2023-04-08 01:17:49 ET
Summary
- In this article, we start by discussing liquid natural gas market fundamentals, as we're in for a prolonged period of supply shortages.
- Cheniere Energy is one of the best stocks in this segment, as it has existing infrastructure supporting organic growth, shareholder distributions, and debt reduction.
- While its dividend yield is low, I expect LNG stock to be a long-term total return star with consistent and further accelerating dividends down the road.
Introduction
Cheniere Energy ( LNG ) is a fascinating company - for multiple reasons. The company is North America's largest exporter of liquid natural gas ("LNG"). It's a mature company that is now generating free cash flow and is capable of both long-term dividend growth and buybacks. While its 1% dividend yield is nothing to get excited about, the company is in a good spot to rapidly hike its dividend, potentially rewarding investors with high long-term total returns.
In an industry with many pitfalls, I consider Cheniere to be one of the best long-term plays thanks to these characteristics and so much more.
So, without further ado, let's dive into the details!
An important note: because the abbreviation of liquid natural gas and the ticker of Cheniere Energy are both LNG, I will NOT refer to Cheniere Energy as LNG in this article. LNG will solely refer to the commodity.
Avoiding Pitfalls
Many roads lead to Rome. This applies to investment strategies and individual stock picks. Especially in the LNG industry, I prefer to bet on quality companies as there are too many pitfalls.
Liquefied natural gas was discovered in 1820 by the British scientist Michael Faraday, who successfully chilled down natural gas to turn it into a liquid state. In other words, it's not a new technology.
What is new, however, is rapidly growing demand. LNG is extremely useful as it allows the United States to supply markets like Europe and Asia with natural gas. As there are no pipelines, it needs to turn to LNG to get the job done.
So, while the LNG technology is very old, the current LNG boom is still in its early stages. Prior to 2016, the USA was irrelevant when it came to LNG exports. That quickly changed when Cheniere's Sabine Pass terminal went online. Last year, the US was capable of exporting 14 billion cubic feet per day. That number is set to reach 20 billion cubic feet per day in 2016.
Energy Information Administration
Also, I think it's interesting to share the map below, which shows that all major LNG export terminals are located on the Gulf Coast, which has access to Texan natural gas production and pipeline connections to the natural gas basins in the US Northeast.
Energy Information Administration
With that said, there are many pitfalls. In general, investing in energy can be tricky, as there are many things to take into account. In the LNG industry, it gets even more complicated as entry barriers are high - very high. Companies need to invest billions in new facilities, close long-term contracts with buyers, and establish relationships with shipping companies and natural gas producers.
One of the most promising stocks in the industry was Tellurian ( TELL ), a company that is working on opening its Driftwood LNG terminal. My goal isn't to analyze TELL. I just wanted to highlight what happened to its stock price. Despite a massive industry demand tailwind, shares are trading close to their 2020 lows.
There are many more examples of this in different stages of the LNG supply chain.
With that said, demand is expected to remain high.
LNG Demand Expectations
Earlier this year, Shell published its LNG outlook. In 2022, European countries, including the UK, imported 121 million tonnes of LNG, a 60% increase from the previous year, as they had to deal with cuts to Russian pipeline gas.
While this situation was tricky, the good news was that reduced demand from China by 15 million tonnes and decreased imports from South Asian buyers due to high prices helped Europe secure more LNG supply. However, Shell warns that the next winter in Europe could be colder, potentially leading to increased competition for LNG volumes, particularly from China as it emerges from its COVID-19 lockdown.
Analysts expect China's LNG demand to rebound in 2023, but it is expected to fall short of 2021's record levels due to relatively high LNG prices and the lingering effects of the pandemic on demand. The total global LNG trade reached 397 million tonnes in 2022, and industry forecasts project a jump in demand to 700 million tonnes by 2040. That's a 76% increase!
A supply-demand gap is anticipated to emerge by the late 2020s, according to Shell's outlook.
Hence, the global LNG market is expected to remain tight in the near term, with limited new supply coming online and prices down over 70% from record highs reached in 2022.
All of this is great news for Cheniere, which isn't a startup but an established LNG powerhouse.
Cheniere Stands For Sustainable Growth
Cheniere Energy exported 2,650 cargoes from its LNG facilities, servicing customers in Europe, Asia, Mexico, and South America.
The company manages two massive terminals in the South. Corpus Christi, which is capable of exporting 25 million tons per year, and Sabine Pass, capable of exporting 30 million tons per year. These two assets have a combined nine trains, which are compressor trains used to turn natural gas into LNG. All of these trains were delivered ahead of schedule and within budget.
Needless to say, getting to this stage came with intense capital spending.
The graph below perfectly displays the company's rapid and volatile transition. Prior to 2016, the company boosted capital expenditures to launch its Sabine Pass and Corpus Christi terminals. Back then, the company had no meaningful operating cash flow. After all, it wasn't able to export anything. That's why it was investing so much in its business. As a result, net financial debt ballooned to more than $24 billion when its projects went online. Net debt continued to rise until LNG demand (and prices) exploded, resulting in rapidly rising operating cash flow.
While Cheniere is still investing in its business, it is now at a stage where it can organically grow its business, reduce debt, and reward shareholders using operating cash flow.
In 2023 (and beyond), the company will focus on three strategic pillars.
- Successfully managing its core business.
- Using organic growth to enhance its capabilities.
- Incorporating climate goals.
Regarding pillar two, during its 4Q22 earnings call , Cheniere updated investors on its ambitious expansion plans. The company has over 30 million tons of LNG currently under development or under construction, emphasizing its focus on organic growth. One of its key competitive advantages is its $40+ billion infrastructure investment, which enables economically advantageous capacity expansions, such as Corpus Christi Stage 3.
Construction activities at Corpus Christi Stage 3 are progressing, with Bechtel executing some aspects of early construction ahead of schedule, although it's still too early to determine if the project is ahead of schedule, as only 2% of construction is complete.
Cheniere Energy is also making progress on other growth fronts beyond Stage 3. It is in the prefiling process for midscale Trains 8 and 9 at Corpus Christi, with plans to submit the full filing to the Federal Energy Regulatory Commission ("FERC") before the end of the first quarter.
Additionally, the company has initiated the permitting process for a significant capacity expansion at Sabine Pass by submitting pre-filing documentation to FERC. This expansion could potentially add around 20 million tons of additional capacity to the site. Cheniere Energy is excited about this project and considers it a major priority for 2023.
So, what does this mean for shareholders?
Suddenly, Cheniere's A Dividend Stock
On September 7, 2021, Cheniere declared its first dividend. Back then, it declared a $0.33 per share per quarter dividend. In October of last year, that dividend was hiked by 19.7% to $0.395. Using the current stock price, this translates to a 1.0% dividend yield.
A 1.0% yield isn't a lot - especially not for investors seeking energy dividend income.
However, it is important to remember that Cheniere is in the early stages of returning cash to shareholders. After all, it was roughly six years ago that the company started to export LNG.
Moreover, the company is very clear when it comes to its dividend. This is what management told us in its 4Q22 earnings call:
We also paid $1.0385 per common share in dividends last year, inclusive of a 20% increase for the third quarter, and declared and paid our 6th quarterly dividend of $0.0395 for the fourth quarter this past month. We intend to follow through with our previous guidance of growing our dividend annually by approximately 10% into the mid-2020s through construction of Stage 3.
As of January of this year, Corpus Christi Stage 3 was about 25% completed.
With regard to buybacks, the company said the following:
[...] in the fourth quarter, we repurchased approximately 4.4 million shares for over $700 million, bringing our total shares repurchased during 2022 to 9.3 million for approximately $1.4 billion. Given our one to one cumulative goal over time, you can expect that we in the fourth quarter, we repurchased approximately 4.4 million shares for over $700 million, bringing our total shares repurchased during 2022 to 9.3 million for approximately $1.4 billion. Given our one to one cumulative goal over time, you can expect that we will continue the share buyback momentum with growing relative buyback allocations for 2023. In order to achieve our cumulative one to one target ratio with debt paydown.
This one-to-one target ratio aims to balance debt repayment and share repurchases. The goal is to spend 30% of the available capital on debt repayment until 2026. The same percentage is expected to flow toward buybacks.
With that said, fundamentals back the company's shareholder distributions.
This year, the company is expected to lower net debt from $22.4 billion to $20.9 billion. This implies a net leverage ratio of 2.5x EBITDA.
Cheniere is expected to maintain an annual CapEx volume of $2.3 to $2.7 billion. This year, free cash flow is expected to be $3.7 billion. This implies a 9.9% free cash flow yield using the company's $37.3 billion market cap.
Next year, moderating LNG prices and higher CapEx are expected to lower free cash flow to $1.8 billion. This still implies a 4.8% free cash flow yield.
This will allow the company to continue to reduce debt and engage in buybacks and dividend growth.
The cash payout ratio is still just 21% in that scenario.
Based on this context, while the 1% dividend yield isn't juicy, the company will consistently boost this dividend until it completes its Stage 3 expansion. Once that is finished, the company will have even higher earnings power and lower spending requirements. At that point, both buybacks and dividend growth are set to accelerate even further.
So, don't think of Cheniere as a cash cow. It's an energy growth stock with healthy fundamentals allowing for buybacks and moderate dividends while investors wait for the company to grow.
It will be a cash cow in 10-15 years. By then, investors will likely sit on a juicy yield on cost and high capital gains.
Valuation
Cheniere shares are trading at 7.3x 2023E EBITDA, based on its $37.3 billion market cap, $2.8 billion in minority interest, $20.9 billion in expected net debt, and $8.4 billion in EBITDA.
In my prior article , I wrote that Cheniere should not trade below 10x EBITDA, which opens the door to 25% more upside in a base-case scenario. My longer-term price target range is $215 to $235.
In other words, my base case target is $191, which is slightly below the current consensus estimate of $199.
FINVIZ
With that said, here's my summary and takeaway.
Takeaway
Cheniere Energy has become a dividend growth stock. The company benefits from a long-term LNG bull case, its existing infrastructure funding dividends, buybacks, debt reduction, and organic growth.
Even better, it already has a healthy leverage ratio less than two years after its net debt peaked. Going forward, the company will focus on its Stage 3 expansion, its debt reduction program applying a one-to-one approach with regard to buybacks, and 10% annual dividend growth over the next 2-3 years. After that, it is likely that dividend growth will further accelerate.
While the stock is not a source of a high dividend yield, I believe that conservative dividend growth investors seeking energy exposure with a secular bull case will enjoy owning Cheniere.
My opinion is that Cheniere is undervalued and poised to generate outperforming total returns versus the energy sector and the market in general.
For further details see:
Cheniere Energy: A Unique Dividend Growth Stock