Cheniere Energy: First-mover advantage in the booming LNG market

This report is first written on FSMOne.com, you can read the original article here.

• Midstream companies in the North American region are poised to benefit from the shale gas revolution. However, natural gas cannot be transported across oceans and seas in its gaseous state. The only solution to that is to transform them into liquefied natural gas (LNG).

• With the US expected to be one of the main exporters of LNG, Cheniere Energy (NYSE.LNG), a full-service LNG provider with one of the largest liquefaction platforms in the world, will certainly benefit from this trend.
  2019 will mark a key inflection point for Cheniere Energy’s earnings because three additional trains will be put into service, hence increasing total production capacity and boosting its earnings and cash flow.

• Cheniere Energy’s long-term contracts provide 20 years of earnings visibility. Only one of its long-term customers, PetroChina, faces tariff concerns. However, we note that PetroChina continues to pay and receive LNG cargoes from Cheniere Energy.

• Cheniere Energy remains attractive at current valuations. We have an end-2020 target price of USD 83.0 for the company, and that implies a 20.4% upside potential.
  

In our previous article on the midstream energy sector, we highlighted the rising production of oil and gas in North America as the main catalyst for the Global X MLP & Energy Infrastructure ETF (NYSE.MLPX). We also mentioned that the demand for energy will continue to grow, with natural gas expected to be the fastest growing as it is the cleanest form of fossil fuel.

Natural gas in its gaseous state is usually transported at high pressures through pipelines. However, in order to export natural gas from North America to other regions, such as Asia and Europe, it would be impractical and costly to build long distance pipelines across oceans just to transport the natural gas. The only solution is to liquefy the gas by cooling it to -162 degrees Celsius, shrinking the volume for easier and economical transportation via shipping. The end product is known as liquefied natural gas (LNG).

With the US expected to be one of the major exporters of LNG globally, we believe that Cheniere Energy (NYSE.LNG), a full-service LNG provider with one of the largest liquefaction platforms in the world, is poised to benefit from the growing LNG industry. Besides that, its multi-year head start over other US LNG exporters and several upcoming growth projects put it in a good position to reap the benefits. We value Cheniere Energy at USD 83.0 with an upside potential of 20.4% as of 21 June 2019.

Growing LNG market share in global gas trade

2018 was yet another record-breaking year for LNG. Global LNG trade hit 316.5 million tonnes, representing a 9.8% increase from 2017, and we expect the strong demand for cleaner-burning fuel worldwide to continue driving growth in LNG as it is viewed as a “bridge” towards a low-carbon future. China, for instance, saw its LNG imports surge by 40% in 2018, as it stepped up on its efforts to improve urban air quality.

Future growth in the LNG market will largely come from Asia, particularly China and India, where poor air quality is likely to drive demand for LNG. Supply, on the other hand, is expected to peak in the early 2020s and decline thereafter as fields deplete. The growing gap between LNG supply and demand (Chart 1) implies additional LNG requirements to bridge the gap in the future.

Chart 1: Global LNG supply and demand to 2035

While the global LNG market is currently dominated by Qatar and Australia, the US has been slowly climbing up the ranks. It overtook Malaysia to become the third largest LNG exporter in May 2019, and is expected to contribute the most in terms of incremental production capacity this year as 29 million tonnes per annum (mtpa) worth of capacity will come into service. In fact, the IEA has forecasted that the US could overtake Qatar and Australia as the world’s top LNG exporter by 2024, led by the US shale production.

In the US, few companies are as focused on LNG as Cheniere Energy (NYSE.LNG), which has one of the largest LNG platforms in the world, and is also the leading producer of LNG in the US. In 2008, it was the first to invest in the liquefaction of natural gas when the US shale revolution has just begun to take flight. Eight years later in 2016, Cheniere Energy became the first company to export LNG in the US.

As the LNG export pioneer of US, Cheniere Energy has an unmatched scale over its peers and also a very strong operational track record where they are capable of executing their projects on time, and on budget. Their production capacity of 18 mtpa represents 85% of the total US LNG exports in 2018 (21.1mtpa), which further showcase their position as US’s leading LNG exporter.

Hence, we believe Cheniere Energy’s first-mover advantage will remain to be their competitive edge, paving the way for them to becoming one of the top five global providers of LNG by 2020.

Growth projects that will boost future production capacity are near completion

At Cheniere Energy, profits are measured by how much LNG it exports. This also suggests that its profits are limited by how much production capacity it has. As of 4Q18, Cheniere Energy has approximately 18mtpa worth of production capacity that comes from its Sabine Pass Liquefaction (SPL) Trains 1 – 4 in Louisiana and another 3 trains known as the Corpus Christi LNG Train (CCL) under construction in Texas.

2019 will mark a key inflection point in Cheniere Energy’s earnings because this is the year when three additional trains will be put into service, increasing total production capacity by another 13.5mtpa. This represents a 75% increase from its current production capacity. In fact, in its 1Q19 quarterly results, Cheniere Energy has updated that SPL Train 5 and CCL Train 1 have been placed into service, both ahead of schedule and on budget.

Management has also guided that CCL Train 2 will be placed into service in a few months’ time (Chart 2) and has increased its guidance on both production capacity and distributable cash flows for 2019 after incorporating the impact of these projects.

Chart 2: Illustration on Cheniere Energy’s upcoming projects

Beyond these three growth projects, Cheniere Energy has also announced that it has made a positive Final Investment Decision (FID) with respect to their SPL Train 6 on 3 June 2019 and expects SPL6 to enter service in 2023. This paints a positive picture for Cheniere Energy’s outlook and further highlights its strong track record when it comes to project execution.

To add on, its CCL Train 3 will reach substantial completion in 2H21, marking the end of their Stage 1 and 2 of the Corpus Christi Liquefaction project. There will then be an expansion of another seven mid-scale liquefaction trains and one LNG storage tank under Corpus Christi Liquefaction Stage 3, which is currently waiting for full regulatory approval from the Federal Energy Regulatory Commission (FERC) by the end of 2019. Once approved, this will add another 9.5mtpa worth of production capacity for Cheniere Energy.

All these added liquefaction capacity is expected to increase and debottleneck Cheniere Energy’s production, hence increasing volume available for sale. Revenue and earnings are expected to rise considerably as these projects come into service in the coming few years.

Rock solid contracts that provide more than 20 years of earnings visibility

Cheniere Energy’s revenue is secured by long-term contracts of about 20 years, providing a high degree of earnings visibility. Moreover, these contracts need to be signed even before the new LNG trains are put into service, suggesting that inventory will be sold almost immediately once production starts.

At this current juncture, 85% of CCL Train 1 and 2 and 88% of SBL Trains 1 – 5 have already been contracted under long-term sales and purchase agreements (SPAs). Each of these agreements are based on a term of at least 20 years, following the date of the first commercial delivery. To sweeten the deal, the majority of Cheniere Energy’s contracted customers are highly creditworthy, which in turn provides payment assurance.

Table 1: Long-term contracts with notable clients worldwide

Customer	Country of domicile	End of contract	Asset	Annual contract quantity (mtpa)
BG Group	United Kingdom	2036	SPL	5.5
Naturgy Energy Group S.A.	Spain	2036	SPL	3.5
Korea Gas Corporation	Republic of Korea	2037	SPL	3.5
GAIL (India) Limited	India	2038	SPL	3.5
Total S.A.	France	2039	SPL	2.0
CPC Corp	Taiwan	2041	CCL	2.0
Polish Oil and Gas Company (PGNiG)	Poland	2043	SPL/CCL	1.5
CNPC	China	2043	CCL	1.2
PETRONAS	Malaysia	2043	SPL	1.1
Source: Cheniere Energy, iFAST compilations Data as of June 2019

These long-term contracts are set at a price linked to Henry Hub natural gas spot price (usually 115% of Henry Hub), plus an additional fixed fee per unit of energy. A portion of the fixed fee component is subjected to annual adjustment for inflation, and in certain circumstances where Cheniere Energy’s customers choose to suspend deliveries of LNG cargoes, they would still be required to pay the fixed fee with respect to the contracted volumes. Hence, these decades-long contracts provide excellent earnings visibility – a key investment merit of Cheniere Energy.

Meanwhile, any excess capacity that remains unsold under long-term SPAs will be available for Cheniere Energy’s wholly-owned subsidiary – Cheniere Marketing. LNG sales under Cheniere Marketing are generally shorter-term in nature and are made under flexible delivery and pricing terms, depending on customers’ needs.

The LNG market is becoming increasingly liquid over the years, with the volume of spot trades and short-term deals jumping nearly 30% in 2018 according to data from the International Group of Liquefied Natural Gas Importers. This trend has attracted several independent commodity traders like Vitol, to step up their presence in the LNG market.

As such, in addition to their long-term SPAs that provide earnings visibility, Cheniere Marketing is also in a good position to capture the growing global LNG trading activities that focus on shorter-term deals.

Investment concerns

The biggest concern for investors now is none other than the US-China trade war, which includes a 25% tariff imposed on US LNG exports. While this may dampen LNG demand from Chinese buyers, we believe the impact on Cheniere Energy’s bottom line should not be significant at this point in time. As observed in Table 1, Cheniere Energy has a fairly diversified customer base. Even against a backdrop of escalating geo-political tensions, Chenier Energy has managed to sell over 80% of their current capacity to date, signalling strong earnings visibility.

To add on, its current exposure to China remains low at this current juncture. The contract between Cheniere Energy and CNPC is still in place as well, with the state-owned company swapping its US shipments for cargoes from other countries to avoid the LNG tariffs. The management has also stated that they “don’t foresee an economic impact to Cheniere”. Besides, there are also other major importers – Europe, Japan, South Korea and India – that Cheniere Energy can focus on should Chinese buyers decide to take their business elsewhere.

Any project delays to Cheniere Energy’s liquefaction trains will also have a negative impact on its earnings in the short-term. However, we note that Cheniere Energy has a strong record of completing its projects on budget and on time. Given its excellent execution capabilities, we can expect their CCL2 train to come online before the end of 2019 as guided by its management.

Trading at attractive valuations

Any investors who have searched for “Cheniere Energy (NYSE.LNG)” would have chanced upon its listed subsidiary – “Cheniere Energy Partners (NYSE.CQP)”. We believe it is imperative for investors to understand Cheniere Energy’s business structure and how it derives its cash flows (Chart 3).

Chart 3: Corporate structure of Cheniere Energy

Through wholly-owned subsidiaries, CQP owns and operates SPL Trains 1 – 6, which generates stable cash flows for its parent – Cheniere Energy (NYSE.LNG). Besides the direct equity investment of 48.6% in CQP, Cheniere Energy also receives cash flows based on its 2% general partner’s share in this subsidiary. As the general partner, it also has 100% of the incentive distribution rights (IDR), which entitle the company to an increasing cut of the cash distributions should CQP start generating higher operational cash flows.

Meanwhile, all of Corpus Christi LNG assets are wholly-owned by Cheniere Energy, which means all earnings from CCL Trains 1 – 3 and the other seven mid-scale liquefaction trains will go to Cheniere Energy. Hence, the Corpus Christi project will serve as the major driver for Cheniere Energy’s future growth as the CCL trains come online in the coming years.

Taking into account Cheniere Energy’s divisible units, we believe an sum-of-the-parts (SOTP) valuation would be most appropriate (Table 2).

Table 2: Sum-of-the-parts (SOTP) valuation for Cheniere Energy

Cheniere Energy	Methodology	Investment Value
CQP Equity Investments	Market Cap (48.6% stake)	9,879.4
CQP GP Interest	DCF	4,641.9
Equity stake in CQP		14,521.3
Corpus Christi Holdings (CC)	EV/EBITDA	13,227.9
Cheniere Marketing (CMI)	EV/EBITDA	5,174.4
Net Debt		(11,569.0)
CC + CMI		6,833.3
Total Investment Value (USD mil)	21,354.7
Shares outstanding (millions)	257.4
Target Price end-2020 (USD)	83.0
Current Price	68.9
Upside Potential	20.4%
Source: iFAST computations, JPMe, Bloomberg, Cheniere Energy Data as of June 2019

Key assumptions:
For Cheniere Energy’s ownership in CQP, we used the market capitalisation implied equity value. GP interest and IDRs on CQP distributions were based on a discounted cash flow valuation. The fair value of Corpus Christi Holdings and Cheniere Marketing were calculated based on a 14.0X EV/EBITDA multiple. Cheniere Marketing’s EBITDA projection is based on the historical utilisation rates and forecasted unused capacity.

Conclusion

Based on these assumptions, we arrived at a target price of USD 83.0 by end-2020, and that implies an upside potential of 20.4% (as of 21 June 2019). With a robust outlook for the LNG market, we believe Cheniere Energy (NYSE.LNG) is in a very good position to capture market share gains as the US transforms into a LNG superpower.

While Cheniere Energy certainly has an attractive investment proposition, investors who prefer a more diversified exposure can consider the Global X MLP & Energy Infrastructure ETF (NYSE.MLPX), which tracks the performance of the North American mid-stream energy sector.

(Related article: MLPX: An opportunity for income and growth in North America’s midstream energy sector)

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities). The analyst who produced this report has a position in Cheniere Energy.

The Research Team is part of iFAST Financial Pte Ltd.

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