VELESTO anticipates stronger average daily charter rates (DCR) in FY24 following the contract renewals for four rigs, but flattish utilisation at 80%-85% due to significant maintenance activities. We raise our FY23-24F earnings forecasts by 20% and 46%, lift our TP by 53% to RM0.26 (from RM0.17) and upgrade our call to MARKET PERFORM from UNDERPERFORM.

We came away from an engagement with VELESTO feeling positively upbeat on the local rig market outlook. The key takeaways are as follows:

1. Rig utilisation to surge in 4QFY23. VELESTO projects a substantial increase in rig utilisation rates in the upcoming reporting quarter, targeting a 90% utilization rate as multiple rigs entered full operations. The average daily charter rate (DCR) for the rigs is anticipated to remain at USD97,000/day in 4QFY23, consistent with the achieved rates in 3QFY23.

2. More DCR renewals in FY24. In addition to NAGA 8, which has secured a DCR of USD137,000/day, Naga 2, 4, and 5 will undergo charter renewals at various points in FY24. VELESTO indicates that the DCR for new contracts will fall within the range of USD120,000-130,000/day. Hence, this is expected to push the average DCR for the group close to USD120,000/day, potentially surpassing our initial expectation of USD107,000/day for FY24.

3. Four rigs to come under scheduled maintenance. Four rigs (Naga 2, Naga 3, Naga 5, and Naga 6) are scheduled for major maintenance in FY24. VELESTO anticipates that average rig utilization will fall within the range of 80%-85%, similar to FY23. The estimated major maintenance cost per rig is USD10m, and the company plans to depreciate these costs over the next five years, following its standard practice.

Forecasts. We upgrade our FY23-24F earnings projections by 20% and 46%, factoring in higher average DCR assumptions (FY23: adjusted from USD90,000/day to USD93,333/day, FY24: adjusted from USD107,000/day to USD118,300/day). Our assumptions for rig utilisation stand at 83% for FY23 and 84% for FY24.

Valuations. As a result, we lift our TP by 53% to RM0.26 from RM0.17 based on 15x FY24F PER, at a slight premium to valuations of regional drilling peers (PETROVIETNAM: 14x) due to VELESTO’s supportive client, Petronas. There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see page 4).

Investment case. We like VELESTO due to: (i) the positive outlook of the local jack-up rig market buoyed by strong demand amidst firm crude oil prices, (ii) its strengthened bargaining power as a result, paving the way for better DCR on contract renewals, and (iii) potential upside surprises to its margins on early signs of easing labour cost inflation. However, we acknowledge VELESTO’s significant scheduled maintenance activities in FY24 which could limit its earnings upside. Nonetheless, its valuations have become more reasonable after our earnings upgrade. Raise to MARKET PERFORM from UNDERPERFORM.

Risks to our call include: (i) a sharp plunge in crude oil prices, (ii) lower-than-expected DCR on rig contract renewals, and (iii) longerthan-expected maintenance duration for rigs.

Source: Kenanga Research - 17 Jan 2024