2Q19 rig utilisation is expected to improve both QoQ and YoY at 70-75% (vs 1Q19’s 66% and 2Q18’s 59%). We are turning more positive on Velesto to turnaround in 2H19 backed by (i) higher average rig utilisation of >90%, (ii) better DCR and lower interest cost. Meanwhile, global supply demand dynamics for jack-up rigs are improving on higher rig demand, lower idling rigs and lower new deliveries. However, we do not discount the possibility of downside earnings risk to consensus FY19 earnings projection of RM26m, which is 35% higher than our in-house estimate of RM19.3m. With no changes in our estimates, maintain HOLD recommendation on with higher TP of RM0.31 pegged to 0.9x FY20 PBV.

Stronger utilisation in 2Q19. Velesto’s rig utilisation for 2Q19 is expected to be stronger both QoQ and YoY at 70-75% (vs 1Q19’s 66% and 2Q18’s 59%) as Naga 2, Naga 3 and Naga 5 have started its new contract with Petronas Carigali. Thus, 2Q19 results are likely to improve from 1Q19’s RM22.5m core losses and 2Q18’s RM22.5m core losses on the back of higher average DCRs (vs FY18 and 1Q19’s USD69k/day), lower interest cost and better rig utilisation. However, we reckon that Velesto would likely to incur small losses with the breakeven utilisation estimated at 78%.

Full year average utilisation could hit 80%. With all the rigs chartered, we expect Velesto to record much stronger utilisation in 2H19. Naga 6’s special periodical survey (SPS), a maintenance check up every 5 years which usually takes 1-2months will be carried out in early 3Q19 while Naga 7 is slated for SPS in 4Q19. Meanwhile, based on our channel check, Velesto is able to secure a small job to fill up the 3 month idle gap of Naga 7 in 3Q19 heading towards SPS. This will lift Velesto’s 2H19 rig utilisation to ~90% and full year utilisation to 80%, which is still in line with our FY19 assumption.

Debt repayment. Velesto has repaid RM50m debt in 1Q19 which is considered as the voluntarily repayment. This is on top of the RM88.8m annual mandatory debt repayment in FY19 which is classified under short term borrowings as at end-FY18. In view of improving operating cash flow, 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, which implies a further RM11.2m voluntary debt repayment in 2H19.

Rig demand. Worldwide rig demand for FY19-20 has increased to 370-382 (from 355-386 previously) with almost half of the demand coming from Middle East and India. At the same time, idling rig number has decreased to 86 (from 95 previously) and potential rigs coming out from the yard have fallen to 63 (from 70 previously). All these data are pointing towards healthy recovery within the drilling space. On the domestic front, HIS World Rig Forecast stated that Malaysia rig demand for FY19-20 has also increased to 13-13 (from 8-10 previously) suggesting that local upstream activities are picking up.

Forecast. Maintain our FY19/20/21 earnings forecasts with rig utilisation assumption of 80%/83%/83%.

Maintain HOLD, higher TP: RM0.31. Our TP is upped to RM0.31 (from RM0.29 previously) after rolling forward our valuation base year to FY20 and pegged to higher P/B multiple of 0.9x (from 0.85x previously), which is slightly above its 2-year average of 0.8x. This is in view of healthier drilling industry outlook. That said, we do not discount the possibility of downside earnings risk to consensus FY19 earnings projection of RM26m, which is 35% higher than our in-house estimate of RM19.3m.

Source: Hong Leong Investment Bank Research - 8 Aug 2019