SHLLF - Is Valaris Limited A Smart Buy As The Offshore Drilling Industry Booms?

Summary

• Valaris Limited is a leading offshore drilling company whose stock price soared by 70% over the past year.
• It has a cheap forward-looking valuation; earnings per share are expected to grow from $3.38 in 2023 to $14.22 in 2025.
• Valaris Limited stock is also near overbought levels and not cheap based on 2023 earnings estimates, and compared to its peers.
• Is Valaris stock a buy here? I break it down below.

Valaris Limited ( VAL ) is a top player in the offshore drilling industry, equipped with a cutting-edge fleet of rigs, a whopping $8 billion in assets and $5 billion market cap, and a strong presence in all major offshore basins.

For those new to the field, offshore drilling is the process of extracting oil and gas from the ocean or coastal areas using drilling platforms or ships. These companies may work for oil and gas corporations or pursue exploration, production, and development on their own. Investing in offshore drilling companies has historically provided great returns tied to oil prices and is expected to continue to do so in the future.

I think Valaris Limited offers a good value based on its future earning potential, but investors should consider buying the stock during price dips due to its overheated share price, as I'll explain further.

Valaris Limited Company Overview

Valaris is a leading offshore contract drilling service provider to the international oil and gas industry with a fleet of 56 rigs. The company owns an offshore drilling rig fleet of 56 rigs, which include 11 drillships, 4 dynamically positioned semisubmersible rigs, 1 moored semisubmersible rig, and 40 jackup rigs.

Valaris serves international, government-owned, and independent oil and gas companies in the Gulf of Mexico, the North Sea, the Middle East, West Africa, Australia, and Southeast Asia. The company was incorporated in 2009 and is based in Hamilton, Bermuda.

The offshore drilling industry is currently thriving due to increasing oil prices and energy demand, driving global oil companies to invest more. For example, recently Valaris Limited reported Q3 2022 earnings that exceeded expectations, with a net income of $78 million ($.98 per share), compared to a loss of $52.8 million in the same quarter a year ago.

Valaris Limited: The Case for Investing

Valaris appears to be a strong investment here for a few reasons.

• Growing demand for offshore drilling. The demand for floater rigs is projected to grow at a 6% compound annual growth rate over the next five years, primarily driven by exploration and development drilling. This indicates confidence in the long-term viability of deepwater projects. Jackup demand is also expected to rise in 2023. A significant portion of this demand is expected to be for exploration and development drilling. This is a positive sign of customers' confidence in the economic viability of deepwater projects and bodes well for the long-term demand for these rigs.

• Oil prices likely to remain elevated. Despite the risk of recession, the U.S. government's commitment to buying back oil at lower prices provides a potential floor for oil prices, which bodes well for Valaris. The White House says “the Administration intends to repurchase crude oil for the SPR when prices are at or below about $67-$72 per barrel.”

• Strong partners. The company has a strong partnership with ARO Drilling, a joint venture with Saudi Aramco ( SAR ), which includes 15 rigs operating and a 20-rig newbuild program planned.

• Attractive forward-looking valuation. Valaris' forward-looking valuation is cheap, with 5 analysts forecasting earnings per share of $3.38 in 2023, rising to $8.84 in 2024, giving the stock a 2023 P/E ratio of 22. The P/E ratio is expected to decrease to 8.46 in 2024, and 3 analysts have forecast 2025 earnings per share of $14.22, giving it a 2025 P/E of 5.25.

• Strong financials. Valaris has a robust balance sheet , with net cash of $102 million and $2.3 billion in contract backlog as of October 31, 2022. Its in much stronger financial shape compared to peers Transocean ( RIG ), Bor ( GBX ), and Shelf Drilling ( OTCPK:SHLLF ).
• Finally, the company was also rated the number one offshore driller in EnergyPoint Research's 2022 customer satisfaction survey.

Valaris: What about the current stock price?

Valaris Limited is a top player in the offshore drilling industry and its future earnings look promising. Currently, the stock is trading at a decent value based on its 2023 earnings projections. It’s even more undervalued when considering its 2024/25 earnings forecast.

However, with a 70% increase in its stock price over the past year and its recent strength, Valaris Limited shares are approaching overbought levels. Investors may want to wait for a dip to enter the stock. Personally, I think a better entry point may be in the mid-$60s, compared to its current trading price of $72 (as of 1/30).

To mitigate risk, consider dollar cost averaging , due to the stock's high volatility and potential for fluctuating oil prices.

Key risks to Valaris stock

Here's an overview of the biggest risks to consider before investing:

• Oil prices in Ukraine and Russia are expected to remain high due to Western sanctions, but the risk of a potential recession and the Federal Reserve's hawkish stance may cause prices to plummet. The U.S. has indicated that they may start buying oil at a lower price ($60-$65), but there is no guarantee this will happen.
• Valaris is somewhat overpriced based on its past year earnings, and only undervalued according to analyst predictions for 2024-25. There's no guarantee that the company will meet these future earnings expectations and this could affect its stock price. For example, a prolonged drop in oil prices will impact its earnings and will likely also result in a drop in Valaris' share price.
• Valaris saw a 70% increase in 2022, and its stock is now close to being overbought on the relative strength index. Existing investors, including insiders, may being to sell soon, leading to a drop in stock price. New investors may want to wait for a dip before buying.

Besides the factors mentioned above, Valaris is also exposed to various challenges that can affect the offshore drilling sector, such as:

• Regulatory changes that could negatively impact the industry;

• Risks associated with its operations and finances, such as excessive costs, safety incidents, or postponed contract agreements or renewals;

• Political and economic instability in regions where it operates.

You can read through the company’s recent quarterly report to view more risk factors; do your own due diligence before considering an investment.

Valaris Limited: The Bottom Line

Here’s a summary of this article and my concluding thoughts on whether or not Valaris’ stock is a buy here:

• Valaris Limited is a leading offshore drilling company, with a modern fleet of 56 rigs and a presence in nearly all key offshore basins. Offshore drilling is expected to grow at a CAGR of 6% in the next five years, providing good investment opportunities.

• The company is expected to increase spending as it reactivates rigs, coinciding with higher labor and material costs.

• Valaris has a strong partnership with ARO Drilling, a good track record of safety, a strong customer base, and a cheap forward-looking valuation, with earnings per share expected to grow from $3.38 in 2023 to $14.22 in 2025.

• However, Valaris Limited stock is near overbought levels and may be volatile, so investors may want to wait for a pullback or use dollar cost averaging.

• I view the low-to-mid $60’s as an attractive entry point for Valaris Limited. I will be on the sidelines until then, watching carefully.

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