VELESTO announced two new contracts comprising: (i) USD6.1m drilling contract for 4 firm wells awarded by Jadestone Energy, and (ii) 2-year Hydraulic Workover Unit (HWU) contract dished out by EMEPMI. We are largely neutral on these contracts as it was well flagged and within our assumptions. We maintain our forecasts, TP of RM0.19 and UNDERPERFORM call.

Corresponds to earlier indication on NAGA 2. The new drilling contract falls well within our estimates and VELESTO’s earlier guidance. To recap, the company had previously revealed that NAGA 2 would undergo repair and maintenance in the early part of 3QCY23. Thereafter, NAGA 2 will execute two more firm contracts until early 1QCY24.

Higher new umbrella contract DCRs. We understand that this contract is estimated to be completed within 2 months. Hence, this translates to estimated daily charter rate (DCR) of USD100k-105k – which is aligned with recent market rates of USD90k-131k in Malaysia. To recap, VELESTO’s average DCR in 1QFY23 was lower at USD86k. The higher DCR offered by this new contract reflects the boost in rates post re-negotiation of existing Petronas umbrella drilling contracts.

GAIT 6 secures long term contract. Whereas for the new HWU contract, we understand that its DCR falls within the higher end of South East Asian rates - that currently ranges at USD18k-23k. Similarly, this contract was also well flagged by the company. To recap, VELESTO had earlier indicated that GAIT 6 had secured a firm longterm contract that commences from 3QFY23 onwards.

Therefore, we had previously incorporated the following assumptions to our FY23F earnings: (i) 75% utilization for NAGA 2, and (ii) average drilling fleet DCR of USD95k, and (iii) 67% utilization for GAIT 6. Based on our estimates, the drilling contract will result in earnings accretion of circa 3% to VELESTO’s FY23F profits, whereas GAIT 6’s new contract will contribute 3%/4% to FY23F/FY24F earnings.

In spite of a rosy outlook for drilling fleet utilization and DCRs, we believe that investors are generally cautious of muted earnings due to opex drag. Recall that this was the case post-release of 1QFY23 results, when consensus downgraded VELESTO’s FY23F and FY24F earnings by circa 30% and 40%, respectively. Therefore, at this juncture, we prefer to stay on the sidelines until cost headwinds dissipate.

Forecasts. Maintained.

We also 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 (i.e. DAYANG). There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see page 4).

We prefer to avoid VELESTO due to: (i) costs inflation may lead to margin pressure arising from higher manpower and materials costs, (ii) catalysts have already played out (i.e. rebound in rig fleet utilization and DCRs), and (iii) rising interest rates translate to earnings drag from higher 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 - 17 Aug 2023