Summary
- Liquefied natural gas prices have compressed in recent months due to abnormally warm winter weather and increased EU imports from Norway and the Middle East.
- Although US gas prices have declined dramatically, the lower spread from LNG prices should negatively impact Cheniere's profitability.
- In all likelihood, Europe's LNG imports from the US will not remain so high due to its inherent inefficiency compared to Norwegian and Middle Eastern pipelines.
- Cheniere's valuation is relatively high, given its significant debt level and immense derivative losses.
- Cheniere's stock, LNG, may decline this year due to overvaluation amid a decline in EU liquefied natural gas demand.
The international price of liquefied natural gas has soared recently as many regions fell into chronic shortages following production cuts in 2020. This issue was worsened last year as Russian gas flows to Europe fell and will likely remain permanently depressed due to the increasingly controversial destruction of the critical Nord Stream pipeline. These catalysts have benefited the largest US liquefied natural gas exporter Cheniere Energy ( LNG ), which traded at its highest price ever following Nord Stream 1's demise last fall and remains near its peak valuation.
LNG is a relatively expensive energy stock after more than doubling since 2019. The long-term increase in US LNG export levels and the significant price gap between the US and Eurasian natural gas prices have boosted the company's prospects. Last year, Cheniere exported around 70% of its total production to Europe amid the extreme price spike in the continent. Although European natural gas prices have declined considerably, they're generally expected to remain elevated due to the loss of Russian gas capabilities (regardless of sanctions/war). Thus, LNG is expected to earn an EPS of around $17.7 this year, giving it an attractive forward "P/E" of ~8.9X. However, its 2025 and beyond EPS consensus EPS estimate is ~$9.6, giving LNG a much higher long-term forward "P/E" valuation of ~15.3X.
Many investors are interested in Cheniere due to its valuation and potential for further benefits from increased capacity and potentially permanently higher European demand. Due to the broader geopolitical situation regarding Russia and China (a major LNG importer), many uncertainties may negatively or positively impact the company. Of course, Cheniere also faces its own risks due to its higher debt leverage and increasing production costs. Overall, I believe it is possible that LNG stock is a bit overvalued today and may decline this year as exuberance fades.
A Sharp Reversal in Prospects
Last year, investors and traders flooded into LNG to capitalize on the price spike in liquefied natural gas and the substantial increase in demand. Cheniere is seen as a company that offers a strong hedge against key geopolitical risk factors since its prospects increase as Europe becomes more reliant on US natural gas. While all of these factors benefit the company, investors may overestimate the impact and duration of the catalysts. Further, despite high prices last year, Cheniere suffered record losses over the past year due to a massive unrealized devaluation of its derivative hedging positions.
The price of liquefied natural gas collapsed over the past few months for a variety of factors, including weaker Asian demand and a sharp fall in European natural gas prices. At the same time, US natural gas prices have fallen by over 75% as production grows and warm weather spurs a glut. In my view, US natural gas prices are now a bit oversold and are likely near minimum levels . The same is likely valid for European natural gas prices, which have fallen even faster than US prices over recent months. See below:
European Natural Gas Price (TradingEconomics)
As European and US natural gas prices decline, LNG prices have begun to fall. Although the data is considerably lagged, it appears to "spread" between US prices, and the liquid price has also compressed significantly, threatening Cheniere's profitability. See below:
The compression in the spread between liquefied gas and US pipeline gas prices likely stems from the reduction in the spread between US and EU prices. EU natural gas remains considerably more expensive at around $13-$14/MMBTU (converting to US units), or roughly $11.5 higher than US prices. However, EU prices were in the $50-$70/MMBTU range for much of last year or at least $40-$60 above US prices. That immense spread spurred tremendous demand for US liquid gas imports into Europe. Still, demand is far lower, given EU gas storage levels are seasonally very high (primarily due to weather).
In the immediate term, Cheniere's prospects are weakened due to two key factors. Firstly, extremely warm winter weather has significantly decreased global natural gas consumption this season. Secondly, significant growth in EU gas imports from Norway and the Middle East . The first issue has had the most significant immediate impact but will likely fade and may reverse next month due to stratospheric warming that could cause rapid extreme weather cooling early next month. However, the second issue may have a more significant long-term impact on Cheniere.
Simply put, liquefying natural gas is a highly inefficient and expensive way to move the commodity. It is useful as a short-term measure countries can use to offset acute weather shifts or temporary supply issues. Still, it is not an effective long-term energy solution due to its cost (and energy needs). I believe it is inaccurate to assume Cheniere will benefit from permanent EU LNG demand. Indeed, Europe's LNG imports fell during most of 2022 after the initial spike. See below:
EU US LNG Imports Monthly (European Council)
Europe imports most of its gas, half of which used to come from Russia. Imports from other nations have made up for the decline in Russian gas, but US LNG only accounted for around 13-14% of Europe's monthly total gas in 2022 (following the end of Russian sources). While US supplies are essential, Norwegian and Middle Eastern imports are far more crucial and will likely be Europe's long-term solution since they are cheaper than liquefied gas.
The Bottom Line
In my opinion, Cheniere's stock, LNG, is overvalued today, given the change in its macroeconomic fundamentals. 2022 was supposed to be an excellent year for the company, but instead, it suffered more extreme losses due to its derivatives exposure. While many investors write those off since they're not realized losses, they have substantially increased Cheniere's total liabilities to a staggering $48B, causing its book value to become highly negative. See below:
Cheniere is highly leveraged, with ~$27B in financial debt and negative EBITDA. Even using its 2020 EBITDA was positive, its debt-to-EBITDA ratio today would be around 9X, which is very high - particularly considering the cyclicality of the LNG business. Many investors see the stock as a "growth opportunity" due to its "long-term" capacity growth plans, but its rapid growth will be low since its CapEx level in 2022 was the lowest in years (~$1.5B vs. $3-$6B pre-pandemic). The company is still expanding at a modest pace, but its growth requires immense capital to finance infrastructure, creating debt growth and a lack of dividends (typically high for a stock like Cheniere).
Further, 2023 and 2024 may not be as strong as many suspects since the recent compression in natural gas spreads should negatively impact its profitability. While this could end if the weather normalizes, the fact remains that Europe (and Asia) likely cannot become dependent on liquid gas imports due to the significant prices and costs involved. Liquid natural gas is also not as "environmentally friendly" as "normal" natural gas due to the immense energy costs of compressing and transporting it (among others) . While US regulators are seemingly preferential to LNG, EU regulators are less so due to the high costs and climate initiatives .
In the long run, after the current volatility fades, Cheniere is expected to generate an EPS of around $9-$12 per share annually . This gives LNG a longer-term forward "P/E" valuation of 12-16X. In my view, that is a relatively high figure, given the industry's significant cyclical exposure and the company's huge liabilities. The stock does not appear so overvalued that it is a short opportunity, but I would not be surprised to see it eventually decline back below $100 this year as exuberance surrounding European imports fade. That decline would give the company "P/E" valuation closer to 10X, a much more sensible figure given the stock's high-risk profile.
For further details see:
Cheniere Energy: Profits Likely To Fall As LNG Prices Collapse