Post 2Q18 results briefing, we project Velesto to record RM10m losses (from RM3m profit estimate previously) after tuning down average utilisation and DCRs but we increase FY19/20 earnings by 23%/12% on lower interest cost. We reiterate our long term positive view on the counter premising on (i) recovering rig demand to sustain rig utilisation, (ii) improving operating cash flow underpinned by higher cost efficiency and (iii) healthier financial position. Maintain BUY recommendation with unchanged TP of RM0.34, based on 1.0x FY19 P/B multiple.

Utilisation rates. Rig utilisation rates have deteriorated to 59% in 2Q18 from 65% in 1Q18 due to higher rig idle time as a result of delay in new contracts for two rigs and earlier than expected job completion for another two rigs. As four rigs are expected to start working in August, we expect 3Q18 utilisation to improve QoQ and hit almost full utilisation in 4Q18. Despite so, we reckon average full year utilisation in FY18 to be lower than management’s target of 75%-80%. Thus, we adjust our FY18 utilisation assumption to 73% from 75% but maintain FY19-20 assumptions at 80%-85%.

Charter rates. Daily charter rates (DCR) in Malaysia are running between USD65k- 70k/day depending on the rig’s specifications and conditions. We do not expect any significant improvement on DCRs in the near term even though slight rate increment is seen in countries such as Vietnam and Indonesia given that local drillers in Malaysia are still receiving higher rates.

Rig demand. Worldwide rig demand for FY18-19 has improved slightly to 354-384 as of July (vs 349-380 as of June) with almost half of the demand coming from Middle East and India. However, this may still be insufficient to cater for all the 448 available jack-up rigs available globally (of which 27% of it remained idle as of July) coupled with the potential 88 rigs coming out from the yard in the next 3 years. Nonetheless, management is still confident that the supply demand dynamics will improve in the longer run as 40% of the global rig fleet are aged more than 30 years, indicating that significant number of rigs could be scrapped in the longer run and provide significant boast to the DCR.

Cost savings and debt repayment. The group managed to achieve RM12m cost savings in 1H18, higher than FY17’s RM9.6m. Bulk of the optimisation comes from renegotiation on drillers’ salaries and bulk purchase discount. Meanwhile, Velesto is looking to repay its USD60m debt by end 3Q18 on the back of improving operating cash flow, which will lower its net gearing to 0.27x by 4Q18 from 0.36x as of 2Q18 and generate interest cost saving of c. RM3.5m/quarter.

Forecast. We project Velesto to incur RM10.3m losses in FY18 from a profit estimate of RM3.4m after lowering (i) DCR assumption to USD68k/day from USD70k/day, (ii) average utilisation to 73% from 75%. At the same time, we increase FY19/20 earnings by 23%/12% after factoring additional interest cost savings subsequent to the USD60m debt repayment by end 3Q18.

Maintain BUY, TP: RM0.34. Maintain BUY recommendation with unchanged TP of RM0.34 based on 1.0x FY19 PBV multiple. We like Velsto for being the largest domestic jack-up rig owner to benefit from the demand uptick in jack-up rig amid stabilisation of oil prices.

Source: Hong Leong Investment Bank Research - 23 Aug 2018