DNR Valens Credit Analysis – Operational sustainability, capex flexibility, and a robust recovery rate indicate that that cash bond markets and ratings agencies are overstating credit risk

May 16, 2018

  • Cash bond markets are grossly overstating credit risk with a YTW of 7.695% relative to an iCDS of 214bps and an iYTW of 4.965%. Meanwhile, Moody’s is materially overstating credit risk, viewing DNR as an extremely speculative, high-yield credit, with its Caa1 rating seven notches below Valens’ credit rating of XO (Baa3)
  • Incentives Dictate Behavior™ analysis highlights that management’s compensation framework should focus them on all three value drivers, likely leading to Uniform ROA expansion and increased cash flows available for servicing obligations. Additionally, half of all NEOs hold material DNR equity relative to their annual compensation, including CEO Kendall, likely aligning them with shareholders for long-term value creation. Finally, management also has low change-in-control compensation, limiting event risk for credit holders
  • DNR currently trades at historical lows relative to UAFRS-based (Uniform) Assets, with a 0.4x Uniform P/B (V/A′). Companies at discounts this material are priced based on perceived credit risk, implying that the market is no longer pricing in expectations based on fundamentals at these levels.  Given that the market is pricing in expectations for imminent bankruptcy, should perceived credit risk improve, equity upside could be material, and absent a default, equity downside is likely limited as well

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