BORR - Borr Drilling: Jackup Market Expected To Remain Strong - Buy

2023-12-16 09:49:48 ET

Summary

• Last month, leading shallow water driller Borr Drilling reported Q3/2023 results in line with management's most recent projections and reaffirmed guidance for both 2023 and 2024.
• Despite the somewhat disappointing terms of the recent debt refinancing, the board of directors approved the initiation of a $0.05 quarterly cash dividend and a $100 million share repurchase program.
• The jackup market outlook remains strong with management projecting potential undersupply of modern rigs going into 2025. As a result, dayrates are likely to recover further.
• However, I wouldn't aggressively chase the stock after last week's recovery rally and rather scale into the shares on renewed weakness.

Note:

I have covered Borr Drilling Limited ( BORR ) previously, so investors should view this as an update to my earlier articles on the company.

Q3 Results In Line With Management's Projections

Last month, leading offshore driller Borr Drilling Limited or "Borr Drilling" reported Q3/2023 results largely in line with recently-lowered expectations. However, revenues of $191.5 million and adjusted EBITDA of $88.2 million represented new all-time highs for the company.

Borr Drilling generated $34.5 million in cash flow from operating activities and ended the quarter with unrestricted cash and cash equivalents of $94.4 million.

Adjusted EBITDA Guidance Reiterated

On the conference call, management reiterated previously-communicated projections for both 2023 and 2024:

Debt Refinancing

Subsequent to quarter-end, the company managed to refinance the majority of its debt obligations, albeit at less-than-stellar terms as the new notes require amortization payments of approximately $100 million per year at a price of 105% of principal amount.

In addition, the indenture governing the new notes contains a cash sweep provision that requires Borr Drilling to repurchase the notes with excess cash flow at 105% of principal amount, with the total cash sweep dependent on the company's leverage ratio.

Quarterly Dividend Initiation and $100 Million Share Repurchase Program

On the flip side, Borr Drilling won't face any major debt maturities before 2028 and gained sufficient covenant relief to initiate a quarterly cash dividend of $0.05 per share which, according to DNB Markets, is expected to grow by 100% in 2025 and another 150% in 2026:

Last week, the board of directors also approved a $100 million share repurchase program.

Jackup Market Outlook Remains Strong

On the conference call, management remained very constructive on the outlook for the jackup market (emphasis added by author):

Jack-up utilization levels have continued to increase since our last report. In particular, the market utilization for modern rigs has now reached 94% with the total number of contracted rigs climbing to 300.

Modern rig availability continues to tighten and is now in high single digit territory, excluding regionally stranded and sanction tainted assets. Amidst this tight market, we continue to experience a marked recovery in day rate levels from modern jack-ups. (...)

Based on the current tenders and discussions with our customers about their future requirements, we see strong indications of an undersupplied market condition developing in the second half of 2024 and into 2025.

Incremental demand is visible across most regions and specifically strong in Southeast Asia, India, Middle East and West Africa. But we note as well some interesting pockets of activity developing in the Mediterranean.

(...) We believe these conditions will continue to support an increasing dayrate environment , particularly for young and high performing rigs, placing Borr Drilling in a unique position to benefit from these developments .

Backlog

So far this year, the company has secured 12 new contracts at a weighted average dayrate of $161,000 thus adding $728 million in backlog.

Total backlog is close to $1.9 billion with an average dayrate of $137,000 and 84% of available days covered for 2024 (including priced options).

Jackup Market Isolated From Current Issues In The Deepwater Space

During the questions-and-answers session, management pointed out that shallow water drilling does not face the same-near term issues as the deepwater market which has experienced a lull in contracting activity in recent months thus resulting in increased near-term idle time for a number of rigs (emphasis added by author):

(...) I think that what you see in the deepwater is based on a completely different set of customers than what we see in the shallow water. In the shallow water, we see that the -- there is a very big scarcity of modern rigs, and that continues to be there. We see very strategic long-playing customers, and let's not forget we're on the short cycle barrel. We can produce much faster from the moment that we start drilling versus any type of a deepwater development . So the barrier to start anything deepwater versus continuing to develop the production in shallow water is very different. And I think that, that is a market that probably going forward will continue to diverge , and I'm very pleased that we are only playing in the jack-up market, so to say.

However, the North Sea market is likely to remain weak until 2025 which might result in some idle time for the Prospector 1 jackup rig in 2024.

With expectations for a significant step-up in contracting activity in the second half of next year and going into 2025, management anticipates dayrates to recover further.

Valuation And Price Target

Valuation-wise, Borr Drilling is currently trading at approximately 5x my estimated 2025 EV/Adjusted EBITDA:

Assigning an EV/Adjusted EBITDA multiple of 6x would yield a $8.80 price target for the shares thus providing for more than 25% upside from current levels:

However, I wouldn't aggressively chase the stock after last week's recovery rally and rather look to scale into the shares on renewed weakness.

Key Risk Factor - Oil Price Correlation

Please note that offshore energy service stocks remain heavily correlated to oil prices so any sustained down move in the commodity would almost certainly result in industry shares taking a hit.

Bottom Line

Borr Drilling reported Q3 results very much in line with management's recent projections and reiterated full-year 2023 and 2024 expectations.

Following the company's successful debt refinancing in November, the board of directors approved the initiation of a $0.05 quarterly cash dividend as well as a $100 million share repurchase program which, given the underwhelming terms of the refinancing, should be considered a positive surprise.

With the jackup market not impacted by increasing contract lead times similar to the deepwater space and ongoing, strong utilization, Borr Drilling does not expect major issues in recontracting its assets going forward.

On the conference call, management pointed to a potential shortage of modern jackup rigs going into 2025 which should result in dayrates recovering even further.

However, I wouldn't aggressively chase the stock after last week's recovery rally and rather scale into the shares on renewed weakness.

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