Valaris Limited: Leveraging at Scale One Year After Bankruptcy (NYSE: VAL)
Valaris Limited (NYSE: VAL) recently announced that it was ranked the top offshore driller in EnergyPoint Research’s 2022 Customer Satisfaction Survey of Contracted Offshore Drillers. Global oil companies are pumping in a lot of money in offshore drilling, a move that appears to reverse a long decline in spending with projects in the United States and on Canada’s Atlantic coast. Investments have been encouraged by soaring oil prices as well as increased energy demand from Europe due to the ongoing war between Ukraine and Russia. Although more expensive than onshore shale, offshore production sites can generate profits at lower prices than other production sites.
Less than a year and a half after emerging from Chapter 11 bankruptcy protection, Valaris’ partnership with ARO Drilling has begun to bear fruit, including the partial prepayment of its shareholder notes. The company looks forward to new contracts and extension awards that will support its growth initiatives through 2023. However, the company is expected to increase spending levels as it reactivates platforms from 2021. The increase will coincide with higher labor and material costs. , and the depletion of reserves from its initial reactivation projects.
I think VAL’s price return has gained⁓ 52% (y/y), driven by significant value in ARO Drilling and the company’s drive to build its backlog.
It has revived its high-quality platforms to ensure it gets long-term contracts at good rates.
ARO Drilling and Jackup Missions
Valaris Limited announced that it had received a partial payment of $40 million from its joint venture ARO Drilling, from its notes receivable from shareholders. This payment means that shareholders’ notes receivable attributable to Valaris amount to $403 million, including $225 million due in October 2027 and approximately $178 million due in October 2028.
The relationship between Valaris and ARO (a 50-50 joint venture between Saudi Aramco (ARMCO) – the world’s largest oil and gas company) took shape in 2017 and 2018 when Valaris provided cash to ARO in exchange for a shareholder note receivable over 10 years with interest. After adjusting the notes at fair value, a discount was recorded from the effective date to the principal amount of $442.7 million. The reprieve for Valaris is that this agreement with Saudi Aramco – in the creation of ARO Drilling, prohibits the sale or transfer of shareholder tickets to a third party. By deduction, Valaris is entitled to 50% of ARO’s net profit as a result of this joint venture agreement.
The partial prepayment also demonstrates that neither Valaris nor Saudi Aramco will be required to provide additional financing to ARO for the new construction project expected in the first half of 2023. Saudi Aramco owns and operates jack-up drilling rigs in Saudi Arabia, which is arguably the largest jack-up platform market in the world. Saudi Aramco – a state-owned oil company is expected to charter 26 new jackups in 2022 expected from ADES, which is owned by Saudi Arabia’s Public Investment Fund (PIF). Overall, Aramco’s total fleet of offshore rigs (under contract) in the Kingdom of Saudi Arabia will increase to 78 jackups. The year 2023 could probably see the number of rigs increase from 10 to 14 depending on market demand. Over the past decade, Aramco has overseen an average of 45 jackups.
In the first quarter of 2022, Valaris signed new agreements with Saudi Aramco which saw Valaris 250 (a jackup for harsh, heavy-duty environments), Valaris 116 (a modern, heavy-duty jackup) and Valaris 143 and 146 (Modern Standard Duty Jackups) begin 3-year extensions of their charter agreements with ARO Drilling following the completion of their existing agreements in December 2021.
There was an increase in jack-up rig revenue in Q2 2022, attributed to more operating days for Valaris 249 after VAL launched an offshore contract in New Zealand in Q1 2022. However, spending contract drilling increased 9.4% (QT) to $361.8 million from $331.3 million. . Total revenue for the quarter soared 29.8% to $413.3 million, while gross profit increased ⁓500%.
Also of note are new contracts and contract extensions, with an associated backlog of $95 million announced by the company as of September 1, 2022. As it stands, VAL’s jackup rigs are getting more work, especially just a month after the owner of the platform. again added $149 million to its backlog.
Assessment of post-bankruptcy growth
Valaris emerged from Chapter 11 bankruptcy at the start of the second quarter of 2021 when it completed its financial restructuring and eliminated $7.1 billion in debt. The company had incurred a $3.6 billion expense related to the Chapter 11 matter, but then recorded revenue of $158 million in the 6 months ending June 30, 2022. During the same period , Valaris also realized a $137.6 million increase in the sale of goods. . Rising income levels indicate an increase in customer confidence after bankruptcy.
VAL’s cash balance in the quarter also decreased by 9.07% (T/T) to $553.5 million, indicating that the company was using some of its cash to fund operations and support operations. reactivations of drilling rigs. However, the company has maintained its debt tranche above $550 million since June 2021 with its senior secured notes (as of June 30, 2022) due 2028. Management did well to exclude any new capital commitments from construction in the third quarter of 2022 as he indicated. annual interest expense payment of $45 million.
Yet, financially, VAL recorded an order backlog of $2.3 billion as of July 28, 2022, up more than 437% from the $428 million order backlog recorded as of May 2, 2022. ARO Drilling owns 7 jack-up rigs operating under contracts with Saudi Aramco with an order book of $935 million as of July 28, 2022.
ARO and VAL hope to capitalize on the additional EBITDA at market multiples. In 2021, ARO’s EBITDA was $91 million and its cash balance was $91 million as of June 30, 2022. The joint venture also announced a program to build 20 platforms through 2023. consisting of guaranteed contracts.
In his Q2 2022 earnings call, Valaris CEO Anton Dibowitz said:
“Recently, we were awarded a 4-year contract with Renishaw Petroleum for the VALARIS 115, which represents the largest overdue contract for a benign environment jackup outside the Middle East this year. We have also been awarded a one-year extension with BP Offshore, Indonesia for VALARIS 106 and several shorter-term contracts for VALARIS 107 offshore in Australia and VALARIS 144 in the US Gulf, demonstrating the global nature of the recent upturn in activity.
Valaris has up to 52 rigs out of a global jackup rig count of 388 and a global floating rig count of 141, Valaris has recorded 8 active floats by the end of 2021, indicating that it controls 5.67% of the float market. Of these 52 platforms, 11 are drillships. 5 are semi-submersibles and 36 are jack-ups. The company also has a modern, high-quality fleet with a gross asset value (GAV) in excess of $7 billion.
Valaris faced increasing shareholder losses before bankruptcy and peaked in December 2020 at $4.18 billion. In the second quarter of 2021 (post-bankruptcy), VAL’s accumulated loss slowed to $6.2 million. Retained losses increased further to $71.6 million in the quarter ending March 31, 2022, before reaching profitability and gaining 155.9% to $40 million in the second quarter 2022.
Despite having 52 rigs, Valaris has not specified the number of rigs to be used in the fourth quarter of 2022 for offshore drilling, as is the case with Transocean (RIG), Shelf (OTCPK:SHLLF), Maersk or even Diamond (DO).
Valaris has 8 active floaters lined up for the third quarter of 2022 compared to 10 a year ago and 25 jackups. Out of a total of 39 platforms, Transocean has 7 platforms ready for use in the fourth quarter of 2022.
Full-year 2022 revenue forecast for Valaris is expected to be $1.57 billion to $1.6 billion. The company hasn’t reached that level since the year ending December 2019 when it stood at $2.053 billion.
These revenues are high but not entirely impossible given the current contractual arrangements, especially for jackups. On the other hand, Valaris hasn’t announced many longer contract deals for floats, especially for the 2022/2023 financial year. As things stand, the demand for deep water jackups is greater than for floats. Nevertheless, Brazil stands out with an expected increase in demand of 22% over the next 5 years. Other key regions include the United States and Mexico at 19%, West Africa at 11% and Australia at 3%. The other share is mainly held by jackups with regions like the Middle East having a level of demand as high as 43% over the next 5 years.
OPEC is also expected to cut oil production by up to 2 million barrels per day, a move that is likely to drive up the price of oil. A drop in production could affect drilling, thus affecting the revenues of companies such as Valaris Limited.
Valaris Limited emerged from bankruptcy and in less than 2 years has proven its ability to win contracts and reactivate its stacked assets. The company operates at scale with platforms that it says are well-suited to the exciting opportunities in the market. It pegged its revenue forecast for the year 2022 at a high of $1.6 billion. The company also expects to leverage its 50/50 ARO Drilling joint venture with Saudi Aramco. Still, the company is facing a drop in production due to OPEC’s call to cut production (to ostensibly raise the price of oil), a move that could lower production forecasts. In my opinion, even though the company hasn’t put enough emphasis on floats as opposed to jackups, it still operates on the leverage of a fluid market. For these reasons, we have raised our rating of the stock to hold against the sale.