1Q20 revenue of RM176.3m (-1% QoQ, 39% YoY) with core PATAMI of RM21.5m (vs. 4Q19: RM8m; 1Q19: -RM22.5) came in above expectations accounting for FY20 forecast of 32%/46% respectively. Despite this, for prudence sakes we are revising our utilisation rate assumptions as Velesto’s drilling schedule is clouded by the current downturn in oil prices and the subsequent capex revisions by the majors. We trim our FY20-21 earnings by 25%. Downgrade to HOLD (from Buy) with a lower TP of RM0.18 based on 0.5x FY20 P/B multiple or -1.0SD below its 5 year mean P/B. We deem discount justified given the cloudiness surrounding Velesto’s drilling schedules and timing of contract renewals with Petronas.

Above. 1Q20 revenue of RM176.3m (-1% QoQ, 39% YoY) with core PATAMI of RM21.5m (vs. 4Q19: RM8m; 1Q19: -RM22.5) came in above ours and consensus expectations as it accounts for 32%/46% of FY20 forecast respectively. The deviation namely stems from improved utilisation rates and invoicing from the drilling segment. In deriving our core earnings we adjusted for EI’s amounting to RM5.2m (forex loss).

QoQ. Revenue declined by 1% QoQ from RM178.6m on lower contributions from oilfield services segment. However, Velesto’s core PATAMI accelerated to by >100% QoQ to RM21.5m (from RM8.0m in 4Q19) on improved invoicing and cost control measures. Note that operating expenses (-4% QoQ) and an effective tax rate were lower during the quarter (18% vs. 30% QoQ).

YoY. Revenue improved by 39% (from RM127.0m) on the back of higher rig utilisation of 86% (vs 66% in 1Q19) and marginally improved day charter rates of USD71k (vs. USD68k). These were the main drivers in core profits reversing its fortunes from a loss position of -RM22.5m to a profit of RM21.5m YoY.

Outlook. In light of the current global economic headwinds and low oil price environment, the prospective renewed terms for rigs coming off contracts moving forward (N2, N3, N5, N6 up for renewal by mid-CY20) could be jeopardized. Whilst we don’t believe that Petronas will not renew the contracts, there will be very little leg room for Velesto to secure rates in similar vein to HESS – N8 award (c. USD90k). We are of the opinion that it would be in Petronas’s favour to renew the contract option in anticipation of a rebound in demand in a post Covid-19, but this will likely be done at existing rates (c. USD60k-70k) and with a potential increase in the maximum zero rate period etched into these contracts (as it currently stands c.60 days/contract). Thus, this will potentially have ramifications for our utilisation rate assumptions as Petronas could delay their drilling schedule with no penalty for up to 60 days or more in FY21. We had earlier envisaged that Velesto would hit >80% utilisation rates in FY20 (vs. 80% FY19) as most SPS activity has been undertaken in FY19.

Forecast. Despite the strong results in 1Q, we are taking a prudent stance to lower our utilisation rate assumptions for FY20-21 to factor in the uncertainties in drilling schedules moving forward. For FY20, we understand that N3 is sitting idle whilst it awaits on Carigali whilst N4 which was supposed to go to Mubadala earlier in 2Q20, has been delayed to July. We understand that N8 has been delayed to 2021 from 3Q20.We adjust our utilisation rate assumption downward to c.70% from >80%. As such our FY20-21 earnings declines by 25%. We introduce our FY22 numbers.

Downgrade to HOLD, TP: RM0.18. Downgrade to HOLD (from Buy) with a lower TP of RM0.18 (from RM0.26) based on 0.5x FY20 P/B multiple or -1.0SD below its 5 year mean P/B; we deem the discount is justified given the cloudiness surrounding Velesto’s drilling schedules and timing of contract renewals with Petronas.

Source: Hong Leong Investment Bank Research - 21 May 2020