www.jpmorganmarkets.comNorth America Equity Research30 August 2019Equity Ratings and Price TargetsMkt CapRatingPrice TargetCompanyTicker($ mn)Price ($)CurPrevCurEnd DatePrevEnd DateDiamond Offshore DrillingDO US893.636.49UWn/c——8.00Dec-19Noble CorpNE US398.691.60UWn/c——n/cn/cTransoceanRIG US2,783.704.55UWn/c——7.00Dec-19Valaris plcVAL US506.544.66Nn/c——12.00Dec-19Source: Company data, Bloomberg, J.P. Morgan estimates. n/c = no change. All prices as of 30 Aug 19.Offshore Drilling2Q19 Model UpdatesOil Services and EquipmentSean C Meakim, CFA AC(1-212) 622-6684sean.meakim@jpmorgan.comBloomberg JPMA MEAKIM J.P. Morgan Securities LLCSee page 16 for analyst certification and important disclosures.J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.We are (belatedly) updating our offshore driller models following 2Q earnings and recent fleet sheets, in addition to a refresh of our Offshore Driller Scorecard(email us for an updated copy of the Excel). The four offshore driller stocks in our coverage have lagged the OSX by ~23% YTD as the path toward normalization in deepwater has yet to be discovered, reinforcing our view that even stocks -80-90% off peak can still be “Watched Pots.” This underperformance comes in the face of a commodity environment that while certainly not acting as a tailwind has stillmore or less cooperated this year. After a brief rally to start, Brent has settled into a range-bound level ($55-60) that operators seem to have accepted as the new normal, and one where offshore projects can still be profitable, though operator urgency remains lacking. We continue to view offshore drilling as overly eager to deploy capital into growth opportunities that require overly optimistic macro assumptions to greenlight them. Overcapacity in the floater space continues to hamper deepwater contracting as drillship terms struggle to exceed six months in most cases, leading to very competitive bidding with slow dayrate progression.Given the level of sensitivity in the valuation models for these stocks (high financial leverage coupled with thin cash margins), small changes to long-term dayrate expectations can shift price targets from offering significant upside to no equity value at all. This quarter again highlighted the perpetual theme of a deepwater “recovery” pushed out to FY2, and we believe that reality is a primary cause of the stocks’ YTD underperformance (-45% v. -22% OSX). However, with each push the recovery nears closer to the headwinds from a demand-driven downturn. We are modeling sub-$300k drillship dayrates in a normalized scenario, and we also tempered dayrate progression for high-spec jackups, haircutting our expectations for the early 2020s and dampening “nornmalized” assumptions a touch, and the net result is to withdrawal our price targets on DO, RIG, and VAL(we already had no price target for NE). The scenario looks dire, but with maturity walls pushed out into the early to mid 2020s, management teams are playing for equity optimality in their respective capital structures today. While acknowledging an errant presidential tweet on trade can push these stocks in the opposite direction of their recent trend, the long-term trend of lower highs and lower lows cannot be ignored. On a multi-year basis, we expect further balance sheet restructuring, market consolidation, and supply contraction through rig retirements as The Long Thaw continues. Thoughts on 2Q19 results plus model updates for the four drillers in our coverage are below.2North America Equity Research30 August 2019Sean C Meakim, CFA(1-212) 622-6684sean.meakim@jpmorgan.com 2Q Wrap: Offshore recovery continues, but deepwater rates, term disappoint the bulls (yet again). Overall, 2Q results reaffirmed that the offshore activity recovery remains underway, but not without some sizable nits to be picked. While the jackup market has gained strength, as pricing and activity have increased broadly, the deepwater market (especially for drillships) has not kept pace. VAL was the most bearish (or frank, depending on one’s view) in terms of the pace of recovery, acknowledging that the progression was occurring at a much slower pace than investors (or certainly drilling executives) were expecting to start the year. One bright spot (though symbolic for now) is the long-awaited return of dayrates to the Fleet Status Reports for RIG and NE; while a small step for now, we view this as a positive indicator for rates going forward as the drillers will now have a public marketing tool to negotiate for higher rates. Regionally, the drillers provided positive commentary around the globe: the North Sea and Middle East have remained shallow water strengths for most, but Asia Pac, Austral...
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