VELESTO's 9MFY23 results disappointed due to high labour cost and weak rig utilisation. Nonetheless, it turned around in 9MFY23 driven by a higher average daily charter rate (DCR), partially eroded by elevated labour cost. We cut our FY23-24F earnings forecasts by 9% each, reduce our TP by 11% to RM0.17 (from RM0.19) and maintain our UNDERPERFORM rating.

Its 9MFY23 core net profit disappointed at only 55% and 54% of our full-year forecast and the full-year consensus estimate, respectively. The variance against our forecast came largely from higher-than-expected labour cost and lower-than-anticipated rig fleet utilisation.

YoY, its top line jumped 1.5x, propelled by a higher average DCR of USD92,000 in 9MFY23, compared to USD75,000 a year ago, coupled with an improved rig utilisation rate of 80% (vs 53% last year). This more than offset higher labour cost, leading to a turnaround, posting a net profit of RM34m (from a loss a year ago).

QoQ, its 3QFY23 revenue increased by 4%, driven by a higher average DCR of USD97,000 (vs. USD94,000 in 2QFY23) coupled with higher billings from integrated rig, drilling, and completion (i-RDC) contract works, partially offset by weaker utilisation of 60% (vs. 88% three months ago). However, its core net profit plunged 77% due to higher labour and depreciation costs.

Outlook. The elevated labour cost will persist into FY24, given the tight labour situation in the drilling sector at present. While there has been a notable improvement in the DCR for the rigs, we believe it has to rise a lot higher, i.e. at least to USD130,000 upon renewal from 2HFY24 to warrant an earnings upgrade. At present, all its six rigs are utilised with Naga 4 recently having completed its 5-year Special Periodical Survey (SPS), while Naga 3 and 4 have commenced work for Petronas Carigali. Therefore, we expect rig utilisation rate to improve in 4QFY23.

Forecasts. We cut our FY23-24F earnings forecasts by 9% each to reflect a 10% increase in labour cost (vs. our previous assumption). Additionally, we marginally lower our rig utilisation assumptions to 88% (from 92%) for FY23 and 89% (from 94%) for FY24 to reflect the potential downtime during rig job transitioning.

Correspondingly, we cut our TP by 11% to RM0.17 (from RM0.19) based on 15x FY24 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).

We prefer to avoid VELESTO at this juncture due to: (i) margin compression from the inflationary cost environment, (ii) several contracts set to expire in FY24, indicating increased downtime in rigs, and (iii) the inability to benefit from the regional DCR of USD130,000- USD140,000, as the majority of rigs have committed to lower DCR. Maintain UNDERPERFORM.

Risks to our call include: (i) fleet expansion via the acquisition of new jack-up rigs, and (ii) higher DCRs as the jack-up market tightens further.

Source: Kenanga Research - 30 Nov 2023