Post 1Q19 results briefing, while we concur with management’s view on recovering rig demand to sustain rig utilisation, we are negatively surprised by the higher number of SPS occurring in FY19 which could affect the overall rig utilisation. Therefore, we cut our FY19 earnings by 17% to RM19.3m on lower utilisation of 80% (from 82% previously). Maintain HOLD with lower TP of RM0.29 (from RM0.31) based on lower FY19 P/B multiple of 0.85x. We anticipate share price would only re-rate if Velesto is able to return to the black consistently, potentially earliest from 3Q19. Preferred entry price at RM0.25.

Utilisation rates. Naga 2 and Naga 5 has just completed its special periodical survey (SPS), a maintenance check up every 5 years which usually takes 1-2months. Naga 6’s SPS will be carried out in early 3Q19 while Naga 7 is slated for SPS in 4Q19. We understand that SPS will cost c.USD10m and will be depreciated over 5 years starting from the date of certification. The number of SPS is slightly higher than what was guided in the previous quarter. Meanwhile, management is also trying to fill up the idle time for Naga 4 and Naga 7 in 2H19 via new jobs/extensions. Therefore, we believe Velesto’s rig utilisation will stay flat QoQ at 66-67% in 2Q19 and hit above >85% in 2H19. Overall, rig utilisation will only hit above 80% in FY19 if Velesto manages to fill up the idle time in 2H19.

Charter rates. Velesto has achieved average daily charter rates (DCR) of USD69k/day in 1Q19, similar to FY18 level. Recall that Velesto has secured four drilling contracts worth USD105m for Naga 2, Naga 3, Naga 5 & Naga 6 with an average contract duration of 1-year earlier on. Three of these contracts are expected to commence in end May. Therefore, we believe Velesto’s average DCR will improve in the coming quarters. Additionally, these new contracts are likely to fetch higher margins as mobilisation cost is now borne by the client, masking potential hike in skilled labour cost.

Rig demand. Worldwide rig demand for FY19-20 remains robust at 355-386 as of Apr-19 with almost half of the demand coming from Middle East and India. However, this may still be insufficient to cater for all the 450 available jack-up rigs available globally (of which 21% of it remained idle as of Apr-19) coupled with the potential 70 rigs coming out from the yard in the next 3 years. The actual number of delivery would be lower than projection depending on the ability of clients to secure financing or pay huge lump sum amount. Nonetheless, management is still confident that the supply demand dynamics will improve in the longer run as 38% of the global rig fleet are aged more than 30 years, indicating that significant number of rigs could be scrapped in the longer run.

Debt repayment. Velesto has repaid RM397.4m in FY18 and another 50m debt in 1Q19 on the back of improving operating cash flow. Apart from its remaining mandatory debt repayment of RM95.6m in the next 12 months, management would consider voluntarily expediting its debt repayment if only if it does not breach the financial covenants. Note that we have imputed debt repayment of RM150m this year.

Forecast. We cut our FY19 earnings by 17% to RM19.3m on lower rig utilisation of 80% (from 82% previously) in view of lower working days as a result of higher number of SPS. No change to our FY20-21 earnings estimates.

Maintain HOLD, lower TP: RM0.29. Maintain HOLD recommendation with lower TP of RM0.29 (from RM0.31 previously) based on lower FY19 P/B multiple of 0.85x, which is slightly above its 2-year average of 0.8x. We anticipate share price would only re-rate if Velesto is able to return to the black consistently, potentially earliest at 3Q19 with our preferred entry price at RM0.25.

Source: Hong Leong Investment Bank Research - 24 May 2019