We maintain our positive view on Velesto Energy’s (Velesto) earnings recovery on the back of improving drilling rig utilisation. In addition, the three-year lawsuit against Frontier Oil Corp has finally come to an end, with Velesto winning the suit. Velesto will now be able to claim damages of RM78m, which is cash-flow positive in our view. We reaffirm our BUY call with unchanged DCF-derived target price of RM0.35, offering 21% upside.

Wins Court Case Against Frontier Oil

To recap, Velesto (previously known as UMW Oil and Gas) sued Frontier Oil in April 2015 for an early termination of UMW NAGA 7 for a total of US$19.2m as well as Frontier's failure to issue a US$5m bank guarantee and a US$15m advance payment. Velesto recently announced that the claim was successful and the company was entitled to a total damages claim of US$19.9m (RM78m), inclusive of accrued interest during the period. We are of the opinion that the amount received will be deployed for future working capital requirements or utilised to repay loans, in an effort to lower its finance costs. As at end 1Q18, net debt stood at RM1.02bn with 0.39x net gearing level.

More Contracts to Roll Out; DCR Sees No Improvement to Date

Velesto was bidding for US$660m worth of jobs, which consists of 77% shortterm and 23% longer-term contracts. Of the total 30 contracts, 15 are from Malaysia, while the rest are from overseas tenders. Daily charter rates (DCR) in Malaysia remain on the higher end, ranging from US$68,000-70,000 per day, as compared to US$55,000-65,000 per day for the oversea contracts. We remain optimistic on the group’s near-term outlook as Petronas has only started drilling 9 out of its targeted 22–24 exploration wells thus far, signalling more drilling contracts to be awarded.

Flat 2Q18 Utilisation, 2H18 Improvement

We maintain our forecast that Velesto will report a profit in our FY18. We expect utilisation rates in 2QFY18 to be similar to 1QFY18, due to the lower contribution from NAGA 7 as it undergoes scheduled maintenance. Nevertheless, 2H18 will likely see utilisation rates rise to 80-85%, boosted by contract extensions and new contracts secured. This will result in a fullyear utilisation rate of 72%, in line with our existing forecasts.

Source: Affin Hwang Research - 25 Jul 2018