Valaris Limited (VAL, Financial) is one of the few stocks in the offshore drilling category that can be invested in after suffering a considerable decline of 28.35% over the last year. Some may regard this as a sign of even more caution, but I believe it actually offers a promising opportunity to longer-term intended investors in the energy sector. The financial position of the company further justifies the outlook of the company. The high net income and healthy free cash flow provide the company with the required operating capital to reinvest in business and shareholders. Moreover, the recent $100 million share buyback is aimed at showing the shareholders that the management deems the company's potential to grow as viable. Additionally, the current valuation and optimistic estimates and earnings mean that Valaris has a more realistic P/E ratio that makes it more lucrative to value investors.
Therefore, I believe that the recent dip in price has put VAL stock in a favorable zone where it could easily post remarkable gains before it experiences any pullback. The stock has come out of the rough period and is ready for possible revival.
Company overview and strategic momentum
Valaris is the largest offshore drilling company. It was developed when Ensco joined Rowan Companies in 2019 and after that, the company rebranded itself as Valaris. But this did not come without some hurdles along the way to success. The business had benefited from a merger and acquisition of a fleet, but it came with a burden of debt, which saw Valaris seek Chapter 11 in 2020 for restructuring. As of now, Valaris has 53 rigs within its fleet, 18 high spec floaters out of which five are idle, and 35 jackups of which ten are idle. It also has a 50% stake in ARO Drilling, a joint venture with Aramco (TADAWUL:2222) that operates nine jackups. Valaris has started reactivating the rigs in recent quarters, however, some are being 'warm stacked' since work prospects appear to be less active.Source: October Fleet Status Report
Furthermore, during the third quarter of 2024, Valaris reported operational and financial improvements, particularly in revenue, which may be regarded as a success in the expansion plan. Let us now examine the specifics of the tactics and goals that have resulted in Valaris' present rate of growth and future prospects.
Operational excellence and contract wins
Valaris has enhanced the fleet efficiency and in Q3 2024 the company recorded an impressive 98% revenue efficiency. This performance is critical in the offshore drilling industry where any amount of downtime is costly to revenues. One of the reasons for this efficiency is the reactivation of the VALARIS DS-7 drillship that the company recently reactivated to full operation and added more space to the fleet and overall revenue possibility. This operational intensity not only improves its financial result but also builds a reputation as a dependable contractor for the energy industry.Additionally, Valaris has obtained significant contract wins that also advance revenue growth in the years to come. For instance, the contract award of VALARIS 118 jackup for a three-year extension which was awarded in October 2024 has also added $168 million to the contract backlog. When combined with other recent contracts this demonstrates that Valaris can secure profitable opportunities within the offshore drilling segment, which would boost demand for its services among energy companies looking to ramp up offshore output.
Meanwhile, for the second year running, the company received the Safety Leadership Award from the Center for Offshore Safety. This award focused on the development of the Restricted Zone Analysis tool by Valaris, an improvement of safety measures during drilling.
Financial health and capital allocation
The improvement in free cash flow of Valaris's Q3 2024 is the place where the right blend of capital investment and cash flow can be looked at their optimum. This gave the company a net income of $63 million and an adjusted EBITDA of $150 million. This implies a good foundation for reinvestment and returns on shareholders' investments for Valaris. Moreover, net operating cash flow was $193 million and FCF was $111 million; both were better than the prior quarters of the current year. This healthy cash generation gives Valaris a position to fund growth while offering returns for shareholders; a critical idea in the fluctuating energy industry.Interestingly, one of the strategic priorities in the company's operation is shareholder returns. In the third quarter, the company's share repurchase program was $100 million. In a way, it is an indicator of management's belief in the current and future valuation of the company. While share buybacks do add to shareholder value, they also signal stability, which makes Valaris an appealing option for investors who are targeting the promising offshore subsector of the sector.
A positive valuation shift
Valaris has made a solid recovery, in fact, earlier this year Valaris looked quite expensive, particularly by the earnings multiples. For instance, the forward price-to-earnings (P/E) ratio in February was 113.22 times, which was around 1000% more than the sector median. At that point, investors might have felt uncomfortable, either seeing signs of market overconfidence or doubting its ability to explain such a premium.Source: Author generated based on historical data
Fast forward to today and what the world realizes is a completely different picture. From a P/E perspective, Valaris has dropped to 11.87 times, which is even 4.65% less than the sector median. This suggests that Valaris is actually cheaper than many of the other stocks in its industry, which should make it more attractive to value investors who might have been scared off by the company's previous high P/E ratio.
Moreover, the analysis of the company's EV/EBITDA ratios also present a similar picture of the changes. In February this year, the trailing-twelve month (TTM) EV/EBITDA was at 35.11 times, which was 554% above the sector. This inflated figure in this case was an indication of problems with profitability and cash generation, which is a no-no as far as investors with an eye towards efficiency are concerned. Today, that same metric has decreased to a decent 10.81 times, which is much closer to the industry average compared to several years ago. This shift means that the company is now profitable, by earning more money. From investors' perspective, this implies that the company is generating more cash but it is doing so with a much better valuation, which makes it more appealing as a long-term investment proposition.
Likewise, the enhancement in the price-to-sales (P/S) and price-to-cash flow (P/CF) ratios also depict the enhancement in the fundamentals of the company. In the prior period, the P/S (TTM) ratio was 2.65 times, which was significantly above the sector median of 1.27 times. Now, it is 1.60 times, which means that the company's revenue generation is more similar to its market capitalization, meaning that the firm's revenue growth may be steadier or market sentiment on the company may be settling down. The P/CF ratio has also reduced from a high of 13.74 times to 10.86 times.
Overall, these enhancements tell the story of a company that has transitioned from being a speculative investment to a more balanced value play.
Anticipate a bullish reversal ahead
This stock has been on a downward spiral in the last year and is now 28.35% down and trading near the 52-week low. This price decline might be an oversold level given that it is near an attractive valuation with a forward P/E of 11.87 times. The market is underestimating its earnings potential. TipRanks analysts have embraced the stock with a Moderate Buy' recommendation and a mind-boggling 86.62% upside potential, making the average price target of $94. This implies a much higher potential than the current levels, which means that the market has a lot of confidence in the company's ability to turn the corner.Source: TipRanks
Actually, the recent stabilization in the price indicates that the selling pressure may be mitigated. This is why I expect the company to deliver positive results in the upcoming quarters and gradually push the stock near the analysts' average price target of $94.
For a more conservative outlook, let's look at Valaris' potential to climb back up to about $72 rather than that $94 target. This would still be a good 40% increase from the current price, which would make sense if market confidence were to return gradually rather than gush.
If Valaris' strategy is successfully implemented and the company meets the expected results, I believe a realistic upside could vary between 40% and 86% in the medium term. However, much will depend on the company's financial results and, in general, the state of the market.
Risk to the thesis
The main source of volatility is oil prices. If prices continue trending down, oil producers may postpone investments, which would be a problem for offshore drillers in terms of landing contracts or keeping their rates.On the specific company level, the risk is that those rigs may remain unemployed and require stacking, which will impede the company's expansion in the future and, therefore, adversely affect its value. Further, the stock could be sold due to tax loss selling which is evident by the stock being down by 28.35% in the past year and is 37% off its high.
Final word
Valaris has made a good turnaround from the operational problems that were characterized by huge losses to the operational stability and growth. Thanks to the strong fleet and long-term contracts the company has every chance to witness steady growth in revenues. A positive cash flow, along with share buyback and othe amazing financial ratios of Q3 2024 prove that the company is moving in the right direction.The company continues to embrace safety standards and industry recognition hence adding strengths to its competitiveness in the market. Additionally, the company's valuation and analyst backing indicate that there is a possibility for a rebound. Of course, there are hazards, particularly those associated with oil prices and idle rigs. Nonetheless, given Valaris' strong fundamentals and strategic ambitions, this firm looks to be very appealing to investors looking for long-term returns and additional chances in the future.
This content was originally published on Gurufocus.com
