Description

Many have pitched offshore drillers on this site. Here’s one more - Borr Drilling.

Relative to other offshore drillers, Borr is unique as a pure-play on jackups – with a high-spec, homogeneous and young fleet. Unlike peers, Borr did not file for BK so its debt balances are a bit elevated but still very manageable. I think this will serve to enhance shareholder returns over time as debt reduction flows to equity and even results in FCF multiple expansion, especially as a growing dividend (currently $0.20/yr) attracts more “generalist” investors to the name. At current prices, Borr shares trade at 6x EBITDA and <5x FCF (in 2025 after bond amortization and expected excess cash flow paydowns).

For background, Borr owns 22 modern jackups with an average age of 6.0 years. These rigs drill in shallow water (depths up to 400 feet) and most were built at Singaporean yards, so the quality is good. The young fleet results in limited maintenance capex requirements so FCF will exceed net income. These vessels have a backlog of $1.9 billion with charters to counterparties such as Aramco, Total, ENI, Qatar Energy, PTTEP, Shell, Pemex and others. By customer-type, the backlog is split 63% NOC (up from ~40% in 2019) and 37% IOC.  NOCs are theoretically more long-term focused (w/ less of a “green” agenda). Furthermore, shallow water breakeven oil prices are among the lowest. In terms of geography, the breakdown is Americas (36%), SE Asia (20%), ME (29%) and West Africa (15%).

Another two vessels will be delivered in 2024 to bring the pro forma fleet to 24 rigs. All 22 existing vessels will be under contract in 2024 at an average day rate of $132k. This compares to opex of $59k (including SG&A and capex). Recent backlog additions were at leading edge day rates of >$160k so as contracts roll and higher day rates are reflected, EBITDA and cash generation should continue to improve. 

Here are some recent contracts.

A recovery of shallow-water demand, particularly in the Middle East coupled with retirements (i.e. fleet is 10% smaller vs 2014 due to 150+ retirements) has resulted in a healthy market backdrop. There is more potential upside should we see West Africa, Southeast Asia and the North Sea recover to prior peaks. From 2014 to now, modern rigs went from comprising 46% to 74% of the total fleet. This is evidence of a shift to higher quality tonnage. Utilization of the modern jackup fleet is 94%. This is expected to increase further to 96% in 1H24 for an effectively sold out position. As such, rates should continue to be strong and contracts terms should improve with lengthening tenor.

As with most commodity businesses, I think the key is supply – and that is the real selling point here. The order book is <5%. No new jackups have been announced and day rates would need to increase significantly to justify new build economics. Energy transition and ESG concerns should serve as a lid on new supply. Even if new orders were announced, delivery times would likely be 3+ years. From a retirement perspective, roughly 30% of the existing jackup fleet is >30 years old. This compares to a historical average rig retirement age of 38 years.

As a result of a recent “global” refinancing, the capital structure is cleaned up. I thought this would be a catalyst to drive the share price higher but it wasn’t. Total debt is $1.8 billion split between 1,540 million of 10% and 10.375% secured notes and $250 million of convertible bonds. This will grow next year to ~$2.0 billion, net of amortization as Borr takes delivery of the two new rigs. Annual bond amortization is $100 million (before capturing the new vessel financing) and starting in 2025, an excess cash flow test results in incremental debt payments. Management targets 2x leverage in the medium term and 1.5x long term.

Let’s get into the numbers. On an LQA basis, EBITDA $353 million, which similar to 2023E EBITDA guidance of $345 million. As a result of contracts rolling to current day rates, 2024 EBITDA is expected to be $500-$550 million. Add in two more vessels for a full year and additional contract rolls and I estimate EBITDA >$650 million. I’m assuming leading edge day rates of $165k. This leads to significant FCF even assuming debt amortization and a creation value through the equity of <5x. 

Below is a reproduced chart from a company presentation illustrating the earnings potential for 2025 and 2026.

On a replacement cost basis, the vessels initially cost $210-$290 million to build. As a result of yard closures (capacity down 50%-60%), a lack of manpower and inflation, new build costs are likely in the $300 million area. Any orders placed today would be completed far in the future as yards are focused on container ships and LNG carriers.

The chairman is very frustrated with the share price and wants to pay out bigger and bigger dividends. In the meantime, the company announced a $100 million share repurchase plan last week. So you ask, why does this opportunity exist considering the steep move in day rates already. I think there are several reasons – OPEC spare capacity, secular oil consumption concern, “white space” within the floater space (deepwater) causing near-term rates to decline and overhang from a recent small equity tap concurrent with the bond offering where investors received higher allocations than anticipated.

What are the risks?

OPEC has been supportive of oil prices. If they reverse course and oil falls, E&P spending will decline and day rates will soften.

“White space” within floaters continues to impact sentiment.

New supply. There’s nothing right now but it’s usually new supply that kills a cycle.

The Chairman is unique. He recently issued $50 million of stock concurrent with the HY offering and last week announced a $100 million buyback. This is because he’s frustrated the shares aren’t higher. One mitigating factor is the CEO who’s excellent and a real calming influence IMO.

Catalyst

Day rates

Passage of time and FCF generation + leverage reduction 

M&A