VELESTO secured a drilling contract from Roc Oil for the Naga 2 rig worth USD14m. Overall, we are positive on the contract win, being reflective of a resurgence of rig demand in the market. Its share price has more than doubled since our upgrade to OUTPERFORM in Sep 2022. While its outlook remains positive, we believe its valuations are rich at the current level. We maintain our forecasts and TP of RM0.16 but downgrade our call to UNDERPERFORM.

Naga 2 contract from Roc Oil. VELESTO has received a letter of award from Roc Oil (Sarawak) Sdn Bhd for the provision of jack-up rig drilling rig services. The contract is for the Naga 2 jack-up rig to drill three firm wells, with an estimated contract value of USD14m and an estimated commencement date of between 25 Jan 2023 to 25 Feb 2023.

Below are some of our takeaways from the contract win:

1. Key assumptions. Based on the job scope, we reckon the duration of the contract should be ~4 months. Assuming ~30% of the contract value are add-ons, this implies a daily charter rate of ~USD80k. This is higher than VELESTO’s historical day rates over the past few years of ~USD70-75k and is reflective of the current up trending rates in the market amidst the demand resurgence. We expect the contract to fetch an EBITDA margin of ~45% - in-line with historical average. The Naga 2 rig is currently also servicing Roc Oil, and hence, this contract award can also be somewhat seen as an extension contract from an existing client.

2. More wins to come. We are positive on the contract win, as this is reflective of a resurgence of rig demand and activity level in the domestic market. Being Malaysia’s largest jack-up drilling rig provider, VELESTO is poised to benefit from this resurgence in demand. As such, with this being the first contract win for the year, we believe more wins will come to quickly fill up VELESTO’s rig schedule for the rest of the year.

Forecasts. No changes to our current forecasts as the new win is deemed to fall well within our assumptions. Our FY22F/FY23F earnings are based on a rig utilisation assumption of 60%/80% and average daily charter rates assumption of USD75k/85k.

Downgrade to UNDERPERFORM (from OUTPERFORM previously), with an unchanged TP of RM0.16 – 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 (see page 4).

While we like VELESTO as a prime beneficiary of the resurgence of the local drilling market, its current valuations are already rich. Since our OUTPERFORM call in Sep-2022, the stock has performed tremendously – having more than doubled. As such, we see this as an opportunity for investors to realise some profits.

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 - 3 Feb 2023