Valaris

Valaris plc (Ticker: VAL) is a major global offshore drilling contractor. Think of them as the landlord of the high seas, renting out massive, technologically advanced drilling rigs to oil and gas giants like Shell, BP, and ExxonMobil. Their fleet includes a variety of specialized vessels, from jack-up rigs that stand on the seabed in shallower waters to sophisticated drillships that can operate in the deepest parts of the ocean. The company's business is fundamentally tied to the price of oil. When oil prices are high, energy companies invest heavily in exploration and production, creating huge demand for Valaris's rigs and driving up the daily rental fees, known as dayrates. However, when oil prices crash, that demand evaporates, leading to brutal downturns. Valaris itself is a testament to this volatility, having been formed from a major merger (Ensco and Rowan) only to file for Chapter 11 Bankruptcy during the 2020 oil price collapse, before re-emerging with a cleaner balance sheet. For investors, Valaris is a classic case study in cyclical industries, offering the potential for spectacular gains but with equally spectacular risks.

The business of offshore drilling is, at its core, a capital-intensive rental service. Valaris spends billions to build or acquire its rigs and then contracts them out for a daily fee. The success of this model hinges on two key factors:

• Dayrates: This is the daily rent an oil company pays to use a rig. It can range from under $100,000 per day for an older rig during a downturn to over $500,000 per day for a top-tier drillship during a boom.
• Utilization: This is the percentage of the fleet that is actively working and earning revenue. An idle rig still costs money to maintain (a phenomenon known as “stacking”), so high utilization is critical.

This simple formula is supercharged by immense operating leverage. Because the fixed costs of owning a rig are so high (crew, maintenance, insurance), a small increase in revenue from higher dayrates can flow almost entirely to the bottom line, creating explosive profit growth. The reverse, of course, is also true.

Investing in a company like Valaris is less like buying a stable blue-chip stock and more like learning to surf. You have to understand the waves. The entire industry rides the massive swell of global energy prices.

1. The Boom: When oil prices are high and sustained, oil majors open their wallets for exploration. The demand for high-quality rigs outstrips supply, sending dayrates into the stratosphere. Companies like Valaris make cash hand over fist. Investor sentiment is euphoric.
2. The Bust: When oil prices crash, exploration budgets are the first thing to be cut. The market is suddenly flooded with unemployed rigs, and drillers are forced to accept painfully low dayrates just to keep them working. Debt taken on during the good times becomes an anchor, pulling many companies—including the “old” Valaris in 2020—into bankruptcy.

For a value investing practitioner, the lesson is clear: the time to get interested is often at the point of maximum pessimism, when the industry is left for dead, and the time to be cautious is when headlines are screaming about a new “supercycle.”

Analyzing a cyclical business like Valaris requires a specific lens. Forget trying to predict next quarter's earnings and focus on survival and long-term value.

• Fleet Quality: Is the fleet modern and high-specification? Newer, more capable rigs (like 7th generation drillships) will always be in higher demand and will be the last to be idled in a downturn and the first to be hired in a recovery. The fleet is composed of various rig types, including jack-ups, semisubmersibles, and drillships.
• Balance Sheet Strength: This is non-negotiable. The company must have a fortress balance sheet to survive the inevitable lean years. Look for low levels of debt (a low debt-to-equity ratio) and a healthy cash reserve. A company that has recently emerged from bankruptcy, like Valaris, often has a significant advantage here as its debts have been wiped clean.
• Contract Backlog: The contract backlog is the sum of all the revenue Valaris expects to earn from contracts it has already signed. A large and growing backlog provides a crucial cushion, offering visibility into future revenues and protecting the company from short-term market slumps.
• Capital Allocation: Pay close attention to what management does with its cash. Are they disciplined? In a cyclical upswing, are they returning cash to shareholders via buybacks and dividends, or are they recklessly ordering new rigs at the top of the market? A prudent management team that understands the cycle is arguably the company's most valuable asset.