2023-06-26 19:04:36 ET
Summary
- Cheniere Energy, Inc. is the largest producer of liquefied natural gas in the natural gas and one of the largest in the world.
- The stock has outperformed the broader energy sector over the past year, but it still has a very attractive valuation.
- The demand for the company's products is expected to grow until at least 2035, which should give it growth opportunities beyond the ones that it is already exploiting.
- The company has a lot of debt, but it is improving in this area.
- Cheniere Energy stock appears to be tremendously undervalued compared to the company's earnings per share growth.
Cheniere Energy, Inc. ( LNG ) is the largest producer of liquefied natural gas in the United States and one of the largest producers of the compound globally. We have been hearing a lot about liquefied natural gas in the news media over the past year or two for a very good reason. This is one of the most rapidly-growing subsectors of the energy industry, as countries around the world are increasing their demands for natural gas. The United States is one of the biggest suppliers of the compound due to the incredibly wealthy deposits that have been unlocked by advances in hydraulic fracturing and horizontal drilling technologies, and energy companies like Cheniere Energy have been moving to take advantage of this situation. Cheniere Energy has certainly benefited from this as it is up 14% over the past year, considerably beating the U.S. Energy Sector ( XLE ) as a whole:
Despite this, the stock still appears to be considerably undervalued today. As such, it is not too late to begin taking a position and profiting from the company's forward growth.
About Cheniere Energy
As stated in the introduction, Cheniere Energy is the largest producer of natural gas in the United States and one of the largest in the world. The company owns two liquefaction plants located in Corpus Christi, Texas, and Sabine Pass, Louisiana.
As we can see, the company currently can produce approximately 55 million tonnes of liquefied natural gas annually. It is in the process of expanding this capacity, which we will discuss later in this article. The company ships the liquefied natural gas that is produced by these facilities to countries all over the world:
As we can clearly see, Asia (mostly China, India, and Japan) was the largest destination for the company's cargo until late 2021. Around that time, tensions between the Western powers and Russia caused the European Union to begin looking for another supplier of natural gas to meet its demands. The European Union consumes an enormous amount of natural gas annually, but it does not have sufficient resources of its own to produce all the gas that it needs. Thus, for most of the past century, the continent has purchased natural gas from the Soviet Union and later, Russia. Prior to the outbreak of the war in Ukraine, Russia supplied about 40% of the continent's natural gas. The tensions and sanctions between the Western nations and Russia caused the European Union to begin importing enormous amounts of liquefied natural gas from the United States, clearly benefiting Cheniere Energy as it is the biggest producer of the compound in the country.
Unfortunately, we can see that the company's exports to Asia started to decline at around the same time as its imports to Europe went off. The reason for this is that China locked down its economy for nearly three years due to COVID-19, reducing its consumption of natural gas. In addition, China and India have both been ignoring the Western sanctions on Russia and have been purchasing natural gas from that country. The fact that Asia has been reducing its natural gas imports has been offsetting some of the growth that Cheniere Energy has seen from European Union import growth. However, we can still see in the chart above that its exports have generally been growing over the past three years. This is a positive sign for the company as it makes its money from exports. After all, nobody purchases liquefied natural gas for shipment domestically since it is much cheaper to use pipelines.
This overall growth in exports has certainly benefited Cheniere Energy's finances. The company posted year-over-year improvements in pretty much every measure of financial performance during the first quarter of 2023:
Q1 2023 | Q1 2022 | |
Adjusted EBITDA | $3,599 | $3,153 |
Distributable Cash Flow | $2,940 | $2,500 |
Net Income | $5,434 | -$865 |
(all figures in millions of U.S. dollars)
This strong year-over-year performance prompted Cheniere to increase its full-year 2023 guidance:
We always like to see improved guidance since that indicates that the company's performance was better than management expected to achieve during the period. In this case, the first quarter was quite a bit better than expectations, and the company expects that it will probably be able to deliver strong performance during the remainder of the year.
As everyone reading this is no doubt well aware, natural gas prices were substantially lower in the first quarter of this year than they were in the equivalent period of 2022. After all, natural gas prices spiked during the first quarter of last year partly due to the outbreak of hostilities between Russia and Ukraine. The fact that any natural gas company could deliver better performance year-over-year in such conditions quite clearly showcases the strength of the company's business model. In fact, Cheniere Energy's business model results in more financial stability than might be expected. This is because the company sells the liquefied natural gas that it produces under extremely long-term contracts. Most of these contracts last for at least twenty years, which guarantees that the company will earn revenue for a long period of time. Energy Tracker Asia provides a great summary of how these contracts work:
The dominant LNG market model is based on long-term take-or-pay LNG imports contracts. They require the buyer to purchase specific quantities of liquefied natural gas regardless of whether it is delivered or not. Alternatively, the buyer is locked in a contract with a length that can last between 20 and 25 years.
The buyer not only has to buy a specific quantity of liquefied natural gas from Cheniere LNG over a long period of time, but that buyer must also pay a price that guarantees Cheniere Energy a certain margin. This tends to result in the company having reasonably stable financial performance over time. We saw that over the past year as the company's cash flows were not affected by the steep decline in energy prices, nor by the fact that the warm winter allowed the European Union to consume less natural gas than it expected.
We see further evidence of the strength of Cheniere Energy's business model by looking at how little its products were actually needed in Europe. As we can see here, throughout the first quarter of 2023, Europe's natural gas storage levels were actually quite a bit above the five-year average:
Despite European gas storage levels being well above both the five-year average and the five-year range, the company still managed to grow its imports to the continent very slightly year-over-year and posted respectable profit growth. It would not be surprising if this continues, especially if the tensions between NATO and Russia remain high and Europe keeps trying to reduce its imports of Russian gas. This is admittedly a tough scenario to predict as we have various parties in both the United States and abroad that are pushing for a near-term end to hostilities. In addition, imported liquefied natural gas is substantially more expensive for the European Union than Russian-supplied gas, so there may be some pressure within Europe to either lessen or ignore the sanctions in order to reduce energy prices. The fact that Cheniere Energy has very long-term contracts with its suppliers does provide some insulation against these things though, and the company is likely to continue to perform well regardless of geo-political and short-term economic events.
Growth Prospects
As I have discussed in various previous articles, liquefied natural gas is expected to see tremendous demand growth over the coming decade or two. This is due to the use of natural gas as a supplement for renewable energy sources. After all, solar and wind are not reliable enough on their own to support an electric grid that needs to have 24/7 activity due to the fact that the sun is not always shining and the wind is not always blowing. The common solution for this problem is to use natural gas turbines to provide power during times when renewables cannot handle the demand on their own. The United States is one of the only countries in the world that has the ability to supply sufficient gas to meet the global demand and the only realistic way to export natural gas to overseas locations is to use liquefied natural gas.
While Europe has been the driver of liquefied natural gas demand growth over the past year or two due to the Russian tensions, Asia is expected to be the long-term driver. In fact, as I mentioned in a recent article , Asia is expected to double its imports of liquefied natural gas between now and 2035:
This will more than offset the stagnant decline for liquefied natural gas imports that are expected from Europe over the long term:
This is good for Cheniere Energy, as it should result in growing demand for the company's products for another decade or two even if Europe manages to achieve its "green energy" ambitions and reduces its demand for natural gas.
In order to take advantage of this demand growth, Cheniere Energy is increasing its production capacity. As mentioned earlier, the company is currently working on an expansion to its production facility in Corpus Christi. This project will increase the facility's capacity by approximately ten million tonnes per year.
The nice thing about this project is that Cheniere Energy has already secured long-term commitments from various customers to purchase the incremental output from this expansion. This is nice from our perspective as investors because it ensures that the company is not spending an extraordinary amount of money to construct production capacity when nobody wants to purchase the incremental product. It also means that Cheniere Energy has a reasonable idea of how much of a return it will be able to earn on its investment in this production capacity. This new capacity is expected to come online in late 2025 so we should see the impact on the company's results around that time.
Financial Considerations
It is always important that we investigate the way that a company finances its operations before making an investment in it. This is because debt is a riskier way to finance a company than equity because debt must be repaid at maturity. As there are very few companies that can afford to completely pay off their debt with cash as it matures, this is usually accomplished by issuing new debt and using the money to repay the existing debt. This new debt will be issued with an interest rate that corresponds to the market interest rate at the time of issuance, so a company's interest expenses might increase following the rollover in certain market conditions. As of the time of writing, interest rates in the United States are at the highest level that we have seen since 2007 so this is a very real concern today. In addition to interest-rate risk, a company must make regular payments on its debt if it is to remain solvent. Thus, an event that causes a company's cash flows to decline could push it into financial distress if it has too much debt. That is a risk that we should certainly never ignore.
One metric that we can use to evaluate a company's financial structure is the net debt-to-equity ratio. This ratio tells us the degree to which a company is financing its operations with debt as opposed to wholly-owned funds. This ratio also tells us how well a company's equity will cover its debt obligations in the event of bankruptcy or liquidation, which is arguably more important.
As of March 31, 2023, Cheniere Energy has a net debt of $24.079 billion compared to a shareholders' equity of $5.440 billion. This gives the company a net debt-to-equity ratio of 4.43, which is incredibly high. I generally do not like to see any company in the energy industry have a net debt-to-equity ratio over 1.0, although it is somewhat understandable in Cheniere Energy's case. After all, it is incredibly expensive to construct a liquefaction plant so the company had to incur high costs to construct two of them.
As I noted in past articles on Cheniere Energy, the company has been judiciously using its improved cash flows over the past few years to aggressively reduce its debt so if it continues to do this, it should be in good shape. This is certainly something that we want to watch going forward though, as we want Cheniere Energy to be reducing its leverage as opposed to increasing it.
Valuation
It is always critical that we do not overpay for any asset in our portfolios. This is because overpaying for any asset is a surefire way to earn a suboptimal return on that asset. In the case of a company like Cheniere Energy, we can value it by looking at the price-to-earnings growth ratio. This is a modified version of the familiar price-to-earnings ratio that takes a company's earnings per share growth into account. A price-to-earnings growth ratio of less than 1.0 is a sign that a stock may be undervalued relative to its forward earnings per share growth and vice versa. However, as I have pointed out in the past, nearly everything in the traditional energy sector looks to be significantly undervalued relative to its earnings per share growth.
According to Zacks Investment Research , Cheniere Energy will grow its earnings per share at a 30.80% rate over the next three to five years. That gives the company a price-to-earnings growth ratio of 0.15 at the current price, which is an indicator that the stock is substantially undervalued today. Indeed, this actually looks like one of the most undervalued stocks in the market if the company can indeed deliver earnings per share growth that is anywhere close to that level. Cheniere Energy thus could be worth picking up today as a deep value play with strong growth potential.
Conclusion
In conclusion, Cheniere Energy looks to be a great way to play the rapidly-growing American liquefied natural gas industry. The company has delivered respectable growth over the last year despite the weakness in natural gas prices, which speaks well to its business model. It is unlikely that the company's growth trajectory has ended, as it has a new project coming online in 2025 that will stimulate growth and the demand for its products is likely to grow until at least 2035. The only real problem here is that the company has a lot of leverage, but it is improving here and the attractive valuation compensates for this at any rate. Overall, Cheniere Energy, Inc. could certainly deserve a place in anyone's portfolio.
For further details see:
Cheniere Energy: Growth, Some Commodity Price Insulation, And Undervalued