 2.169 3.403 1.424 5,267 Reported net income 623A 774 961 1.044 Ncnrecurring items. disc ops 675 0 0 0 Nonrecurring items. dsc ops OA 0 0 0 Adjusted net income 2.844 3.403 4.424 5.057 AcVusted net income 623A 774 961 1.044 Average diuted shares outslandng 902 851 850 260 Average dibted shares outslandng 853A 850 850 260 EPS 3.15 4.00 5.20 5.95 EPS 0.73A 0.91 1.13 1.23 EPS growth rale (%) 5.1% 262% 30.1% 14.3% EPS growth rate (%) 9.0%A 24.8% 35.7% 31.5% Dividend per share 0.53 0.63 0/2 0.84 Dividend per share 0.15A 0.15 0.15 0.18 WTI crude price (Stitt) WTI crude price ($ibbt) Henry Hub natural gas price (Sind) Henry Hub natural gas price (Strad) Balance Sheet and Cash Flow Data FY134 FY14E FY1SE FY16E Ratio Analysis FY134 FY14E FY1SE FY16E Cash and cash anivalents 2.356 3.721 6.328 9.265 Valuation Other careen assets 11.348 11.883 12.707 13.103 PIE (adjusted) 212 16.7 12.9 11.3 Total current assets 13/04 15.604 19.035 22.958 PACE 13.6 102 8.8 7.4 Net PP8E 11.322 12.179 13.011 13.701 Enterprise valueiEBITDA 8.2 6.8 5.2 4.3 Other assets 4.197 4.307 4.307 4.307 EVIDACF Total assets 29.223 32.090 36.353 40.967 Ratios Total debt 7.816 7.816 7.816 7.816 Nal debtequily 40.1% 25.4% 7.5% (8.4%) Tolal labiltes 15.608 15.964 16.412 16.679 Net delattapdal 26.0% 18.1% 5.8% (6.8%) Minority interests 34 27 27 27 Net coverage rata 12.9 13.9 17.7 20.4 Preferred stock ROE 19.4% 22.9% 24.6% 229% Shareholders equity 13.581 16.099 19.914 24.260 RDCE 14.9% 16.4% 18.3% 17.9% Net income 2.169 3.403 4.424 5.057 Yield and cash returns DO&A 1.900 2.130 2.420 2.740 CEPS 4.93 6.22 7.61 9.02 Deferred taxes Change in working capital (437) (232) (376) (128) FCF yield 2.9% 4.5% 6.1% 7.9% Other 815 (7) 0 0 DMdend yield 0.8% 0.9% 1.1% 1.3% Cash flow from operations 4.447 5294 6.468 7,669 Divdend payout ratio 21.8% 15.8%