Review

• Velesto Energy Bhd (VEB)’s 9M19 core profit of RM23.5mn (9M18: RM47mn loss) trumped our expectations and but was within consensus’ – accounting for >100%/73% of full-year estimates. The outperformance versus our estimates was due to higher-than-expected contribution from the drilling fleet.

• QoQ, profit jumped more than 3-fold mainly due to a surge in fleet utilization to 92% (2Q19: 74%). This was underpinned by: (1) NAGA 6 was deployed for a new long-term contract for Petronas Carigali in Jul-19, and (2) full 3-months contribution from NAGA 2, 3 & 5 in 3Q19 for contracts that commenced in May-19.

• Additionally, 3Q19 results were boosted by deployment of a second Hydraulic Workover Unit (HWU) unit. The combination of the above factors more than compensated for sequentially higher depreciation and taxes.

• Stellar 9M19 results were mainly driven by the Drilling segment on the back of: (1) improved fleet utilization of 77% (9M18: 66%), and (2) higher Daily Charter Rates (DCR). Recall that NAGA 2, 3, 5, & 6 (deployed: Mar-Jul 2019) secured long term contracts at higher DCR of 3%-12% (versus FY18).

• Additionally, to a lesser extent, 9M19 profits were boosted by:- (1) higher utilization and DCRs from the HWU fleet, and (2) turnaround of the Oilfield Service (OFS) segment with pretax profit of RM1.4mn (9M18: RM7mn LBT). OFS’s losses in 9M18 were mainly attributed to a provision for retrenchment benefits (RM4.0mn).

• The drivers above more than offset drag from higher depreciation, finance costs and taxes in 9M19. Depreciation inched up due to capitalization of Special Periodic Survey (SPS) costs (circa RM82mn).

Impact

• Maintain earnings estimates pending updates from management at today’s analyst briefing.

Outlook & Valuation

• We expect full fleet utilization in 4Q19 except for SPS downtime for NAGA 3 and 7. Following completion of their SPS by end-19, both rigs will resume their existing contracts. Meanwhile, we expect NAGA 8 to undergo SPS in FY20,

• Recall that 5 out of 7 rigs in VEB’s fleet are chartered out to Petronas Carigali on long term basis (up to 2Q 2022 – 2H23). Meanwhile, we believe there is high chance that the balance 2 rigs (expiry: 2H20) will secure new contracts or extensions. This is given high demand in both local and regional markets.

• Domestically, Carigali requires more than 16-18 jack-ups in FY20, including 5 rigs chartered from VEB. Whereas locally-owned jack-ups merely amounted to 8 rigs (including Perisai’s rig). Recall that Carigali prioritizes local players for contract awards. Therefore, this implies demand far surpassing supply in the local jack-up market. Vice versa, VEB also prioritizes local contracts, given higher rates, cost efficiency and a reliable counter party in Petronas.

• We believe VEB’s earnings still has room for growth, on the back of: (1) upside in DCRs, - for new projects and contract extensions, (2) higher HWU fleet deployment, and (3) interest savings from management’s intentions to progressively pre-pay loans.

• Currently, 2 out of 4 HWU are chartered-out – which implies room for improvement. Additionally, upside risk lies in management’s intentions to charter out 3rd party rigs locally. Against this backdrop, we maintain Buy on VEB with unchanged target price (TP) of RM0.43 based on 13x CY20 EV/EBITDA.

Source: TA Research - 29 Nov 2019