LNG - Global Energy Security - Cheniere Energy Is Where It's At

2023-11-15 10:42:44 ET

Summary

• Natural gas storage levels in Europe are indicating net outflows for the first time since spring, highlighting the continent's reliance on LNG imports.
• Cheniere Energy, the largest LNG company in the world, reported notable financial achievements and highlighted the progress of its expansion projects.
• The LNG market remains sensitive to potential disruptions, and Asia's total LNG imports are expected to continue growing, supporting prices. Cheniere is well-positioned to benefit from these trends.

Introduction

It's that time in Europe again when people watch the weather outlook for two reasons:

• What will I be wearing?
• What could this mean for natural gas demand?

For the first time since spring, natural gas storage levels are indicating net outflows.

Ever since Russia prepared for its Ukraine invasion, natural gas flows to Europe have been reduced, causing the continent to rely on imports from liquified natural gas ("LNG") from nations like Qatar and the United States.

Last year, Europe got lucky, as it avoided a cold winter, causing gas demand to remain subdued and storage levels to be elevated going into this heating season.

While estimates vary, I believe it's fair to say that it may take until 2026 until Europe has enough import capabilities to receive enough LNG for its demand - assuming Russian gas flows are still close to zero.

With that in mind, a big part of global LNG success relies on the United States, which has become the leader in LNG thanks to a rapid expansion in its export capabilities.

The other day, the Energy Information Administration reported that LNG export capacities from North America are expected to more than double through 2027 - most of it coming from the U.S.

According to the EIA :

We expect North America's liquefied natural gas ((LNG)) export capacity to expand to 24.3 billion cubic feet per day (Bcf/d) from 11.4 Bcf/d today as Mexico and Canada place their first LNG export terminals into service and the United States adds to its existing LNG capacity. By the end of 2027, we estimate LNG export capacity will grow by 1.1 Bcf/d in Mexico, 2.1 Bcf/d in Canada, and 9.7 Bcf/d in the United States from a total of 10 new projects across the three countries.

On top of that, LNG is getting support from the realization that the energy transition is going to be a tough endeavor (who would have guessed?).

As reported by the Wall Street Journal , the energy transition, once seen as a seamless shift towards renewable sources, is facing setbacks on multiple fronts.

Offshore wind projects are being canceled, and renewable-energy companies are witnessing a decline in share prices. In the U.S., automakers are scaling back electric vehicle plans due to weakening demand.

Meanwhile, contrary to expectations, the oil and gas industry is thriving with megadeals, supported by soaring profits.

Fossil fuel proponents assert their longevity, while carbon emissions are projected to reach record levels this year.

Geopolitical factors, amplified by events like the Ukraine war, have shifted the focus to energy security. Governments and companies are reassessing the pace of decarbonization, emphasizing the continued need for oil and gas.

This benefits LNG tremendously, including Cheniere Energy (LNG) , which is my go-to stock for LNG exposure.

While smaller LNG companies that are early in the process of constructing export facilities may come with much higher upside potential, they also come with elevated risks.

On August 8, I wrote my most recent article on Cheniere, discussing guidance, demand, and shareholder distributions.

In this article, we'll do it again, using its recently released earnings, new developments in the industry, and updates regarding shareholder distributions.

To give you a spoiler, my belief that Cheniere is the go-to stock in this industry has been reinforced, as it truly seems to be the total package.

So, let's dive into the details!

The King Of LNG & Construction

There are two reasons to care about Cheniere's numbers and comments.

• Investors require frequent updates (this one is obvious).
• Owning the Corpus Christi and Sabine Pass plants, the company is the largest LNG company in the world, which means it has better intel than pretty much any other company. Analyzing Cheniere tells us so much about global energy developments.

During its 3Q23 earnings call, the company highlighted the production of the 3,000th cargo, making Cheniere the fastest LNG producer in history to reach this milestone.

On top of that, the company reported notable financial achievements, with consolidated adjusted EBITDA of approximately $1.7 billion, distributable cash flow of about $1.2 billion, and net income of around $1.7 billion, up from a $2.4 billion loss in the prior-year quarter.

During Q3, the company recognized income from 555 TBtu of physical LNG, with 89% of these volumes sold under long-term agreements exceeding ten years.

The higher proportion of LNG sold under long-term contracts was a key contributor to the positive financial performance.

Although the full-year guidance was not raised, the company is tracking toward the high end of the $8.3 to $8.8 billion consolidated adjusted EBITDA and $5.8 to $6.3 billion distributable cash flow ranges.

The improved outlook is attributed to portfolio optimization activities, expense timing, and higher marketing margins than initially forecasted.

On top of that, the company continues to engage in major deals.

During its earnings call, long-term contracts with BASF and Foran were highlighted, indicating the evolution of LNG into Europe.

These contracts illustrate the company's success in securing agreements with industrial consumers, with over 75% of the almost 6 million tons of long-term offtake executed in the year contracted with repeat customers.

Furthermore, the company's SPL (Sabine Pass Liquefaction) expansion project is progressing well, with nearly 6 million tons per year of long-term contracts signed since its announcement.

Speaking of construction and progress, the company's Corpus Christi Stage 3 expansion is going well, with over 44% completion across engineering, procurement, and construction.

The project is tracking ahead of the guaranteed schedule, with optimism about commissioning Train 1 by the end of 2024 and substantial completion of all seven trains by the end of 2026.

It is truly impressive how smoothly these operations are progressing, as it's hard to manage multi-billion dollar construction projects - especially in current times of labor shortages.

Favorable Demand Developments

Energy markets are complex. Agriculture and energy research is tough, as short-term volatility is very hard to predict. Countless factors impact prices. This includes geopolitical headwinds, strikes, weather changes, production numbers, inventory changes, etc.

During its call, the company noted that the market's precarious balance and lack of spare supply capacity contributed to significant volatility in LNG prices.

Proposed strikes at Australian LNG export facilities and a 48% decline in Norwegian piped gas to Europe in September further intensified pricing fluctuations.

• TTF (Dutch natural gas) spot prices experienced notable swings, settling at $11.30 in July, dropping over 25% to $8.30 in August, and rebounding to $11.50 in September.
• JKM (Japan/Korea natural gas) prices closely tracked TTF, settling slightly lower at $11.20 in September but rising to $13.30 in October, driven by uncertainties around Australian strikes and increased demand from China and India.

Despite elevated storage inventories, the LNG market remains sensitive to potential disruptions, exposing key risks and highlighting the critical need for global capacity development, which I expect to be an issue for at least two to three more years.

Asia's total LNG imports grew over 4% in Q3, with China and India showing significant gains.

China's increased gas demand, driven by a recovery in gas-fired power generation, contrasts with India's higher LNG imports due to a heat wave and below-average rainfall.

On a longer-term basis, the company expects that current LNG supply expectations are unlikely to satisfy future demand, with the projected need for more than 130 million metric tonnes by 2040 to meet demand, which should keep a floor under prices.

This brings me to the next part.

Debt Reduction & Shareholder Distributions

During the third quarter, the company continued to implement its comprehensive capital allocation plan, focusing on increasing shareholder returns, strengthening the balance sheet, and investing in accretive growth.

Notably, $50 million of long-term debt was repaid during the quarter. The company's efforts in efficient refinancing and deleveraging have resulted in multiple credit rating upgrades across its structure.

It now holds an investment-grade BBB credit rating.

Furthermore, share buybacks amounted to approximately 2.2 million shares of common stock, representing a deployment of approximately $357 million.

This action aligns with the company's intention to catch up on buybacks compared to capital deployed for deleveraging, reflecting a strategic balance in capital allocation.

A big aspect of the company's financial strategy is the pursuit of a 1:1 ratio of deleveraging and share buybacks on an aggregate basis through 2026, which means for every dollar used to reduce debt, one dollar is spent on buying back stock. This is a win-win for shareholders, as debt reduction shifts the focus from debtholders to shareholders (it also lowers financial risks).

Additionally, the company announced a 10% increase in the quarterly dividend to $0.435 per common share or $1.74 annualized, translating to an implied 1.0% yield.

This move is consistent with the 2020 plan, which outlines a goal of growing the dividend by approximately 10% annually into the mid-2020s through the construction of Corpus Christi Stage 3.

The company aims to steadily increase its payout ratio over time while maintaining financial flexibility, which opens the door to a much higher yield after 2026.

Valuation

Putting a valuation on Cheniere is tricky. The company just recently became profitable as past investments started to generate cash.

It also remains subject to fluctuating LNG prices.

With that in mind, Cheniere is trading at 7.5x NTM EBITDA. Its consensus price target is $200, which is 16% above the current price.

Hence, I stick to what I wrote in my prior article.

I believe that LNG's fair value is somewhere between $200 and $220, depending on the severity of the next winter and the development of macroeconomic factors influencing natural gas demand.

I also believe that LNG will continue to outperform the market in the years ahead, as it benefits from lower investment requirements, higher income, lower debt levels, and its ability to boost its dividend and buybacks once CC Stage 3 has been completed roughly two years from now.

Takeaway

As Europe grapples with reduced natural gas flows due to geopolitical tensions, Cheniere Energy emerges as a key player in the global LNG market.

Boasting record-breaking production, robust financials, and strategic expansions, the company navigates uncertainties with resilience.

Favorable demand dynamics, coupled with a comprehensive capital allocation plan, position Cheniere as a strong investment.

With a commitment to shareholder value through debt reduction, buybacks, and dividend increases, Cheniere's strategic foresight aligns with a promising future in the LNG sector.

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