We attended Velesto’s 3Q19 analyst briefing. Naga 3 SPS was brought forward due to a technical issue at the designated platform. Rather than staying idle management brought forth the SPS. Naga 3 should be up and running by 2H of January. NAGA 2,3,4,5,6&7 will come up for renewal throughout 2020 and we expect rates to converge to those dished out to N8. Maintain our BUY call and TP of RM0.46 based on 1.3x FY20 P/B multiple or +1SD above its 5 year mean P/B (from 0.9x FY19 P/B); we deem this justified as we are of the opinion that the jack up rig market is on the cusp of an upswing cycle.

We attended the 3Q19 results briefing hosted by Velesto’s top brass, the following are some of the key takeaways.

Recap 3Q19 revenue of RM208.6m (+33% QoQ, +39% YoY) with core PATAMI of RM33.0m (+177% QoQ; 3Q18: -RM8.9m) due to improved utilisation of 92% (vs. 74% in 2Q19 and 66% in 1Q19), brought 9M19 straight back to black with a core PATAMI of RM22.4m (vs. core loss of -RM41.0m SPLY). The results were above ours and consensus expectations as they exceed FY19 forecast of RM19.3m/RM21.9m.

Naga 3. Management elaborated on the slight change in drilling schedule, recall that NAGA 3’s SPS has been brought forward earlier into 4Q19 (initial guidance was in 2Q20). This is due to a technical issue at Petronas’s drilling platform. Management had to take a prudent stance and did not wish to have the rig staying idle (note that Petronas has imputed into its contract terms c.30-60 days of zero rated days that they can exercise – this option was exercised). As such, Velesto chose to bring forth the SPS for N3 as this will allow for a clean run in 2020. As highlighted in our previous report, this should result in a drop in utilisation rates to c.80%-90% in 4Q19. Despite this, Velesto remains on track to hit c.80% utilisation rate in FY19 (vs.73% FY18).

Rig market. There is a total of 521 JUR available globally. 70 are sitting idle, with only 451 available to be contracted. Of these c.160 rigs (c.36%) are >30 years old and are potentially retired soon. Based on IHS’s world rig demand forecast, 2020 will see a net increase of 21 additional rigs needed (c.402). This forecast does not include tenders (specifically, Petronas tenders). Management expects demand should be higher than 402 in FY20, based on the Petronas activity outlook; Malaysia will require c.18-19 rigs in FY20.vs. IHS’s forecast of 10. Management expects Jan-Feb to see more tenders being awarded as the budget is approved from Petronas. Note that FY19 only saw 14 rigs contracted in Malaysia vs. a guidance of 16-18. Management believes this could spill over into FY20 thus resulting in rig demand of 21-19 vs. 19-17 as per the outlook.

Outlook. The recent NAGA 8 contract award (c. USD120-100k/day including mobilisation costs) essentially serves as the benchmark for rig rates to uprate when they come up for renewal (NAGA 2,3,4,5,6&7 will come up for renewal throughout 2020). We remain upbeat on the prospective renewed terms for rigs coming off contracts moving forward. 2019 had a lot of SPS activity – (once every 5th year mandatory dry docking). In FY20, there won’t be any SPS except N8 – this will result in optimal downtime and a higher utilisation rate.

Forecast. Unchanged.

Maintain BUY, TP: RM0.46. Maintain our BUY call and TP of RM0.46 based on 1.3x FY20 P/B multiple or +1SD above its 5 year mean P/B (from 0.9x FY19 P/B); we deem this justified as we are of the opinion that the jack up rig market is on the cusp of an upswing cycle. Velesto remains an excellent proxy to recovering of oil prices and an uptick in upstream exploration and production activities.

Source: Hong Leong Investment Bank Research - 2 Dec 2019