(Image: Zen Buddha Silence, by Marilyn Barbone)
March 8, 2020
We continue with examples of Boole’s quantitative investment process in action.
A few weeks ago, we looked at Ranger Energy Services (RNGR): https://boolefund.com/ranger-energy-services-rngr/
Before that, we looked at Macro Enterprises (Canada: MCR.V): https://boolefund.com/macro-enterprises-mcr-v/
This week, we are going to look at Valaris (VAL)—the largest offshore oil driller in the world and the cheapest stock I’ve ever seen—which comes out near the top of the quantitative screen employed by the Boole Microcap Fund. This results from four steps.
Step One
First we screen for cheapness based on five metrics. Here are the numbers for Valaris:
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- EV/EBITDA = 4.01
- P/E = 0.14
- P/B = 0.01
- P/CF = 0.07
- P/S = 0.03
These figures—especially P/E and P/B—make Valaris one of the top ten cheapest companies out of over two thousand that we ranked. (Note: This assumes a medium-case recovery with EBITDA at $1,510 million and net income at $700 million. The current market capitalization is $99 million.)
Step Two
Next we calculate the Piotroski F-Score, which is a measure of the fundamental strength of the company. For more on the Piostroski F-Score, see my blog post here: https://boolefund.com/piotroski-f-score/
Valaris has a Piotroski F-Score of 7. (The best score possible is 9, while the worst score is 0.) This is a very good score.
Step Three
Then we rank the company based on low debt, high insider ownership, and shareholder yield.
We measure debt levels by looking at total liabilities (TL) to total assets (TA). Valaris has TL/TA of 45.0%, which is reasonable.
Insider ownership is important because that means that the people running the company have interests that are aligned with the interests of other shareholders. At Valaris, insider ownership is approximately 5%. This isn’t a high percentage, but it does represent a total insider ownership of $5 million.
Shareholder yield is the dividend yield plus the buyback yield. The company has no dividend and is not buying back shares. Thus, shareholder yield is practically zero.
Each component of the ranking has a different weight. The overall combined ranking of Valaris places it in the top 5 stocks on our screen, or the top 0.2% of the more than two thousand companies we ranked.
Step Four
The final step is to study the company’s financial statements, presentations, and quarterly conference calls to (i) check for non-recurring items, hidden liabilities, and bad accounting; (ii) estimate intrinsic value—how much the business is worth—using scenarios for low, mid, and high cases.
See the company presentation (dated February, 2020): https://s23.q4cdn.com/956522167/files/doc_presentations/2020/02/02212020-Valaris-Investor-Presentation.pdf
Valaris is the largest offshore oil driller in the world, with presence in six continents and nearly all major offshore markets. The company has a large and diverse customer base including major, national, and independent E&P companies.
Valaris has 16 drillships, 10 semisubmersibles, and 50 jackups. Valaris has one of the highest-quality fleets: 11 of its 16 drillships are the highest-specification. 13 of its 50 jackups are heavy duty ultra harsh and harsh environment jackups. High-spec assets are preferred by customers.
Valaris is also one of the best capitalized drillers. Valaris has a market capitalization of $99 million. The company has $2.5 billion in contracted revenue backlog (excluding bonus opportunities). It has $1.7 billion in liquidity, including $100 million in cash and $1.6 billion in credit available. And it has only $858 million in debt maturities to 2024. Valaris is one of two public offshore drillers with no guaranteed or secured debt in the capital structure. With the asset value of its fleet at $9.1 billion (according to third party estimates), Valaris has ample flexibility to raise additional capital if needed.
In April 2019, Ensco plc (ESV) and Rowan Companies plc (RDC) merged in an all-stock transaction. The combination (renamed Valaris) has brought together two world-class operators with common cultures. Both companies have strong track records of safety and operational excellence. And both companies have a strategic focus on innovative technologies that increase efficiencies and lower costs. Ensco was rated #1 in customer satisfaction for nine straight years according to a leading independent survey.
As a result of the merger, Valaris has already achieved cost savings of $135 million pre-tax per year. The company expects to achieve additional savings of $130 million a year. The full savings will be $265 million a year, which is $100 million more a year than the company initially projected.
Intrinsic value scenarios:
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- Low case: If oil prices languish below $55 (WTI) for the next 3 to 5 years, Valaris will be a survivor, due to its large fleet, globally diverse customer base, industry leading performance, low cost structure, and well-capitalized position. In this scenario, Valaris is likely worth at least 10 percent of current book value (which is depressed) of $48.15. That’s $4.82, about 860% higher than today’s $0.50.
- Mid case: If oil prices are in a range of $55 to $75 over the next 3 to 5 years—which is likely based on long-term supply and demand—then Valaris is probably worth at least current book value (which is depressed) of $48.15 a share, roughly 9,530% higher than today’s $0.50.
- High case: EBITDA under a full recovery is approximately $4 billion. Fair value can be conservatively estimated at 6x EV/EBITDA. That would be EV (enterprise value) of $24 billion, which implies a market cap of $17.6 billion. That works out to $88.94 a share, over 17,685% higher than today’s $0.50.
Bottom Line
Valaris (VAL) is the cheapest stock I’ve ever encountered. Assuming the return of normal circumstances within the next 3 to 5 years, the potential upside is roughly 9,530%. We are “trembling with greed” to buy VAL for the Boole Microcap Fund.
BOOLE MICROCAP FUND
An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time. See the historical chart here: https://boolefund.com/best-performers-microcap-stocks/
This outperformance increases significantly by focusing on cheap micro caps. Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals. We rank microcap stocks based on these and similar criteria.
There are roughly 10-20 positions in the portfolio. The size of each position is determined by its rank. Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost). Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.
The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods. We also aim to outpace the Russell Microcap Index by at least 2% per year (net). The Boole Fund has low fees.
If you are interested in finding out more, please e-mail me or leave a comment.
My e-mail: jb@boolefund.com
Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.