• 4Q20 results missed our and consensus estimates. Velesto incurred RM461m impairment on its rigs, ahead of an anticipated domestic capex recovery
• Full year 2020 average rig utilisation came in lower at 66% (2019: 80%) as 4Q20 utilisation dipped to 50% (from 60% in 3Q20)
• Maintain Buy with a DCF-based target price at RM0.24, implying a PBV multiple of 0.18x

2020 Revenue Fell on Lower Utilization, Swung Back Into the Red

2020 was off to a good start, recording an 86% utilization rate in 1Q20, but this was subsequently disrupted as COVID hit and impacted its drilling programme, driving utilization lower to 67% in 2Q20, 60% in 3Q20 and 50% in 4Q20. Full-year utilization rate came in at 66% as compared to 80% in 2019, driving revenue 19% lower yoy. Velesto also had to incur RM15m additional COVID-related costs, but thankfully were able to keep overall group cost lower by 24% yoy. Despite the losses in 2020, operating cash flow improved by 60% yoy, bringing down its net gearing to 0.28x (end-19: 0.39x).

Kitchen Sinking Ahead of Capex Upcycle Recovery

Velesto recognized a RM461m impairment on its drilling rigs in 4Q20. The previous kitchen sinking exercise on its rigs was back in 2017, which amounted to RM982m during the period where it was undergoing its rights issue exercise. Prior to that, Velesto had to make an impairment charge of RM780m on its rigs in 2016. During the last 5 years, Velesto had to write down a total of RM2.2bn on its rigs as a result of the oil price crash in 2014 and 2020. These kitchen sinking exercises were necessary to reflect a more realistic scenario of its long-term utilization rates and daily charter rates due to unforeseen crisis. With Brent oil price now hovering around US$60-70/bbl and with Petronas raising domestic capex to RM22-25bn (+25-44% yoy) for 2021, we believe the worst is over and could see upside to the 10 rig requirement (2020: 11.5 rigs) previously announced in Petronas Activity Outlook, benefiting the jack up space.

Maintain Buy

We expect Velesto to record a smaller loss in 2021, on the back of lower depreciation charges post impairment and from finance cost savings (total borrowing reduced by another 11% qoq as of end-2020). We recently upgraded the stock to a Buy in our sector note, highlighting it as a beneficiary from potentially higher industry capex spending. Our DCF-based target price stands at RM0.24. Downside risk: delay in securing new contracts leading to low rig utilization and daily charter rates.

Source: Affin Hwang Research - 25 Mar 2021