What Happened?

• Carigali Hess Operating Company Sdn Bhd (Carigali-Hess) awarded a contract to Velesto Energy Berhad (VEB) for the Provision of 10K Jack Up Drilling Rig for 2020 Drilling Programme.

• VEB will assign NAGA 8 for this contract with an estimated value of USD131mn (for the tenure of its firm period).

• This contract is expected to commence in 2H20, for a tenure of 3 years with 3 extension options of 6 months each.

• Carigali-Hess is engaged in gas production in Block A-18 of the Joint Development Area administered by the Malaysian-Thailand Joint Authority.

Our Take.

• Deployment of NAGA 8 falls within our expectations, as we have factored in a new contract for this rig post-expiry of its current contract with Carigali-Hess (expiry: Apr-20). We had also assumed that NAGA 8 will undergo its Special Periodic Survey post-completion of the latter.

• Nevertheless, the contract terms surpass our expectations, in terms of: (1) contract tenure, and (2) Daily Charter Rates (DCR). In particular, the implied DCR of USD120K far exceeds our previous assumption of USD76K in FY20-21. It also implies a whopping 58% jump versus NAGA 6’s DCR (estimate: USD76K). To recap, the latter had the highest DCR amongst recent contracts secured by VEB.

• NAGA 8’s new contract has the longest tenure amongst projects secured by VEB since the oil price downcycle in 2017-18. Recall that back in Apr- 19, the Group secured its first batch (client: Carigali) of long term (1+1+1 year) contracts for 4 rigs with expiries stretching up to 2Q22. Therefore, NAGA 8’s contract (tenure: 4.5 years until up to 1H25) further enhances the Group’s earnings visibility.

• Out of VEB’s fleet of 7 rigs, VEB now has 5 rigs on long term contracts. Therefore, only NAGA 4 and NAGA 7 have near term expiries in 2020. Nevertheless, we believe that both rigs are in high demand locally - given Petronas’ heightened requirements. Based on Petronas’ Activity Outlook 2019-21, Carigali requires more than 16-18 jack-ups in FY20, including five rigs chartered from VEB.

Impact

• We raise NAGA 8’s DCR assumptions in FY20-21 to match actual new contract terms. Correspondingly, our FY20/21 earnings forecasts for VEB is raised by 13%/41%.

Valuation

• FY19 will be a good year for VEB – underpinned by earnings turnaround and improved income visibility. Correspondingly, this was reflected in YTD doubling of VEB’s share price. Nevertheless, we believe VEB’s earnings still have legs for growth, underpinned by: (1) upside in DCRs, (2) higher fleet deployment for VEB’s Hydraulic Workover Units (HWUs), and (3) interest savings from management’s intentions to progressively pre-pay current loans.

• Due to a tight market for global jack-ups, we anticipate higher DCRs from current spot rate of USD72k. Furthermore, DCRs for 4 of VEB’s rigs contracted to Carigali are subject to annual review before exercise of options. Therefore, this implies potentially higher DCRs for VEB’s fleet, including rigs on long term charters.

• On the back of the robust outlook above, we upgrade VEB’s target price to 13.5x CY20 EV/EBITDA (previous: 12.5x). This implies a 1x premium versus global peers’ average of 12.5x. We believe this is justified - given Petronas’ favour for local content, and coupled with the fact that VEB owns 7 out of 8 Malaysian rigs. Therefore, VEB’s orderbook is relatively resilient compared to its peers. Furthermore, Malaysian DCRs are currently at a premium versus regional rates.

• Our target price (TP) for VEB is hence raised to RM0.43 (previous: RM0.38). Maintain Buy.

Source: TA Research - 6 Nov 2019