This article first appeared in The Edge Malaysia Weekly on November 25, 2024 - December 1, 2024

NAGA 5, one of six jack-up drilling rigs belonging to Velesto Energy Bhd (KL:VELESTO), is in its 55-day major maintenance programme at a Seatrium Ltd-owned shipyard in Tuas, Singapore.

Another two jack-up rigs, Naga 3 and Naga 8, are scheduled for drying dock in the first half of next year.

Naga 5, with a drilling depth capability of 30,000ft, has just completed its two-year integrated rig, drilling and completion (I-RDC) contract together with Halliburton, the services contractor. US oil and gas (O&G) company, Hess Corporation, was the client.

It has been a “very successful project”, says Velesto president and CEO Megat Zariman Abdul Rahim when the group hosted The Edge on board the rig. According to him, it exceeded the client’s targets, and thus resulted in better financial returns for the contractors involved in the projects.

“In this integrated project management model, if [one contractor] is down, [the other contractor] doesn’t get paid. Everybody has skin in the game, meaning we [and] all the contractors have to work together to get the work done,” says Megat.

This could be one good reason to celebrate besides Velesto’s improved financial performance. However, that isn’t Megat’s priority. The veteran knows that this is a crucial period to secure contract as the window of opportunity could be closing.

At the helm, Megat’s main job is making sure all the rigs are chartered out despite the cyclical nature of the O&G industry so that Velesto will not fall into the same trouble it did in the past. 

For Naga 5, which is expected to complete its major maintenance in January 2025, the group is in the final stage of securing a two-year development contract.

“After the major maintenance, the rigs are good to go for the next five years,” says Megat, an electrical engineer by training.

“This year is going to be very, very good for Velesto. What keeps me awake is two, three years down the road. 

“The geopolitical impact on the O&G industry is very uncertain right now. We are preparing for the market to become soft in late 2025, and that is why we have got to lock in the [charter] rates now, so [that] we are protected.”

He sees some challenges ahead, as the Saudi-induced slowdown in the Middle East is expected to bring more rig capacity into this region.

He does not expect the impact to be felt in the next 12 months as contract bidding takes time. Still, Velesto needs to act fast.

“Cost efficiency and long-term contracts will remain the group’s focus,” he says.

Megat tells The Edge that the group is bidding for contracts beyond Malaysian waters to ensure the continuity of its jack-up operations and optimise its utilisation rate.

Velesto has an order book north of RM1 billion now, but the CEO is looking beyond 2025. He is hoping to secure a long-term project, with tenure of at least two to five years for its jack-up rigs.

As at July, Velesto was bidding for five long-term contracts worth RM1.9 billion and over a dozen short-term contracts totalling RM1.3 billion — across Malaysia, Vietnam, Indonesia and Thailand.

For now, three of its jack-up rigs are under contracts that will run until February 2026. Of the remaining three, Naga 3 and Naga 8 are bidding for jobs from late 2025 onwards, as the two rigs are scheduled for dry docking in the first half of next year. The maintenance process, dubbed special periodical survey (SPS), will take about two to three months before the rig can resume operations.

Megat believes Velesto’s rigs come with a premium — the group has upgraded Naga 5 and Naga 6 to allow them to conduct multiple scopes of activities simultaneously, thus reducing charter days for clients. Naga 6 will also be installed with a robotic arm by 1Q2025, which automates some of the pipe installation process. The company is already exploring autonomous drilling, he adds.

“Our rig utilisation going forward is going to be a blend between Malaysia and Southeast Asia,” he says, adding that Velesto is also looking at partnerships to expand into other rig-related projects such as decommissioning that will be a new revenue stream for the company.

Megat agrees that geopolitics “is the biggest concern” for the O&G industry, but flags that most of its project bids are gas-heavy, which is seeing slightly different treatment in the current emission-focused energy landscape.

When asked whether the dynamics between Petronas and the states of Sabah and Sarawak could further weigh on market outlook, Megat says, “A lot statements are being made, but at the end of the day it is about the capex that will be rolled out in the next three years.

“Whatever is being discussed, I am sure that every party is looking at a win-win situation, because that’s the only way to come to an agreement and move forward.”

The group is keeping a close watch on the upcoming Petronas Activity Outlook, which had previously indicated that up to 13 rigs would be required in 2026.

Roughly seven years after the recapitalisation in 2017, Velesto has posted six consecutive quarters of net profit and started paying dividends in May. According to Megat, the company will be in a net-cash position by early next year.

As at June 30, it had cash of around RM212.1 million and total borrowings of RM354.71 million. Part of that debt includes RM236.15 million in term loans that Megat says have already been settled in the fourth quarter this year, ahead of its 2027 deadline.

It is on track to neutralise its accumulated losses by 2026, which stood at RM429.3 million at end-June, partly as its warrant reserve of RM211.88 million will be transferred to retained earnings following the expiry of its warrants last month. The warrants were issued in 2017 with an exercise price of 39.5 sen as part of a sweetener for its RM1.8 billion rights issue then.

In the first half of the year ended June 30, 2024 (1HFY2024), Velesto booked a net profit of RM109.62 million, on revenue of RM732 million. It declared dividends of 0.25 sen per share for the period.

The accumulative revenue achieved in the six-month period represented 72% of the annual revenue in its record year of FY2014, when it made revenue of RM1.016 billion and net profit of RM251.31 million. Its best quarterly profit was in 4QFY2014, with a bottom line of RM71.3 million on revenue of RM327.7 million. The average DCR in 2014 was high at US$151,000, against around US$115,000 currently.

For the financial year ended Dec 31, 2024 (FY2024), Velesto is expected to achieve an annual net profit of RM184 million based on analysts’ consensus forecasts, sharply higher against RM99.5 million in FY2023. In fact, its net profit of RM109.62 million for the first half of FY2024 is equivalent to 59% of the forecast.

It is not hard to fathom why Velesto is among the top picks for the O&G industry, given its decent earnings growth and improved balance sheet. However, investors appear to have reservations on the stock as reflected in the share price trend. Besides the cyclical nature of the industry, environmental concern could be one factor that keeps investors at bay.

Velesto’s share price has been on a downward trend for the past seven months since April, falling from its near five-year high of 30.5 sen to 18.5 sen last Wednesday (Nov 20).

As a pure-play drilling rig operator, Velesto does not have direct peer comparison among Bursa Malaysia-listed companies. The counter last traded at 9.3 times forward price-earnings ratio — higher than the average of 7.4 times among locally listed upstream-linked companies that operate mostly in Malaysian waters.

Nonetheless, it is worth noting that analysts anticipate a drop in annual net profit for FY2025 to RM154 million.

With two SPS to be conducted next year, Megat explains that each SPS capex amounts to between US$10 million (RM45 million) and US$20 million. And the capex would eat into Velesto’s earnings in FY2025. On top of that, there will be a vacuum in earnings when two rigs are dry-docking at the yard.

The past two industry downturns dragged Velesto, which was known as UMW Oil & Gas Corp Bhd then, into severe financial stress mainly because its new rigs were unable to secure enough chartered contracts. Megat certainly does not want the history to repeat by not expanding fleet size aggressively and reducing dependency on local contracts. 

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