FY19 results managed a turnaround from losses, slightly beating our expectations, thanks to healthier drilling rig utilisation (80% vs 73%). Moving forward, with all rigs expected to be utilised throughout 2020, we believe FY20 will be an even stronger year. Possible renegotiation of higher charter rates could also act as further catalyst. Maintain OUTPERFORM with TP of RM0.43.

Above our expectation, but below market’s. VELESTO recorded FY19 core net profit of RM32m, exceeding our forecast by 8% due to slightly better-than-expected margins. However, results came in below market’s expectations, making up only 74% of consensus estimate. We suspect this could be due to market’s overestimation of VELESTO’s drilling rig utilisation rates during the year. Meanwhile, no dividends were announced, as expected.

FY19 turning to black, but weaker 4QFY19. VELESTO managed to turn around in FY19 from losses last year, thanks to healthier rig utilisation (80% vs 73%). 4QFY19 posted core net profit of RM8.1m – a steep decline both YoY and QoQ. The poorer quarterly results were due to lower rig utilisations of 86% versus 92% in 3QFY19 and 91% in 4QFY18, as two of its rigs (namely Naga 3 and 7) underwent their mandatory five-yearly Special Periodic Survey (SPS).

An even stronger FY20 to come. Moving forward, VELESTO is set to post an even stronger year in FY20, as all seven of its rigs already have contracts at hand and will be utilised throughout the year. Meanwhile, a possible rate renegotiation with Petronas Carigali upon extension of contracts for rigs Naga 2, 3, 5 and 6 (existing firm period contracts set to expire in at around mid-FY20) could also act as another catalyst for the stock, should the renegotiated rates be higher than existing ones. We believe should a renegotiation take place, it would most likely be announced by end-2QFY20.

Maintain OUTPERFORM, with unchanged TP of RM0.43 pegged to 1.2x FY20E PBV – which is still close to -1.5SD below its 5-year mean valuations. Post-results, we made no changes to our FY20E forecasts, but introduce new FY21E numbers. Our forecasts are based on the assumptions of: (i) 90% rig utilisation, (ii) USD75k/day and USD77k/day daily charter rates for FY20 and FY21, respectively, and (iii) MYR/USD exchange rate of RM4.10/USD. We continue to like VELESTO given its clear earnings visibility for the next 1-2 years. Key catalysts would include continued earnings delivery, and the aforementioned renegotiation of rates, on top of further contract awards. 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, (iii) lower-than-expected margins, and (iv) stronger-than-expected Ringgit.

Source: Kenanga Research - 26 Feb 2020