VELESTO posted a solid set of 1QFY20 results, turning around from losses last year thanks to higher rig utilisation (86% vs. 66%) coupled with some cost saving efficiencies. However, we believe its outlook remains uncertain, as four of its rigs chartered to Petronas Carigali could face under utilisation risks. Maintain UP, given the earnings risks, with TP of RM0.14.

Deemed as below expectations. Despite the positive results (a turnaround from losses last year), VELESTO’s 1QFY20 core net profit of RM20.4m (arrived after stripping-off forex) is deemed below expectations, coming in at 31% of our, and 42% of consensus, forecast full-year earnings. This came about as we are anticipating a weaker 2HFY20, stemming from rig utilisation uncertainties amidst the low oil price environment. No dividends were announced, as expected.

Solid 1QFY20 quarter. YoY, 1QFY20 rebounded from losses last year, mainly attributed to higher rig utilisation (86% vs. 66%). Sequentially, core net profit also vastly improved, despite flattish revenue and rig utilisation of 86%. This was due to higher invoicing efficiencies, coupled with fruition of cost saving efforts resulting in improved margins, coupled with lower tax expense recognition.

Uncertainty in outlook. Despite its solid 1QFY20 performance, some uncertainty still lingers going forward. Four of VELESTO’s rigs which are chartered to Petronas Carigali (namely, Naga 2, 3, 5 and 6) have their firm contract periods due in the coming months. VELESTO is currently in contract extension negotiation with Petronas Carigali for up to two years’ for the rig charters, but we understand that there may be lower demand for drilling rigs from the client. Therefore, this poses a risk on its rig utilisation moving forward, as even with a successful materialisation of contract extensions, the rigs could still be left idle for duration of time.

Maintain UNDERPERFORM, given the earnings risk, especially going into 2HFY20. Post-results, we slashed our FY20E/FY21E earnings by 61%/60% as we lowered our rig utilisation assumption to 75%, from 90% previously. Our TP is slightly raised to RM0.14 (from RM0.11 previously) as we roll over our valuation base year to FY21E, pegged to “floor” valuations of 0.4x PBV at -2SD from its 3-year mean. Given the uncertain outlook despite the solid set of 1QFY20 results, we suggest a “take profit at strength” strategy when trading the counter, in anticipation of the weaker quarters ahead.

Risks to our call include: (i) unexpected recovery in utilisation, (ii) stronger-than-expected charter rates, (iii) higher-than-expected margins, and (iv) weaker-than-expected Ringgit.

Source: Kenanga Research - 21 May 2020