Velesto Energy’s (Velesto) 1Q20 result missed our and consensus expectations. While there was a sharp jump in earnings, we believe this was partly due to some one-offs, one of which being inventory write-back. Risk lies with 4 out of 7 rigs due for renewal (Naga 2, 3 and 5 in May-20 and Naga 6 in August-20) from Petronas Carigali. Management did not provide a clear timeline on contract renewals; however, the base renewal rates are likely to be similar to current firm contracts. We cut our earnings to factor in weaker utilisation and daily charter rates (DCR). Downgrade to Sell on the uncertain outlook, despite raising our target price to RM0.15 after rolling forward valuation.

Rig Utilization Rose to 86% in 1Q20

1Q20 revenue rose 39% yoy to RM176m as the rig utilisation rate rose to 86% vs 66% in 1Q19. This led to an EBITDA margin improvement of 19.6ppts and with results swinging back to a core profit of RM20m. Current firm contracts in hand would translate to a ~55% average rig utilisation rate in 2020E. Any level higher than this is dependant on securing contract renewals from Petronas Carigali for the 4 rigs.

Operating Cost Down 22% Qoq on Write-backs, But Undisclosed

Sequential revenue was relatively flat at RM176m with similar rig utilisation at 86%. Notwithstanding this, core net profit saw a 1.5x fold jump as a result of a 22% decline in operating costs, inevitably driving EBITDA margin up 11.6ppts. We gather that one of the reasons was due to an inventory write-back recorded, however the quantum of one-off was not disclosed.

Downgrade to Sell

We slash our 2020-22E earnings forecasts as we project lower average rig utilisation of 72%/67%/75% (from 81-88% previously) and DCRs of US$71,000-73,000 (from US$73,000-79,000 previously). We now expect Velesto to fall back into a loss in 2021, as we believe there is risk for Petronas and the other oil majors cutting back on capex in 2021E. We raise our target price to RM0.15 (from RM0.14), but downgrade the stock to our Sell rating given the uncertain outlook. Risks to our call depends on better-than-expected or worse-off rig utilisation and DCR.

Source: Affin Hwang Research - 22 May 2020