We are initiating coverage on VELESTO with an OUTPERFORM call with TP of RM0.35, on its expected turnaround underpinned by improving utilisation and charter rates outlook. In addition, further impairment is also unlikely. VELESTO being the single largest jack-up drilling rig provider in the country with almost non-existent local competition is well-positioned as the prime proxy for increased drilling activities from Petronas.

Largest jack-up drilling rig player in the country. VELESTO, best known as a jack-up drilling rig provider, is the largest jack-up drilling rig player in Malaysia, operating 7 rigs (named numerically from ‘Naga 2’ to ‘Naga 8’), and services roughly less than half of Petronas’ jack-up drilling rigs requirement. Local competition is almost non-existent, with the only other local competitor being PERISAI, which has only 1 jackup rig, while international players fill up the rest of Petronas’ jack-up rigs demand. Although this means that realistically, VELESTO may not be venturing overseas for the time being, but instead focusing its efforts in the local market, this also inevitably positions the company as the best proxy in Bursa for local oil and gas drilling activities.

Beneficiary of Petronas’ increased activity. In the latest Petronas activity outlook, the oil major states that it is expected to roughly double its demand for jack-up rigs, from 9-10 units in 2018 to approximately 16-18 in 2019, and 17-19 units in 2020-2021. This is as Petronas looks to increase its brownfield activities. Nonetheless, this would make VELESTO the prime beneficiary of Petronas’ increased drilling activity, given its position as the main jack-up drilling rig player in Malaysia, although it is still imperative for it to remain competitive to withstand pricing pressures from international players.

Turnaround story driven by improving utilisation. Overall, we are expecting VELESTO’s bottom-line to post a turnaround in FY19-20, underpinned by an increase in rig utilisation rates (projected FY19E/FY20E utilisation rate to be at 80%/85%, up from 73% in FY18A and 70% in FY17A). This comes after the company managed to secure 1+1-year contracts for four of its rigs back in April 2019 (namely Naga 2, 3, 5 and 6). Meanwhile, charter rates are also expected to stabilise on the back of the increased demand, currently hovering slightly above USD70k/day, after bottoming out at USD68k/day in 2017, from a peak of USD151k/day in 2014.

Initiate coverage with OUTPERFORM call, on the back of a turnaround story, clear earnings visibility for the next 1-2 years, while we also see limited downside risks from current share price levels. Our TP of RM0.35 is pegged to 1x PBV on FY20E – roughly in-line with its 2-year mean valuations. Our ascribed valuation is also somewhat inline with the local oil and gas sector average. We believe our ascribed valuations to be fair, as we deem further impairments to be unlikely, after massive impairments of RM2.1b over the past 4 years, on the back of improving utilisation and charter rates outlook. Additionally, VELESTO reportedly had also demonstrated strong environmental, social and governance practices, being one of the few names within the oil and gas industry to be included into the FTSE4Good Bursa Malaysia index. That said, we believe a range-bound trading strategy of RM0.30-0.35 would suite the stock (i.e. prices of RM0.30 and below would pose as an opportune entry, while prices of RM0.35 and above as an attractive take-profit level), as opposed to a “buy-andhold” approach.

Risks to our calls include: (i) poorer-than-expected rigs utilisation, (ii) weaker-than-expected charter rates, and (iii) lower-than-expected margins.

Source: Kenanga Research - 20 Aug 2019