Via SeekingAlpha.com

Source: Valaris.

Note: The title used for my article is the title of the fourth book from the “Hitchhiker’s Guide to the Galaxy” tetralogy.

Investment Thesis

The London-based Valaris plc (VAL), formerly EnscoRowan, reported its first-quarter results on April 30, 2020.

We knew what was coming for a while because we learned from Reuters that “Valaris, which employs about 5,800 people worldwide, in recent weeks hired corporate restructuring experts at turnaround firm Alvarez & Marsal”.

Offshore drilling has been struggling for numerous years, even before this double black swan event messed up the entire oil industry. However, this time, the downturn is so severe that the company is on its way to restructuring under Chapter 11.

Jonathan Baksht, the CFO, said in the conference call:

“These challenging market conditions have led several customers to defer, suspend or cancel offshore projects, and in turn, we have seen the majority of the rig contracting opportunities we are pursuing get deferred or canceled. As a result, we expect to continue to report losses and negative cash flows throughout the remainder of the year.”

The last straw that broke the camel’s back was the termination of a very lucrative contract with Total (NYSE:TOT) after the drillship DS-10 accidentally dropped a blowout preventer stack to seabed offshore Angola in March this year.

However, Valaris holds a loss of hire insurance for $602.5K per day after the expiration of a 45-day deductible waiting period. The contract was supposed to end in November 2020 and could represent an insurance payment between $100 million to $120 million. The two questions are IF and WHEN.

The investment thesis is not optimistic, and I recommend avoiding Valaris until it emerges from bankruptcy and assuming that the debt situation has been solved.

The backlog indicated for 1Q’20 is now $1.88 billion.

Valaris PLC – 1Q’20 and Balance Sheet History: The Raw Numbers

Valaris 3Q’18 4Q’18 1Q’19 2Q’19 3Q’19 4Q’19 1Q’20
Total Revenues in $ Million 430.9 399.0 405.9 583.9 551.3 512.1 456.6
Net Income in $ Million -145.0 -203.6 -190.4 405.5 -197.1 -215.4 -3,006.3
EBITDA $ Million 66.9 2.2 35.0 713.3 80.1 129.0 -2,879.2
EPS diluted in $/share -0.33 -0.47 -1.75 2.09 -1.00 -1.09 -15.19
Cash from Operating Activities in $ Million -64.2 26.5 -24.4 -269.0 -134.1 150.6 -204.4
Capital Expenditures in $ Million 46.8 48.0 29.0 105.8 39.4 52.8 36.3
Free Cash Flow in $ Million -111.0 -21.5 -53.4 -374.8 -173.5 97.8 -240.7
Cash and Short-Term Investments $ Billion 0.63 0.604

0.54/1.5

ESV – VAL pro forma

1.094

0.13 97.2 184.9
Long-term debt 5.00 5.01

5.02/7.10

ESV – VAL pro forma

7.15

6.17

6.53

6.37/ Estimated fair value is $1.37 billion per the 10Q filing

Shares Outstanding (diluted) in Million 108.6 108.6 108.7 188.6 197.6 197.6 197.9
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Note: Most of the data indicated above come from Morningstar and company 10-K filing

Trends, Charts, and Commentary: Revenues, Free Cash Flow, and Upstream Production

Note: The charts have been created by Fun Trading using the 10-K filing and my files. Only subscribers can access the spreadsheet.

1 – Quarterly Revenues of $456.6 million in 1Q’20

Total revenues increased to $456.6 million from $405.9 million in the year-ago quarter, and are down 10.8% sequentially, though caution is required here, as this does not compare the same company year to year. Revenue details for 1Q’20 are indicated below:

Floaters Jack-ups Aro Drilling Other Reconciling Items Total
179.6 million 212.8 million 140.3 million 64.2 million -140.3 million 456.6 million

VAL reported a loss of $15.19 per share for the first quarter of 2020 (loss of $3,006.3 million) compared with a loss of $1.75 per share a year ago. Adjusted EBITDA was a loss of $39.7 million for the quarter.

Jon Baksht, the CFO, said in the conference call about the first quarter:

“However, the largest item in our first quarter results was a $2.8 billion non-cash impairment to adjust the book value of several large rigs…

industry challenges over the past 2 months have negatively impacted customer demand for offshore drilling services. This led to an impairment for 3 drillships, 3 semisubmersibles and 7 jackups. The vast majority of this impairment was to adjust book values for 6 modern floaters to scrap.”

2 – Free Cash Flow is a loss of $240.7 million in 1Q’20

The free cash flow is an excellent financial gauge that shows why VAL is not doing financially well and reveals that the business is in distress mode. Unfortunately, the picture presented above is quite depressing.

I have estimated free cash flow for Q1’20 at a loss of $240.7 million, and a yearly loss of $691.2 million (“TTM”).

I wanted to emphasize that the free cash flow situation was a concerning issue that illustrates the heartfelt weakness of the offshore drilling industry as we speak. But, I believe it is not necessary, and all of you know perfectly what is going on and what is the end of the story here.

3 – Fleet status released on April 22, 2020

The company announced on April 22, 2020 that the backlog has shrunk by about $655 million since February. For the ones who want more details, please read my article about the fleet status.

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The backlog indicated for 1Q’20 is now $1.88 billion from $2.453 billion on February 13, 2020.

Source: VAL FSR April.

4 – Net debt is ~$6.15 billion at the end of 1Q’20 (not including the outstanding balance of the credit facility). Bankruptcy cannot be avoided

As of March 31, Valaris had $184.9 million of cash on the balance sheet and outstanding balance on the company’s revolving credit facility of $328.9 million, leaving Valaris with approximately $1.3 billion of available revolver capacity. In total, available liquidity from cash and the remaining revolver capacity was roughly $1.5 billion.

(Note: Valaris currently has only $236 million of debt maturing before 2024.)

Valaris has $0.9 billion in debt maturities before 2024.

Source: Previous presentation VAL (2020 may not be accurate this quarter)

Conclusion and Technical Analysis

Johnathan Baksht is not leaving any doubt about the near dreadful outcome that awaits the common shareholders, and said in the conference call:

“Therefore, we are evaluating various alternatives to address our capital structure and annual interest costs. To facilitate the evaluation of these alternatives, we are engaged in discussions with our creditors and their advisers around these alternatives, including, without limitation, a comprehensive debt restructuring, which may require a substantial conversion of our indebtedness to equity.”

I have said in my precedent article that the debt would be restructured, and a new company will emerge from bankruptcy with a smaller debt load and eventually more cash. It is not a death sentence for the company and, if done correctly, could be considered a good new start.

The issue is that the actual common shareholders who own VAL now will probably get 1% or 2% of the new company emerging from Chapter 11. Perhaps some worthless warrants as well. I am talking about the best-case scenario. The worst-case scenario is that common shareholders will receive nothing, and it could happen in this case, as it happened to Paragon Offshore, for example.

A large part of the debt will be converted in shares, and to keep it simple; your old shares will be exchanged with new shares that could amount to $0.02 or less at today’s stock price value, and again, assuming the best-case scenario.

As soon as the news is announced, we should expect Valaris Plc to get quickly delisted from the NYSE and trade to either the OTCBB or the pink sheets until the new company emerges from Chapter 11. It happened recently with Diamond Offshore (OTCPK:DOFSQ), which is now trading in the pink sheets.

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I do not see any other alternatives at the moment.

VAL: Technical Analysis (Short Term)

The short-term trading is quite specific for such “bankrupt stocks,” and in general, we can see about three phases to oblivion.

We are in the first phase, and we are trading the range of $0.28-$0.55. You can profit by using a timing related to the overall oil market. When oil prices are bullish, the stock tends to get a little lift, and when the oil prices turn bearish, it adds to the gloom. In this period, a day trade is the best alternative, and keeping shares overnight is not recommended.

The second phase comes without any warning. The company announces bankruptcy, which will take several months, and the stock is immediately delisted to the pink sheet under probably VALSQ. After a few days, traders will be able to trade their stocks again under VALSQ. The range will probably be about 30% lower or $0.15-$0.35. Generally, buying early in the process will give an advantage because many investors will sell out at this stage, and a small uptick could happen later to over $0.35.

The third phase happens much later when the company has completed the restructuring, and Chapter 11 gets the green light from the judge. In this case, the stock will trade from $0.001 to probably $0.08.

Good luck.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I only day trade the stock occasionally.