Investment Highlights

• We maintain our HOLD call on Velesto Energy (formerly UMW Oil and Gas Corporation) with a lower fair value of RM0.24/share, based on a 25% discount to the revised book value of RM0.32/share. As a comparison, Malaysia Marine & Heavy Engineering, which has a net cash of RM0.40/share, is currently trading at half its book value.

• Velesto’s 1QFY18 net profit of RM5mil appears to be within our expectations, accounting for 32% of our earlier FY18F earnings of RM16mil while better than street’s loss of RM14mil. However, excluding the realised forex gain of RM18mil, Velesto would have registered a worse-thanexpected loss of RM13mil instead.

• Hence, we have cut our utilisation assumptions, which reversed FY18F earnings to a loss of RM29mil and reduced FY19F-FY20F earnings by 36%-57%. We caution that the group’s bottom line will be volatile over the next few quarters, depending on whether its fleet of 7 rigs are able to secure a utilisation of over 90%. As expected, no dividend was declared due to the losses.

• Velesto’s 1QFY18 revenue dropped 37% QoQ to RM122mil as the number of rigs on active charter fell from 7 to 5, which led to rig utilisation dropping from 95% to 65%, below the group’s breakeven level with a drilling loss of RM18mil. This was partly alleviated by higher demand for repair and premium connection threading services at Velesto’s plant in Tianjin, China. As such, the group’s 1QFY18 core performance reversed to a loss of RM13mil from a net profit of RM9mil.

• With Naga 2, 3 and 4 aiming to secure fresh charters, the group is hopeful for improved utilisation rates amid a slow pace of recovery in drilling activities. Even though the group’s average rig charter rate of US$70K appears to have bottomed out with Brent crude oil price above US$70/barrel, we expect many of these new contracts to be short-term charters to replace current contracts which are expiring in 2018.

• The group’s rig utilisation outlook remains uncertain as 4 rigs – Naga 2, 3, 4 and 5 – may not have a charter in 2QFY18, leaving only 4 rigs in operation. The Naga 2 and 5 rigs had already completed their charters by end-December 2017 while Naga 4 is on short-term charters and Naga 3 is still unutilised. Two more rigs are expected to be mobilised in 3QFY18 which will leave only 5 rigs in a still loss-making operation.

• Even full utilisation at current rates will mean that Velesto will continue to be just breaking even, notwithstanding the group’s efforts to draw further cost efficiencies with a stronger credit profile amongst suppliers and financiers. Against the backdrop of weak earnings prospects shackled to a weak market outlook, we view the 13% share price discount to its book value as justified.

Source: AmInvest Research - 25 May 2018