FLNG - FLEX LNG: A Promising LNG Shipper

2023-06-20 00:24:15 ET

Summary

• FLEX LNG operates a young fleet of 13 LNG tankers and is set to benefit from the EU's energy transition program, which aims to replace Russian gas with LNG.
• The company's fleet is fully booked until 2030, with major clients including BP, Cheniere Energy, Chevron, Trafigura, and Guvnor.
• Despite promising long-term prospects, it is too early to invest in FLEX LNG stock due to market sentiment, high gas storage utilization in the EU, and lower demand for LNG in Asia.

Investment Thesis

FLEX LNG ( FLNG ) is one of the largest public companies that specializes in transporting LNG. The company has a fleet of 13 modern LNG tankers, with the average age of around 3.5 years. The entire FLEX LNG fleet is fully booked until 2030, and the company's main clients include BP, Cheniere Energy, Chevron, Trafigura and Guvnor.

FLEX LNG will become a beneficiary of the EU's energy transition program, which seeks to replace Russian gas with LNG (by putting into operation new LNG reception terminals with a combined capacity of up to 100 thousand tons of LNG per year).

We don't expect the value of ships to fall significantly in the near future, as most existing shipyard capacities are fully booked through the end of 2028. As a result, the price of long-term contracts will remain stable and continue to hold high at around $140 thousand per day. Shipping companies are gradually passing their capital expenditures on to new customers, with charter rates rising ever higher.

But we believe that it is too early to invest in FLEX LNG stock due to market sentiment, driven by high gas storage utilization in the EU and lower demand for LNG in Asia, is currently weighing on spot freight prices and, as a result, on FLNG shares. Rating is HOLD.

The LNG market and its potential

What is LNG? LNG (liquefied natural gas) is a clear, colorless and non-toxic liquid that forms when natural gas is cooled to -162º Celsius. The cooling process shrinks the volume of the gas 600 times, making it easier and safer to store and ship as the chances that LNG will ignite in its liquid state are extremely small.

LNG production and use comprises 5 main phases:

In 2021, the global LNG export market reached 387 mln tons or 513 bln cubic meters of dry gas equivalent, according to IGU . More than 50% of all LNG exports come from only 3 countries: Australia, Qatar and the US, which are energy-surplus countries.

LNG consumption leaders are the European Union, Japan and China (power-hungry regions). As the situation around Nord Streams 1 and 2 is escalating, while business activity in Asian countries, particularly in China, is slowing down, European countries could make up more than 30% of the global import market.

The prospects for the LNG market are directly dependent on the capacity for its export and demand for gas. Over the past 5 years, North America, particularly the US, has been steadily but surely approaching the leading position in terms of investment in the industry. It's noteworthy that final investment decisions in North America were made for a volume in excess of 30 bln cubic meters in the first half of 2022, while the rest of the players had nothing to report, according to EIA .

Bloomberg estimates that the US will be building the most LNG liquefaction capacity until 2026 and the world's total LNG export potential will expand to 460 mln tons a year by 2026. It's worth noting that, despite the global energy crisis, 2023 is expected to see the least new liquefaction capacity coming online.

The ongoing energy crisis coupled with some of the slowest introduction of new capacity in 2023 will mean LNG capacity utilization will remain high across the globe. For example, 7 export markets out of 21 reached the capacity utilization of more than 90% due to high demand for gas and the desire of Asian partners to conclude long-term supply contracts.

Let's now turn to demand. Geopolitical tensions in eastern Europe and the stoppage of gas supplies through the key gas pipelines, Nord Stream 1 and 2, have led to a situation when EU daily imports of Russian gas over the past 30 days, according to Bruegel, totaled about 0.5 bln cubic meters a week (~25 bln cubic meters a year ). Most of these imports come through the Turkish Stream and Ukraine.

In an effort to stabilize the energy market and steer away from Russian gas, EU countries have implemented a plan to reduce gas consumption by a record 15% for the period from August 2022 to March 2023. As a result, EU demand for natural gas in 2022 fell by 10% from 535 bcm to 480 bcm.

Over the long term, according to Shell, as the EU reduces its offtake of pipeline gas, it will need 140 thousand tons of LNG a year to replace it until 2030.

That's why the EU is right now readying massive additional infrastructure with potential reception capacity of up to 100 mln tons a year. Increasing reception capacity ramps up demand for shipment, which will reflect positively on the FLEX LNG business. It's also worth noting that current regasification capacity leaves a window to build up LNG reception.

The existing LNG reception terminals are mostly located in Spain, France and Italy. The overwhelming majority of new projects will be based in Poland, Germany and Lithuania.

The global LNG market will be balanced until 2026. However, the faster pace of energy transition in the developing and developed countries will cause a shortage, which will set off a new round of energy crisis in the regions.

We believe that the LNG market continues to hold promise over the long term for a number of reasons:

• Given the accelerated phasing out of "dirty" types of fuel, the slow introduction of new LNG capacity will provoke its shortage, pushing prices up;
• The limited capacity is exacerbated by an insufficient number of tankers. There are 640 LNG tankers now operating in the market. As of this moment, construction is underway on another 216 LNG tankers, but it takes an average of 30-50 months to complete construction. Only about 35 new tankers started operating in 2022, and no more than 40 are set to start operating in 2023. And there's a lot of gas to replace!

The business of FLEX LNG

FLEX LNG is a small-capitalization company listed in the US and Norway, which engages in the business of LNG shipments. Based on the size of its fleet, it ranks as the 15th-biggest LNG shipper globally.

The company's tanker fleet numbers 13 ships with the average age of ~ 3.5 years (which constitutes a competitive advantage, compared with the rest of the players) and total capacity of 175 thousand cubic meters of gas. The company doesn't plan to buy new ships in the short term, so when it comes to the forecast period, the number of ships will remain stable at 13 units, while capital expenditures will be non-existent.

The company financed the acquisition of the tankers when their prices sank to a historical bottom. We estimate the current book value of the tankers, adjusted for depreciation, at about $3.2 bln, while the EV of the FLNG business stands $3 bln, according to our estimates. That has so far escaped investors' attention.

As of now, all of FLEX LNG's fleet has been booked until 2030, with BP, ?heniere Energy, Chevron, Trafigura and Guvnor being the key customers.

Therefore, we expect that the total fleet-on-hire days (the total of on-hire days for all ships) per quarter will continue to be about 1180. The company will send 3 ships for dry-docking in the second quarter of 2023, which will slightly reduce the total number of on-hire days to about ~1000.

To move on to forecasting the company's charter rates, let's take a look at what drives medium-term charter rates. The daily charter rate under long-term contracts is tied to the average newbuilding of LNG ships, which started to rise at the height of the global energy crisis and continued to accelerate following record growth in LNG imports by EU countries. Shipping companies gradually pass their capital expenditures on to new customers, with charter rates rising ever higher.

We don't expect newbuilding prices to drop significantly over the next year, as almost all existing shipyard capacity has been fully booked through the end of 2028 . However, we anticipate that, as an increasing number of newbuild ships comes to market, newbuilding prices will slightly decline (vacant slots), which will entail a downward movement of long-term charter rates.

Based on the historical data from the company, FLEX LNG's charter rates are sensitive to spot charter prices, even as the contracts are long-term. Transocean, for example, has fixed charter rates.

Spot charter rates incrementally follow the industry's long-term rates, taking into account quarterly seasonality. We use long-term charter rates to forecast spot rates, and then use spot price estimates to move over to FLNG charter rates.

Therefore, we expect average charter rates for ships with the capacity of up to 165 thousand tons of LNG to total $99.6 thousand a day in 2023, and rise by 2% y/y to $102.1 thousand a day in 2024.

The company also expects charter rates to rise significantly when the time approaches to start filling EU storage facilities and with the start of the heating season, which will mostly be driven by a lack of free tonnage to ship LNG.

Financial results

Therefore, we expect that the company will earn a revenue of $384 mln (+10% y/y) in 2023, and will boost it by another 2% y/y to $396 mln in 2024.

The shipper's operating costs are relatively stable at ~$1.2 mln per vessel every quarter. Fuel makes up most of the operating costs (about 50% of total operating costs). That's why we have tied operating costs to the performance of the oil price.

The company's EBITDA will reach $306 mln (+12% y/y) in 2023, and will rise by another 3% y/y to $314 mln in 2024.

The company has shown a stable FCF since the start of 2022 due to the absence of high capital expenditure as it capitalized on high freight prices. We expect that FCF will total $250 mln (+14% y/y) in 2023, and will rise by a further 14% y/y to $286 mln in 2024.

Net income is set to slump by 18% y/y to $154 mln in 2023 due to debt issuance fees (underwriting costs), but is poised to jump by 28% y/y to $196 mln in 2024.

We expect that as freight prices continue to hold high in the near future, the company will keep paying high dividends, with a forward dividend yield of ~10% a year.

Valuation

We evaluate the company using two methods: the EV/EBITDA multiple method and the EV/market value of the fleet method. The second method shows the enterprise value is too low compared with the market value of its fleet. The fair value of the stock is $33. Rating is HOLD.

Conclusion

FLEX LNG is a promising LNG shipping company. The company operates the youngest fleet, compared with its competition, and is also distinguished by low capital expenditures, which is the strongest competitive advantage over the rest of the players in the industry. We believe it is still too early to buy shares in the company because the market sentiment, driven by high gas storage utilization in the EU and lower demand for LNG in Asia, is currently weighing on spot freight prices and, as a result, on FLNG shares. Rating is HOLD.

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FLEX LNG: A Promising LNG Shipper