KUALA LUMPUR (Feb 8): CGS-CIMB Securities has reiterated its "add" recommendation for Velesto Energy Bhd, raising the target price (TP) to 29 sen (from 27.5 sen) in anticipation of stellar results in the fourth quarter ended Dec 31, 2023 (4QFY2023), set to be released on Feb 27.

In a note on Thursday, the research house anticipates Velesto to report a core net profit of RM23 million, marking its strongest quarterly performance in four years.

The better profits are attributed to increased jack-up rig drilling utilisation rates, reaching approximately 92%, said the research house.

CGS-CIMB expects daily charter rates to average US$95,000 (RM452,770) in 4QFY2023, compared to US$78,000 in the previous corresponding quarter.

As a result, CGS-CIMB has increased its forecast for Velesto's FY2023 core net profit by 18%, adjusting the utilisation rate to 83%, up from the previous 80%. However, it lowered its projections for FY2024 and FY2025 core net profit by 23%-27%, reflecting a rise in effective tax rates from 11%-12% to a flat 22%, based on insights from discussions with Velesto.

CSG-CIMB said the change in tax rates is attributed to increased scrutiny by Malaysian tax authorities on the transfer pricing mechanism between Velesto's Labuan-based asset-owning companies and its private limited (Sdn Bhd) companies responsible for drilling jobs.

"The asset-owning companies charge rig bareboat charter to the private limited companies, and hence those bareboat charter revenues are booked in the low-tax Labuan jurisdiction.

"Certain rules and restrictions on the transfer pricing formula have been put in place by the Inland Revenue Board that have the effect of raising Velesto’s effective tax rates going forward, according to the company," it said.

Nevertheless, CGS-CIMB believes Velesto's strong performance in 4QFY2023 will likely continue into 1QFY2024, estimating rig drilling utilisation to reach 98%.

"Velesto recently guided for FY2024 utilisation at 80% to 85%, against an estimated 83% for FY2023, and we have pencilled in a top-down assumption of 80% utilisation for now. Anything above that will be a bonus," it said.

Despite Velesto having secured only 63% utilisation for FY2024, CGS-CIMB expressed confidence in Velesto's ability to meet its guidance.

CGS-CIMB noted that this confidence was supported by domestic clients already reserving the Naga 2 and Naga 4 for additional drilling work in Malaysia, with specific job details to be disclosed after finalising the new two-year umbrella contract. Furthermore, negotiations for additional work on the Naga 5 in Malaysia or Southeast Asia are underway.

At 11.45am on Thursday, shares in Velesto traded half a sen or 1.96% higher at 26 sen, giving the group a market capitalisation of RM2.17 billion.