Operating costs hurt more than expected

■ 9M21 core net loss underperformed at 150%/110% of our/consensus FY21F forecasts due to higher-than-expected opex in 3Q21 on multiple factors.
■ Consequently, we cut our FY21-23F forecasts, reduce our DCF-based TP to 14 sen (Ke: 15.3%, rolling forward to end-CY22F), and downgrade to Hold.
■ Despite rising utilisation rates, a difficult operating environment has impacted Velesto over multiple quarters, heightening the risks to investors in the name.

3Q21 hit by drilling commencement delays and higher opex

The 3Q21 core net loss of RM55m was narrower than 2Q21’s RM82m loss, due to a higher jack-up (JU) utilisation rate of 51%, vs. 38% in 2Q21. Still, the 3Q21 disappointed as we had expected 2H21F as a whole to report a small core net profit of some RM12m; this is now unlikely with our new forecast for 4Q21F to merely break even. For 3Q21, we had forecast 58% utilisation, but delays in the start of drilling work for the Naga 4 and Naga 6 resulted in lower utilisation of 51%. This was made up for by higher-than-expected daily charter rates (DCR), as we had probably underestimated DCRs on certain contracts, resulting in 3Q21 revenue that was in-line with our expectations. However, 3Q21 opex was c.RM35m higher than forecast due to multiple factors; Velesto said that it had secured a hydraulic workover unit (HWU) contract in Vietnam, but incurred upfront costs from its reactivation from layup and mobilisation from Malaysia. Velesto may have also incurred reactivation costs for the Naga 2 and Naga 6, as both were in layup during 1H21, prior to their new drilling campaigns in Aug and Oct 2021, respectively. The delays
at the start of the Naga 4 and Naga 6 drilling campaigns may also have resulted in Velesto incurring extra crewing costs, while the strict Covid-19 compliance requirements for rig crew may have imposed a continuing cost burden on Velesto.

Concerns over the Naga 3’s more-limited employment options

We widen our FY21F core net loss forecast by 52% to RM198m, as we now expect Velesto to merely break even in 4Q21F on JU utilisation of 70% (FY21F: 46%), based on drilling work already secured, and on the assumption that Velesto may continue to incur elevated levels of opex in 4Q21F. We have also penciled in additional costs for FY22F and beyond as Covid-19 protocols may continue indefinitely, resulting in a cut in our core net profit forecasts for FY22-23F by 14-45%, and a 15% reduction in our DCF-based TP to 14 sen. Our top-down assumption of 70% JU utilisation from FY22F onwards remains intact; contracts on-hand suggest bottom-up utilisation of 41% in FY22F and 17% in FY23F, and more work may emerge later. However, we are slightly concerned about FY22F, as its utilisation can only reach a theoretical maximum of c.90% considering the Naga 5 and Naga 6 may be dry-docked for some 90 days each next year in order to install ‘offline’ capabilities. We are also concerned about the employment prospects for the Naga 3, as it has been laid up for two years and its shorter-than-average usable leg length reduces its employment options. If we assume the Naga 3 remains idle for another whole year, the theoretical maximum utilisation rate for FY22F falls to just 75%. Upside risk: stronger order intake due to high oil prices.