Reach’s 9M19 core loss of RM35.6m came below our expectations on lower than expected production volume. We understand that the reason behind the drop in production is due to some workover on the wells being undertaken; hence some of the wells have been shut down. NK-2 (one of the top producing well) has been recovered after the workover and is now producing which should result in higher production figures in 4Q19. We understand that the company has made all the necessary applications to prolong the exploration license that is expiring in Jan-20 as well as the application to obtain production contracts for North Kariman and Yessen fields are in the final stages of approval by the authorities. We are ceasing coverage on Reach Energy due to a reallocation of our internal research resources. Our previous forecast, HOLD recommendation and TP of RM0.18 (based on DCF) should no longer serve as a reference going forward.

Results below expectations. 3Q19 core loss of -RM15.9m (2Q19: -RM11.8m, 3Q18: -RM9.8m) brought 9M19’s total core loss to -RM35.9m (widening by 50.3% YoY). This came below our expectations as we have forecasted core losses of -RM14.8m in FY19. The negative results were largely due to weaker than expected production volume (-8% QoQ, -15% YoY, -11.9% YTD).

QoQ: Core loss widened by 35% to -RM15.9m (from -RM11.8m in 2Q19) mainly due to lower production (-8% to 2.2k bopd in 3Q19).

YoY: Core loss widened by 62.6% from -RM9.8m in 3Q18) mainly due to lower production (-15% to 2.2k bopd in 3Q19 from 2.6k bopd). This was further exacerbated by higher finance cost (interest expenses on loan from corporate shareholder in a subsidiary and interest expenses on deferred consideration +183% YoY).

YTD: 9M19 core losses also widened by 50.3% to -RM35.9m as a result of lower production and higher finance cost. This was partially offset by better operating efficiency resulting in a decrease in distribution cost (-47.8% YoY), staff cost (-44.0% YoY) and admin costs (-18.2% YoY).

Outlook. We understand that the reasons behind the drop in production is due to some workover on the wells are being undertaken; hence some of the wells have been shut down. NK-2 (one of the top producing well) has been recovered after the workover and is now producing. We can expect higher production in 4Q19. We understand that the company has made all the necessary applications to prolong the exploration license that is expiring in Jan-20 and expects to receive the required approvals from the authorities before expiry. We also understand that the application to obtain production contracts for North Kariman and Yessen fields are in the final stages of approval by the authorities

External funding needed. In order to execute its capex plans, Reach needs to raise funds up to USD100m to repay the outstanding deferred consideration and capex with debt financing being the preferred option. Note that there is RM312.9m due to MIE Holdings Corporation by end-2019 and Reach is in discussion with the former to defer the payment.

Cease Coverage. We are ceasing coverage on Reach Energy due to a reallocation of our internal research resources. Our previous forecast, HOLD recommendation and TP of RM0.18 (based on DCF) should no longer serve as a reference going forward.

Source: Hong Leong Investment Bank Research - 3 Dec 2019