Valaris Limited (RIG) Earnings Call Transcript & Summary

Hi, I'm David Anderson, Head of U.S. Oilfield Services Research at Barclays. Our next guest today is Mr. Anton Dibowitz. He has been named recently been named as CEO of Valaris. Mr. is a highly experienced executive with more than 20 years in the drilling industry. He joined the Valaris Board of Directors in July of 2021. Prior to that, he served as an adviser to Seadrill from 2020 until 2021 and was CEO there from July 2017 until 2020. Anton is going to give a presentation on Valaris on the Valaris story, which many of you may not be familiar with recently, and then I'll have a few questions at the end. So Anton, please. The floor is yours.

Thank you very much, Dave, and thank you very much to Barclays for inviting us to present today. So I'll get my presentation up on the screen. It should be there, so you can all see it. Before I start, obviously, need to point to our standard forward-looking disclosure, which you can read very quickly here or at a more leisurely pace on the investor page of the Valaris website. As far as today's presentation is concerned, I'm going to break it down into 4 sections; the first being an overview of Valaris highlighting our key attributes; the second, providing an overview of the current market environment as we see it for offshore drilling; third, to explain the value proposition, and it is compelling that is Valaris today; and lastly, to vote just a couple of moments to our ongoing ESG efforts, in particular, what we're doing to reduce our carbon footprint. It is 30 minutes. I'm going to cover a lot of ground, we'll try to cover as much as possible, but if you do have follow-up questions, I'd love you just to reach out to the Investor Relations folks at Valaris, and we'll be happy to follow up with you. Valaris is the largest drilling contractor by fleet size in the industry. The 11 drillships we have, have an average age of only 7 years, and many of these rigs are amongst the highest specification units available on the global fleet today. We have 5 semisubmersibles, including 4 of which are dynamically positioned. And of those, 2 can operate in both DP and moored mode, so-called hybrid rigs. We have 12 ultra-harsh and harsh environment jackups, 3 of which are capable of operating on the Norwegian Continental Shelf. We have 24 modern heavy-duty and standard duty jackups. These are jackups that serve the benign jackup markets, for example, in the Middle East, Southeast Asia and Latin America. And lastly, we have 7 legacy standard jackups in order of 40 years old. These assets will likely be retired when they finish their current contracts. If they don't have follow-on work or if they require significant investments to keep working. Valaris not only has the largest fleet in the industry, more importantly, it is the highest quality fleet in the industry. This slide shows fleet rankings of various fleets of us and our competitors broken down into quartiles. And I'll point out that these rankings are not our internal numbers. This is done by a third party scoring system. Fleet quality matters. Customers today have options. And given those options, they generally want to take the most technically capable asset that they can get their hands on to deliver safe and efficient operations on their wells. More than half of Valaris' fleet rank in the top quartile, and more than 80% of it rank in the top half by fleet quality. Operational excellence and delivery of safe and efficient wells is what we focus on every day. Safe, reliable and efficient operations are our license to operate. A good safe working environment, one in which nobody gets hurt is what we worked very hard towards every day in what is an inherently risky industry. This focus is underpinned by being a purpose-driven and values-driven culture, which you can see on the left hand side of the slide. A safe and efficient operation is also the starting point for revenue generation. During the first half of this year, Valaris demonstrated outstanding revenue efficiency of 99% across our fleet and we improved our HSE performance year-over-year during the first half of this year versus last year. This performance is particularly impressive in light of the challenging working conditions that our offshore crews face due to the ongoing pandemic. Scale is important in this business. It's important for global reach, it's important for efficiency, and it's important so that we can marshal resources. Valaris operations have unmatched scale and geographic reach. This is underscored by the fact that during the last 2 years, we won contracts in 21 different countries, more than any other driller in the industry. Valaris also has the largest customer base in the industry, and you can see many of them put here. Having a good mix of IOCs, international oil companies, national oil companies and independents is an important part of our strategy, both increasing our revenue potential and diversifying our risk profile. Our best-in-class fleet and deep customer relationships and demonstrated operational excellence have allowed us to start using our operational leverage to secure backlog, adding more than $1.8 billion of backlog this year. Majority of this backlog has been amongst our high-specification floater fleet. I'm just going to line out a couple of contracts. A 3.5-year contract with the DS-11 with Total Energies. This rig will soon begin upgrades to make it 20,000 capable, making it one of only 3 rigs in the world that will have this capability. A 3-year contract from the DS-18 with Chevron and a 2-year contract with the DS-16 with OXY. These backlog additions, including term contracts, have added earnings visibility and will help lay the foundation for future earnings. Importantly, these contracts have come at significantly improved day rates. As you can see on the slide, we've had a 30% increase in the average operating rate in our floater fleet year-to-date, bringing it to $245,000 a day. It's also worth noting that 80% of this backlog was with major oil companies, which are the primary users of high-specification assets. Our contracting success year-to-date represents an outsized share of the contracts awarded, both from a fixtures and a value perspective. Put in context, we own about 8% of the global fleet, but have won 14% of total fixtures and 11% of the total rig years awarded today. Valaris is an operationally leveraged play into a recovering market, but is one that is underpinned by the strongest balance sheet in the sector. We have only 1 tranche of debt, our $550 million senior notes, which are due in 2028. And this debt has a lot of flexibility in it. If needed, we can choose to only pay interest on maturity. Together with that, we have more than $600 million of cash on hand, and we have no new build capital requirements. This cash position provides ample liquidity for us to fund our operations, but also to make disciplined decisions about how and when we bring new capacity back into the market when they're justified by opportunities. And finally, Valaris has an industry-leading cost structure. This was not always the case, but a huge amount of work has gone into significantly reducing the average cost per rig, making it market-leading today, but as importantly, implementing a shared service model that will allow our cost structure to be flexible in the improving market we see today and allow us to adapt to changes in the market going forward. The combination of these strengths leave Valaris well positioned and competitively advantaged to benefit from the improving market today. So let's take a moment to move on to the market environment. As we all know, the offshore drilling business is cyclical. The most recent downturn starting in 2014 has been both the deepest and longest in the history of the industry. However, global utilization is on an upward trajectory, albeit interrupted by the impact of COVID in 2020. Overall, the trend is constructive. And as a result, we expect earnings to increase from the trough we've seen in 2020. This supply -- this slide presents supply and total utilization, broken out into the 4 markets where we compete, namely drillships, benign semisubmersibles, harsh environment jackups and benign environment jackups. In each of the 4 categories, total utilization has increased over the past 5 years, albeit at a slightly different rates, but they're all on an upward trajectory as of late. This increase in utilization is primarily to this point being driven by a reduction in supply in which Valaris has played a meaningful role. The number of rigs have declined significantly in 3 of the 4 categories with benign environment jackups lagging a little bit in the supply rationalization process. Jackup demand, however, has been more resilient during the downturn because of the holding cost for jackups are limited compared to what loaders are and because jackup supply is more fragmented. However, I would point out that given that around 1/3 of the fleet in the jackup market is more than 35 years of age, supply rationalization and retirement of jackups is a trend that we expect to continue over time. So moving on to where we go from here. Demand for offshore drilling services is expected to increase over the next several years with floater demand growth expected to outpace jackups. As you can see on the slide, floater demand is expected to grow at a compound growth rate of around 7%, while jackups at 1%. We need to remember, as I just referenced in the last slide, the jackup demand was more resilient during the downturn and is driven significantly by infill drilling and a significant portion of it is driven by national oil companies, making the demand particular more stable. The other interesting takeaway from this slide, if you look at the top is the portion in green, and that a significant amount of floater demand going forward is going to be driven by increased exploration. The commonly held narrative that exploration, floating and deep offshore is dead, I think, is misplaced. This highlights the conviction that our customers have in future potential deepwater projects, and it's a very positive sign for our industry because we all know that the exploration drilling done today leads to tomorrow's appraisal and next week's major development. Against that backdrop, I'd like to transition to why Valaris represents a compelling investment opportunity. Valaris' investment proposition is made up of 4 parts, and we believe at this point in the cycle, the best way to view it is that some of the core parts level. I'm going to briefly talk about them here and then discuss each of these components in a little more detail. Starting on the top left, we have an active fleet of 31 rigs that is expected to generate operating margin of $250 million to $260 million in 2021. While $340 million to $360 million, exclusive of onetime reactivation costs, which we think is the right way we should be looking at this. The second component are our leased and managed rigs. 8 leased rigs to ARO, our joint venture with Saudi Aramco and 2 rigs that we manage on behalf of a customer in the Gulf of Mexico. These operations are expected to generate an operating margin of between $75 million to $85 million in 2021. The third component is our stacked fleet of 18 high-quality modern assets. These assets, as we talked about before, are amongst the most capable assets in the world. And Valaris was recently awarded contracts for 2 of these assets. So while they sit in this number of 18 right now, when we begin that reactivation process is when we will move them out of the stacked fleet and into the active fleet component. And the last component is ARO Drilling, our 50-50 joint venture with Saudi Aramco, which is expected to generate $105 million to $110 million of EBITDA in 2021 and had cash of almost $320 million as of midyear. On this slide, you can see how we break down our fleet mix between those 4 components about. So let's look at a little detail of each of those components. As mentioned previously, the active fleet is expected to generate around $340 million to $360 million of operating margin adjusted for reactivation costs. We believe this is the right way to look at this component. With the reactivation costs, although they will be expensed, viewed as kind of one-off investments to bring rigs back into the active fleet. Valari's active floater fleet currently consists of 4 drillships and 3 semisubmersibles, all of which are under contract or future contracted for work. We also have contracts, as I mentioned previously, for 2 of our drillships, which will be added to this component later. Valaris' active jackup fleet, excluding the 8 rigs that are leased to ARO, consists of 24 rigs, all but 1 of which are under contract or future contracted. Moving on to the leased and managed rigs. Valaris leases 8 rigs to ARO Drilling through bareboat charter arrangements. Substantially all of the operating costs for operating these rigs is borne by ARO. So the lease payments that we receive represent nearly 100% margin business. Valaris also has management contracts with 2 drilling rigs that are located on customer platforms in the Gulf of Mexico. Together, these leased and managed rigs represent about $75 million to $85 million of operating margin for 2021. So this is the stacked fleet, the option value. Due to the uncertain market outlook over the last couple of years, we carefully preservation stacked a number of our rigs both to preserve cash in the short term but also to maintain their option value when the market was recovering as we see today. These 18 rigs are largely high-specification modern assets with significant useful lives still available, including 4 drillships that are ranked in the top quartile of the global floater fleet, and 5 jackups that are also ranked in the top quartile of the global fleet. The quality of these rigs, a demonstrated track record of being able to bring rigs from stack and into the working fleet with no drop in performance leads us confident that we will continue to be in the front of the queue when customers want to bring additional capacity back into the market. We will continue to take a disciplined approach to our reactivations. The stack rigs only return to the active fleet when there is clear visibility of future work and the economics that justify the reactivation expenditure to bring them back into the fleet. Reference on numbers. We expect reactivations on our drillships to be in the $30 million to $45 million range, and our jackups to be in the $10 million to $20 million range. Most of these costs have to do with crewing up the rig, deep preserving the equipment and recommissioning equipment on the rig. If there are upgrades that are -- these numbers will be incremental to the numbers I just gave you, but we would also expect customers to reimburse us for those expenditures. The last component is ARO Drilling. ARO is a cash generator business with significant growth prospects given its 20 new build rig program. These new build rigs are backed by term contracts with Saudi Aramco of 8 plus 8 years, and the day rates for the first 8-year contracts will be set to achieve 6-year EBITDA payout based on the build costs. This new build program is expected to be financed by cash from ARO and third-party financing. There is no expectation that Valaris or Aramco will need to provide any additional financing for this new build program. And as I said before, ARO had nearly $320 million of cash on hand as of midyear, and Valaris, in addition, has a note receivable from ARO in order of $440 million. Here, we see the earnings potential of the entire Valaris fleet. Coupled with our industry-leading cost structure, the Valaris fleet provides significant earnings potential in the market recovery that we're experiencing today. I would say that in addition to the numbers you see here, don't forget about $440 million receivable we have from ARO, and this doesn't include any uptake from our 50% equity interest in ARO. The Valaris management team and Board are laser-focused on maximizing earnings and driving meaningful cash flow from this business as the market recovers. We will take disciplined approach to capital allocation, including returns to shareholders when free cash flow permits. To achieve these objectives, we're focused on 4 things, as you can see slide. One is winning additional backlog for our active fleet. We've added more than $1.8 billion year-to-date when we published our latest fleet status report, and we will continue to do so. Reactivating our high-quality fleet, long-term contracts recently awarded to 2 drill ships are expected to return investments above the reactivation costs even when considering our cost of capital. Third, taking a rational approach to fleet management. Valaris has done more than its fair share of rationalizing the fleet and retiring assets that we don't see a future for in the long term. But we will continue to evaluate our fleet on an ongoing basis and take further retirements when economics don't justify holding on to these assets. And lastly is maintaining the industry-leading cost structure that we have, adaptable for the future. Valaris is currently trading at a significant discount to our major peers when comparing enterprise values for ultra-deepwater rig equivalent adjusted for backlog. In my personal opinion, this discount is not justified, considering our industry-leading fleet in terms of both size and quality, our demonstrated track record of delivering safe and reliable operations to our customers, the strongest balance sheet in the industry and the ability to generate significant earnings in the market recovery, which is what we're seeing today. On to the last section, focusing on our green footprint and ESG. This slide comes from Wood Mac to study on emissions, the emissions intensity from various sources of oil. And it demonstrates oil -- our offshore oil and gas production piece in that picture. As a result, we in the offshore space, are well placed with operators with exposure to multiple sources of production as they shift their focus to meet their emissions targets. Today, there is a significant focus on ESG and rightly so, from a range of stakeholders, particularly within the energy and history. However, for Valaris, because of the environment that we work in, we've had a significant focus on sustainability for some time now, publishing our first sustainability report in 2016. Valaris both has an ESG committee in the senior management team as well as the subcommittee on the Board focused on our ESG footprint and how we're going to develop it going forward. You can expect to see us publish our new sustainability report here in the next few weeks, including a new ESG position statement lining out how we will develop our ESG efforts going forward We are committed to reducing our carbon footprint. And for us, this comes down to kind of 3 areas. The first is power plant optimization. This is about using the assets that we have as efficiently as possible. It's about operating fewer engines at a higher load and essentially taking engines offline, allowing us to both lower fuel costs as well as lower our greenhouse gas emissions. The second component into the middle is about adding technologies that filter out pollutants from our operating asset sets. This is about reducing NOx, SOx and CO2. NOx reduction technologies that we already have installed on 4 of our ships, SCR, or selective catalytic reduction. Have the potential to reduce up to 90% of NOx emissions. And we will look to expand this technology to other rigs in the fleet. And finally, in the longer term is about hybridization and potentially using shore power to power our rigs. These are next steps for us. These are in 3 -- in the free status -- feed status, I can't get that one right. And we have plans to put this on 2 of our jackups and we'll do say when we get support from the right customers. The other thing that we're doing internally is monitoring our emissions on our assets. As they say, you manage what you monitor, and Valaris has developed a tool that we call VIP or the Valaris Intelligence Platform, which allows us real-time tracking of our greenhouse emissions from our assets. This is already in place in 14 rigs, and we're looking to expand this to the entire fleet by the end of the year. This technology allows us to track in real time the relative emissions from different assets, monitor progress against the goals that we've set and also help to identify when one of our assets is underperforming, potentially meaning that we need to do repairs or maintenance on those assets so that we can bring it back in line with the fleet. That covers what I wanted to cover today, it brings me to the end of the presentation. But I'd like to close by reiterating why I am so excited about Valaris and its place in the future. As I said, we have an industry-leading fleet both in terms of size and fleet quality with global reach, deep customer relationships, from who -- for whom we continue to deliver best-in-class performance. We have the industry's leading balance sheet and a highly competitive and scalable cost structure, and we have the ability to generate significant earnings and improving market, which is what we're experiencing today. Thank you very much for your attention, and I look forward to speaking with you all about Valaris in the future.

Well, thank you, Anton. Just a couple of minutes left here. Just a question for me on -- you had highlighted your expectation on the floating rig demand over the next 5 years or so, you had a 7% CAGR. Question is how that ties in with mobilization fees? And you had talked about the $30 million to $40 million reactivation fees. Are customer -- a, are customers paying for that now in your negotiations? And I guess the follow-up question is, under your sort of 7% growth, do you -- would you expect them to pay for those and kind of really support day rates from here?

Look, how we market our fleet and where we place it is core to what we do other than delivering operations. Our goal when we contract rigs is not to be moving them around the world kind of willy-nilly. So we're really focused on those basins and those places and those customers where we can see a long-term profile, so we don't have to do that. That being said, we are getting to the point in the market where customers do want attractive assets and we are seeing them help and contribute to mobilizations and upgrades that have to do with reactivations. So we're not back to where we were historically, but the customers are willing to pay for performance, and they're willing to pay for an asset that they want to use in their program.

So when you look at your '22 number, is that back-end loaded in terms of kind of the growth? I'm just kind of curious what you're thinking in terms of the next several quarters. In my head, I've had sort of a second half timeframe for floaters to pick up. What's your -- where is your head on that?

No, I think there are a lot of constructive conversations that are happening right now. I mean, obviously, there's a time lag. You contract today as we have in our fleet, you sign a contract today. It's for a program, the lead time on the floater business, which is where the real upside is, and the earnings growth is going to come from is set at some time in the future. So you have to reactivate, the operator has to get their plans together. So yes, you do need to look at some point in the future to see the contract wins that we have today pulling into the earnings. So I think you're thinking about it the right way.