VELESTO’s FY22 results disappointed due to surging costs. Going forward, it could still be weighed down by a high cost structure until it renegotiates for higher charter rates from new contract cycle. We cut our FY23F net profit by 30% but raise our TP by 19% to RM0.19 (from RM0.16), and maintain our UNDERPERFORM call.

Results missed expectations. FY22 core net loss of RM96m came in 56% wider than our loss forecast and >3x larger than consensus loss estimate. The variance against our forecast came largely from higher-than-expected project and corporate costs.

More specifically, 4QFY22 results plunged deep into losses amidst: (i) overrun of project costs due to supply chain disruptions, which impacted availability of oilfield equipment and spares, (ii) unanticipated project work programmes and demobilisation, (iii) reactivation costs to mobilise a work-over unit which was idle for an extended period of time, and (iii) adjustment of inventories and tax expense in relation to prior periods. These combined factors more than erased the positive impact from the healthy rig utilisation of 90% (versus 3QFY22 of 78%).

Narrowed losses. YoY, FY22 core losses narrowed 45%, on the back of the improved rig utilisation of 62%, versus 48% last year. On a cumulative full-year basis, this was more than enough to offset the impact of the higher project and corporate costs seen in 4QFY22.

Utilisation outlook set to improve. After sluggish rig utilisations for almost the past two years, we believe the market outlook for jack-up rigs are finally turning a corner. Regional demand for jack-up rigs is currently on the rise, which will inevitably benefit VELESTO being the largest jack-up rig provider in Malaysia. Nonetheless, we believe VELESTO could still suffer from a high cost structure amidst supply chain disruptions. As such, we see successful renegotiation of contracts to higher charter rates as crucial for VELESTO to continue operating profitably.

Forecasts. We lowered our FY23F earnings by 30% to account for lower operating margins assumption, while simultaneously introducing new FY24F numbers. Our forecasts are based on a rig utilisation assumption of 80% and charter day rates of USD85k-100k.

Maintain UNDERPERFORM, albeit with a higher TP of RM0.19 (from RM0.16 previously), as we roll forward our valuation base year - pegged to 15x PER, in-line with the ascribed valuations for other local centric equipment and service providers within our coverage universe (e.g. DAYANG). There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see page 4).

While we like VELESTO as a prime beneficiary of the resurgence of the local drilling market, we believe its current valuations are already rich. Additionally, VELESTO could still suffer from the higher cost structures until it secure higher charter rates from new contract cycle.

Risks to our call include: (i) oil prices scaling new highs, and (ii) oil production rig market continues to tighten, taking daily charter rates higher.

Source: Kenanga Research - 28 Feb 2023