We attended Velesto’s 2Q20 analyst briefing. Global jack-up rig demand is expected to fall from 364 rigs to 320 rigs in FY20 and jack-up rig demand for Malaysia is expected to fall from 10 rigs in FY20 to 9 rigs based on current market conditions. Naga 2 has secured a short extension from August until the end of October and the Company would be left with 2 chartered rigs from November until December and only 1 rig in 1Q21 as Naga 8 is only expected to start its Carigali HESS contract in 2Q21. We maintain our utilization rate assumption of 55% for FY20. Maintain SELL at TP of RM0.12 based on 0.35x FY20 BVPS. The jack-up rig market is expected to stay subdued without an increase in spending from Petronas on exploration activities.

We Attended Velesto’s 2Q20 Analyst Briefing; the Following Are the Key Takeaways:

Recap. 2Q20 core loss of -RM8.3m (QoQ: RM20.4m, YoY: RM11.9m) brought 1H20 core profit to RM12.1m (YoY: -RM10.6m). The results was within our expectations (FY20f: -RM11.6m) but below consensus’ (FY20f: RM8.4m) as we expect 2H20 to be significantly weaker due to lower rig utilisation rates.

Macro outlook. According to IHS, there are 443 jack-up rigs available for contracts globally and there are plenty of potential for more rigs to be retired as about 146 rigs are above the age of 30 years, while 296 are below the age of 30 years. Of the 443 rigs available to be contracted in the market, 79 (18%) rigs are idle and 364 (82%) are contracted. New build rigs coming in the year 2020/21/22 globally is expected to be 14/18/11. Velesto believes that there is a high likelihood that new build rigs would come in lower than expected due to weak utilization globally as total jack-up demand is expected to fall from 364 in FY20 to 320 in FY21. 10 rigs are expected to be contracted in FY20 in Malaysia and 9 are expected in FY21. However, the Company expects more than 9 jack-up rigs to be chartered in FY21 as more wells needs to be drilled.

Status of rigs. Naga 2 has secured short extension from August 2020 until the end of October 2020. There would be 4 contracted rigs until the end of 3Q20, 3 contracted rigs from October to November 2020 and 2 contracted rigs from November to December and only 1 contracted rig in 1Q20 as Naga 8 is only expected to commence its Carigali HESS contract in 2Q21.

Daily Charter Rates. DCR was flat over the last 3 quarters. DCR for 2Q20 stood at USD72k (1Q20: USD71k, 4Q19: USD71k). DCR is expected to remain flat going forward.

Cost saving initiatives. Velesto has saved RM25m in FY19 from operational cost and is expected to save up to RM20m this year through further cost rationalization plans. The Company has taken steps to move its office staff to offshore and have frozen hiring for the time being.

Covid-19 expenses. Covid-19 expenses has almost fully recovered in 3Q20; Covid- 19 expenses in 2Q20 would not recur in 2H20 based on the current trend of cases in Malaysia.

Impairments. Minimal to no impairments expected as impairments have already been done significantly from FY18-19.

M&A. Not expected to acquire any new jack-up rigs despite its fire sale valuation to be prudent as the Company is aiming to improve its net gearing position.

Outlook. We believe that exploration drilling would continue to suffer from Petronas’ lower capex spending. Our blended utilisation rate assumption for Velesto remains unchanged at c.55%. Assuming no renewal of contract extensions, the Company would be left with 2 chartered rigs from November until December and only 1 rig in 1Q21 as Naga 8 is only expected to start its Carigali HESS contract in 2Q21. However, we have assumed that Velesto will be able to secure several 6 to 9 months contract next year to bring its total average utilisation to 50% and we expect daily charter rates to remain flat at about USD70,000/day.

Forecast: Unchanged

Maintain SELL, TP: RM0.12. Maintain SELL recommendation with unchanged TP of RM0.12 based on 0.35x (-1.2SD below 5 year mean) FY20 BVPS. We believe that Velesto would need to secure more rig contracts from Petronas for us to warrant a re rating on our call

Source: Hong Leong Investment Bank Research - 27 Aug 2020