Investment Highlights

• We maintain our HOLD call on Velesto Energy (formerly UMW Oil and Gas Corporation) with an unchanged fair value of RM0.24/share, based on a 25% discount to its 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.

• As we had indicated in our update on 28 May, Velesto has secured a US$31mil charter for its Naga 4 jack-up rig from Roc Oil (Sarawak) Sdn Bhd for its 11-well D35 Phase 2 Infill Drilling Programme, beginning in August this year.

• Assuming each well could take up to 40 days, we estimate that the daily charter rate at US$70K, which is largely in line with the range of US$68K-US$70K in Malaysia

• As Naga 4’s current short-term charter with Conoco Philips will expire in July this year, this new charter from Roc Oil is merely a replenishment for a current operating asset.

• However, the group's 2QFY18 rig utilisation is likely to be similar to 1QFY18's 65%, which will potentially mean that the group will not be able to break even with daily charter rates still soft at US$68K.

• Naga 2 and 6 are currently warm stacked while the charters of Naga 3 and 7 will expire in June this year. All-in, there will be 4 rigs that could be out of charter by 3QFY18 unless fresh charters materialise soon. The Naga 5 charter will likewise expire by September this year unless Repsol exercises its option to renew another year.

• With regional daily rig charter rates at US$55K-US$65K, management affirms that Petronas does not foresee any increase in 2018-2019. We understand that Naga 2, 3 and 6 may be close to securing short-term charters of around 4-5 months while Naga 5 could have a 6-month charter until early 2019.

• Management is hopeful that 7 rigs could be working by July this year and restore Velesto to profitability in 3QFY18. However, we note that 3 of those short-term potential charters will expire by 4QFY18, which will translate to only 4 rigs in operation and resumption of losses for the group. Recall that Velesto's 1QFY18 net profit of RM5mil would have been a loss of RM2mil-RM3mil, excluding realised forex gains of RM18mil.

• The group is tendering for 23 short-term charters and 7 longterm charters which have a combined value of US$660mil vs. its current firm order book of US$359mil and optional extension worth US$426mil. However, the major portion of these tenders stems from overseas which have lower charter rates compared to Malaysia's.

• We view the 13% share price discount to its book value as justified given that weak charter rates and short-term charters, comprising a significant portion of its tenders and order book, cloud Velesto’s earnings visibility.

Source: AmInvest Research - 4 Jul 2018