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This article first appeared in The Edge Malaysia Weekly on October 25, 2021 - October 31, 2021

MISC Bhd

MISC Bhd is involved in international energy-related maritime solutions and services. Its operations are divided into four main segments, LNG shipping, petroleum (crude oil and product) shipping, offshore business (involved in floating production storage and offloading units, or FPSO) and heavy engineering, which caters for engineering, procurement, construction and installation (EPCIC) solutions and fabrication.

MISC’s major profit contributor, LNG shipping (more than 50%) business model is mostly recurring income in nature. This explains MISC’s strong cash flow generation capability, which remains relatively robust throughout the volatile oil price environment in the past five years (see Table 1 below).

For 1HFY2021, LNG contributed about 52% of total operating profit, followed by FPSO (37%) and petroleum shipping (22%), while heavy engineering remains the main loss-making segment (see Table 2).

Moving forward, we are sanguine about MISC’s prospects. We expect to see an earnings recovery moving into 2022, driven especially by FPSO offshore division strength (won Petrobas Mero 3 FPSO award in August 2020) and petroleum tanker rate recovery from the current multi-year low levels.

The term of the FPSO charter is 221/2  years and operation commencement is expected to be in 1H2024. Currently, progress of vessel conversion has bolstered its offshore segment’s financial results.

As for oil tanker, strong demand for middle distillates and heavy residues has induced significant draws from storage, and as a result, oil product stockpiles at UAE’s Port of Fujairah have fallen to their lowest level on record since the start of 2017.

What all this means is that seaborne oil transportation is set to recover fundamentally, which bodes well for MISC’s petroleum tanker division — currently about 28% are spot charter (see chart below).

In view of imminent earnings recovery in 2022 and an indicative dividend yield of about 4.6%, we rate MISC a buy.

Velesto Energy Bhd

Velesto Energy is an offshore drilling rigs provider, catering mainly to upstream operators such as Petronas and Shell in Malaysia. Close to 98% of the company’s revenue is derived from customers within the country.

The company generates its income mainly from chartering out drilling rigs to customers for exploration, development and production activities. Velesto currently owns and operates six drilling rigs. The amount of profits it can generate will largely depend on the (1) utilisation rate and (2) daily charter rate (DCR) of its rigs.

Rigs chartering was once a lucrative business, before the oil price crashed in 2014. Average DCR was US$151,000 per day in FYEDec2014 while the utilisation rate was as high as 95% in that year. The dive in oil price caused a signification slowdown in exploration and development activities, which resulted in an oversupply of drilling rigs. Consequently, average DCR dropped for three consecutive years before stabilising at around US$70,000 since 2017 (see Chart 1).

In tandem with the lower DCR, the company’s revenue dropped from RM1.01 billion in 2014 to an average of RM594 million between 2017 and 2020 — despite having an additional drilling rig, which was completed in January 2015. Nevertheless, the company’s adjusted earnings before interest, taxes, depreciation, and amortisation (Ebitda) margin (excluding impairments) has recovered to above 40% since 2018, in line with the higher utilisation rate (see Chart 2).

Despite achieving higher adjusted Ebitda margins, the company only reported profits once between 2015 and 2020. During the period, the company recorded a total net loss of RM3.2 billion, predominantly due to huge impairment provisions and high depreciation costs, which amounted to RM2.6 billion and RM1.4 billion respectively (see Chart 3).

However, the impairments and depreciation charges are non-cash expenses. In effect, the company was actually generating positive free cash flow since 2017 despite the headline losses. Positive cash flows coupled with proceeds from right issues lowered net debt from the peak of RM3.2 billion to RM0.7 billion by the end of 2020 (see Chart 4). In other words, its balance sheet was being gradually strengthened.

In May 2021, one of the company’s rigs, Naga 7, tilted and submerged during preparation for drilling activities offshore Sarawak. Fortunately, all 101 personnel on board were safe and there was no other severe consequence as the drilling activities had not started Due to the incident, the company wrote off RM461 million of assets but recognised insurance claims of RM552 million. Therefore, while the incident caused the loss of an income-generating asset in the long run, the company’s balance sheet actually improved in the aftermath. Upon receiving the compensation, Velesto’s net debt can be further lowered to less than RM300 million, resulting in net gearing of around 0.1x.

Moving forward, we think demand for drilling rigs will improve on the back of the current rally in oil prices and postponement of activities during the pandemic. Case in point, the number of jack-up rigs chartered in Southeast Asia is already showing improvement y-o-y since July 2021 (see Chart 5). Hence, we expect the utilisation rates of Velesto’s drilling rigs improving, moving forward.

The company’s data showed that average DCR in 2Q21 had recovered to US$76,000, above the pre-pandemic average of US$70,000 (see Chart 1). Subdued DCR over the years has discouraged investments in new rigs. As a result, total supply of jack-up rigs has been on the decline since 2014 (see Chart 5). Recovery in demand amid contracting supply bodes well for potential hike in DCR moving forward.

On top of that, Velesto is currently trading at 47% discount to its average share price of RM0.30 in 2019. Meanwhile, valuation in terms of P/B ratio is also hovering around the lower end of its historical range (see Chart 6). In a nutshell, improved outlook, coupled with stronger balance sheet and undemanding valuations, provide an attractive risk-reward ratio for investors. Hence, we rate Velesto a “buy”.

 

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