VELESTO was awarded a contract by Carigali Hess for its Naga 8 jack up drilling rig, valued at USD131m. The contract is for 3 firm years, with 3 x 6 months extension options, commencing 2HCY20. Excluding add-ons, we guesstimate daily rate for the contract to be ~USD90k/day – one of the highest in the region, given the long contract duration. We are positive on the award, given the high charter rates and increased earnings visibility. Maintain OP with TP of RM0.40.

Naga 8 drilling rig contract from Carigali Hess. VELESTO announced that it has received a letter of award from Carigali Hess for the provision of 10K Jack Up Drilling Rig for 2020 Drilling Programme. VELESTO will assign the “Naga 8” drilling rig for this contract, with an estimated contract value (firm period only) of USD131m. The contract is expected to commence in 2HCY20 for a firm duration of 3 years, with 3 extension options of 6 months each.

Our take on the contract win. We reckon that roughly 20-25% of the contract value could be from added on services (e.g. mobilisation and other reimbursable costs). Excluding the add-ons, we guesstimate the contract value to imply daily charter rates of roughly ~USD90k/day. We expect the contract to fetch EBITDA margin of ~45%. We understand that the awarded charter rate is one of the highest in the region. As a comparison, average daily charter rate for VELESTO in FY18A was only USD69k/day. The unusually high charter rate is due to: (i) Naga 8 being one of VELESTO’s better performing rigs, and (ii) the long contract duration of 3 firm years (also one of the longest in the region), and thus, the higher-than-average charter rates could provide some degree of “future proofing” for VELESTO, in anticipation of a gradual uptrend in charter rates in the coming few years. That said, we believe it is still somewhat unrealistic to benchmark future contract awards with the aforesaid charter rates, at least for the next couple of months. For upcoming charter contracts within the next few months, we are still expecting charter rates to come in within the region of USD70-80k/day for mid-term charters (i.e. roughly 1 year or so). Overall, we are positive on the contract award, given its highly attractive charter rate coupled with longer-term utilisation visibility for the rig. The award is also in-line with Petronas’ Activity Outlook of higher rig demands going forward for the next 2-3 years.

Naga 8’s charter schedule. Currently, Naga 8 is still servicing its contract with Hess until mid-CY20. The rig will then undergo a special periodical survey (SPS) for about 1-2 months, before being redeployed into the Carigali Hess contract in 2HCY20. Meanwhile, we foresee the next contract award to likely go to Naga 4, with the rig due to be out of contract in end-1QCY20 (currently servicing Roc Oil), while the rest of VELESTO’s rigs have already secured contracts for most of CY20. As for the upcoming results (3QFY19 results due for release later this month), we foresee 2HFY19 to reach utilisations of ~90% (versus 1HFY19 of 70%) as all of its rigs have been contracted out.

Maintain OUTPERFORM, as we continue to like VELESTO given the certainty in its turnaround story, underpinned by clear earnings visibility for the next couple of years. Post-contract award, we raised our FY20E earnings forecasts by 58%, after increasing our daily charter rate assumption to USD75k/day (from USD72k/day previously), and rig utilisation assumption to 90% (from 85% previously). That said, given the increase in earnings outlook and visibility, we raised our PBV valuation to 1.2x (from 1x previously) – which is still close to -1.5SD below its 5-year mean. As a result, our TP is also raised to RM0.40 (from RM0.35 previously). Note that our TP also accounted for a 7.5% share base dilution from the ESOS.

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

Source: Kenanga Research - 6 Nov 2019