VELESTO is now bidding for more long-term contracts regionally in-lieu of stabilizing DCRs. We are wary of earnings de-rating given that DCRs have plateaued and weaker fleet utilization in 3QFY23. We cut our FY23F earnings forecast by 15%, but maintain our TP of RM0.19 (based on unchanged 15x FY24 PER) and UNDERPERFORM call.

We came away from VELESTO’s post-results briefing feeling cautious of its near-term prospects. The key takeaways are as follows:

Flattening DCRs. VELESTO believes that current daily charter rates (DCRs) are stabilizing at c. USD130K. On the back of this, the company is now targeting to secure long-term contracts in the range of 2-3 years to lock-in current rates. Correspondingly, VELESTO’s current tender book of RM4.2b mainly comprises long-term contracts (74%) spread over 6 tenders (short term: 19 tenders). However, at this juncture, such long-term contracts are only available in regional markets. As such, 19% and 21% of VELESTO’s tenders are in Vietnam and Thailand respectively. In contrast, the company’s fleet of 6 rigs are currently all working in Malaysian waters. In addition, VELESTO is also bidding for DCRs in the range of USD130k for its current negotiations with clients. This includes the Petronas umbrella contract that expires soon in Feb 2024.

Market remains robust. The jackup market remains tight, whereby current marketed rig utilization in Southeast Asia (SEA) and Malaysia is stable at 100%. Meanwhile, DCRs in Jul-23 remain strong at USD68kUSD152k (1QFY23: USD68k-USD131k) in SEA and USD88k-USD131k (1QFY23: USD90k-USD131k) in Malaysia. Nevertheless, according to VELESTO, the higher range of USD152k in SEA was for a short-term contract extension.

Expectations of a weaker 3QFY23. VELESTO expects a weaker 3QFY23 on the back of lower fleet utilization. This is due to: (i) repair and maintenance works for NAGA 2 until late 3QFY23, (ii) NAGA 3 was unable to exercise a contract extension due to unstable soil conditions at the previous project site, (iii) special periodic survey for NAGA 4 in 3QFY23, and (iv) underwater inspection in-lieu of drydocking for NAGA 8 in late 3QFY23. As such, VELESTO expects lower fleet utilization in the range of 58%-60% in 3QFY23 (2QFY23: 88%). On the bright side, the company provided guidance that 3QFY23 earnings will be partially cushioned by higher DCRs. Additionally, the deployment of GAIT 5 hydraulic workover unit towards the latter half of 3QFY23 will also provide a slight uplift to earnings.

Opex under control. VELESTO believes that ongoing opex escalation is stabilizing and is currently “under control”. This is underpinned by implementation of its new Enterprise Resource Planning software for inventory management. Additionally, manpower costs are also stabilizing after an earlier round of salary adjustments. Similarly, interest costs are also expected to stabilize after the rise in effective interest rate from 7.15% in Feb-23 to 7.5% currently. On the other hand, based on our view, cost headwinds may still linger given tight supply of materials and manpower resources. This is on the back of ongoing multi-year, multi-rig tenders in the Middle East. According to Westwood Riglogix, contract tenures for outstanding tender and pre-tenders in the Persian Gulf have snowballed to 29 years currently.

Forecasts. We cut our FY23F earnings forecast by 15% as we reduce our drilling fleet utilization assumption to 83% (from 88%).

We maintain our TP of RM0.19 based on 15x FY24F PER. This is in-line with ascribed valuations for local-centric service providers within our coverage (ie. DAYANG). There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see page 4).

We are cautious due to: (i) possible earnings de-rating due to drag from lower fleet utilization in 3QFY23, (ii) stabilizing DCRs amidst persistent high costs may compress margins, and (iii) higher interest rates may result in increased financing costs. Maintain UNDERPERFORM.

Risks to our call include: (i) fleet expansion via acquisition of new jack-up rigs, (ii) inflated DCRs as jack-up market tightens further, and (iii) topline boost from a strong USD/MYR.

Source: Kenanga Research - 1 Sept 2023