Investment Highlights

• We upgrade our call on Velesto Energy to BUY from HOLD with a higher fair value of RM0.37/share (from an earlier RM0.34/share) underpinned by the group’s full recovery in earnings on rising rig utilization rates amid improvement in charter rates regionally.

• Our valuation has now been adjusted to FY20F PE of 20x vs. the book valuation methodology given that the group is on the cusp of reversing its past 4 years of dismal consecutive losses.

• Nevertheless, we caution that the escalation in earnings will be partly mitigated by the group’s huge share base of 8.2bil that stemmed from its past debt restructuring exercise.

• We have raised Velesto’s earnings to RM48mil from breakeven in FY19F and 4.4x–4.5x for FY20F–FY21F, translating to 1.9x–3.5x consensus currently. This came from increasing our rig utilisation rate assumption from 70% to 80% in FY19F and to 90% for FY20F–FY21F. Additionally, our daily rig charter rate assumptions are maintained at US$70K for FY19F but raised to US$75K in FY20F and US$80k in FY21F.

• Velesto’s registered an improved 1HFY19 loss of RM10mil (vs. RM34mil core loss in 1HFY18) on a 6ppt improvement in rig utilisation rates to 70% and US$2K increase in daily charter rate to US$70K. This was better than our earlier breakeven expectation for FY19F and likely above consensus’ RM25mil.

• The group’s 2QFY19F registered a net profit of RM12mil (vs. a RM22mil loss in 1QFY19) as rig charter rate rose US$2K to US$71K while utilisation rates rose to 74% from 66%.

• Rig charter rates are beginning to track upwards on tightening utilisation rates while older rigs are being retired amid slowing new units from China yards. In the North Sea, Borr Drilling has recently secured rig charter rates above US$100K vs. currently US$70K in Malaysia.

• In April this year, Velesto secured 4 fresh jack-up rig charters worth US$105mil (RM432mil), which translates to a higher charter rate of US$72K vs. US$70K in 1HFY19. These Petronas Carigali charters for Naga 2, 3, 5 and 6 commenced April–July this year over tenures of 1 year with 2 annual extension options, which allow Velesto to negotiate at market rates during these extensions.

• This means that rig utilisation could rise on these new charters to over 90% on minimal rig downtime amid improving charter rates, translating to stronger earnings growth trajectory in 2HFY19F and onwards. As such, we view Velesto’s FY20F PE of 16x as undeserved against the backdrop of a substantive earnings recovery following years of negative sentiments.

Source: AmInvest Research - 3 Sept 2019