Contract for Naga 4 drilling rig. VELESTO announced that it has received a letter of award from Mubadala Petroleum for the provision of jack-up drilling rig unit and services for the Pegaga Development Drilling Campaign, with an estimated contract value of USD30m. The contract is to drill 7 firm wells with expected commencement in 2QCY20. VELESTO will use its Naga 4 drilling rig to undertake the works.

Takeaways from the contract. While no contract tenure was officially disclosed in the announcement, based on the job scope, we guesstimate the contract would roughly take 12 months to complete. Assuming ~10% of the contract value are for add-ons (e.g. mobilisation and other reimbursable costs), the contract value would imply charter rates of ~USD75k per day, which is in-line with current market rates for premium rigs. We expect the contract to fetch roughly ~45% EBITDA margin, contributing to ~16% of our FY20E EBITDA.

Positive on the contract win. While the award for Naga 4 was highly anticipated (as highlighted in several of our previous reports), we are still positive on the contract award nonetheless, as it not only signifies VELESTO’s ability of continued contract wins, but also sustained uptick in drilling rig demand for Malaysian waters. The contract win also means that all 7 of VELESTO’s drilling rigs would be utilised throughout most of 2020, assuming contract extensions for Petronas Carigali charted rigs (Naga 2, 3, 5 and 6).

Maintain OUTPERFORM, with unchanged TP of RM0.43, pegged to 1.2x PBV, which is still close to -1.5SD below its 5-year mean valuation. No changes to our FY19-20 forecasts, as the contract win have already been well imputed into our assumptions. Our FY19E/FY20E numbers are derived based on the assumptions of (i) 80%/90% rig utilisation, and (ii) average daily charter rates of USD72k/USD75k, respectively.

We highlight VELESTO as a proxy for the drilling rig space in Malaysia, being the largest and only listed jack-up drilling provider in the country. That said, we continue to like VELESTO given the certainty of its turnaround story, with clear earnings visibility for the next 1-2 years. The name is also an ESG-play within the oil and gas sector, being a constituent of the FTSE4GOOD index.

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 - 12 Dec 2019