2023-05-09 10:22:30 ET
Summary
- Cheniere Energy shares are roughly 20% below their all-time high, as warm winter weather and slow Chinese buying have caused LNG demand and prices to drop.
- However, long-term price and volume fundamentals remain healthy, providing a path for Cheniere to accelerate its export volumes for decades to come.
- The company is attractively valued. It has a healthy balance sheet, internally-funded projects ahead of schedule, a dividend growth plan, and buybacks.
Note: because the abbreviation of Liquid Natural Gas and the ticker of Cheniere Energy are both LNG, I will only refer to the commodity when using LNG in this article.
Introduction
I'm sure I've said something similar in prior articles. However, it needs to be said again. I believe that Cheniere Energy (LNG) is one of the most fascinating energy stocks on the planet. While the company doesn't come with a high yield, which tends to be a turn-off in the energy sector, it is the largest LNG exporter in North America, providing much-needed supplies for both Europe and Asia.
Currently, the stock is roughly 20% below its all-time high, as LNG demand was much weaker than expected, triggered by warm weather.
FINVIZ
However, long-term demand is expected to accelerate, while the mid-term case for higher LNG prices is strong.
Not only that, but Cheniere is set to benefit from decades of rising demand and favorable pricing. When adding this to its ability to let shareholders benefit through distributions, I believe that Cheniere shares remain undervalued and poised to deliver highly satisfying long-term returns.
Allow me to elaborate!
LNG Remains So Very Important
Since 2021, when Russia started to prepare for the invasion of Ukraine, I warned that Europe was playing a dangerous game in a situation of unfortunate headwinds. It reduced domestic natural gas production, it suffered from Russia reducing exports, and it risked massive blackouts during the 2022/2023 winter months.
Luckily, I was wrong for one reason only: the weather was much warmer than expected. As Bloomberg's Javier Blas explained, Europe was fortunate last winter due to mild temperatures, which limited consumption, and China's zero-Covid policy, which allowed Europe to import a significant amount of LNG that would otherwise have been unavailable. As a result, Europe's gas storage bottomed out at 55% of capacity at the end of the heating season, which was well above the 10-year average of 33%.
Thanks to these tailwinds, Europe needs to inject around 35 billion cubic meters of gas into storage by late October to reach the 90% target, which is well below the 10-year average of about 55 billion.
The market is pricing an easy-peasy scenario, and gas contracts for immediate delivery are trading at a significant discount to contracts for the 2023-2024 winter. It is a sign that supplies are plentiful for the current injection season, and the market believes that European demand needs to be curtailed again next winter via punitive high prices.
ICE's NWE (Northwest Europe) LNG futures are trading at $10 per MMBtu, which is down from almost $40 at the end of last year. While this is still way above the price of Henry Hub natural gas (a certain premium is warranted), we're dealing with a market that is pricing in rather low risks.
The regional gas stockpiles have already increased to 60% of their capacity, a level that they did not hit in 2022 until early July. At the current pace, the 90% target will likely be exceeded well before October, possibly by late August or early September, although this will depend on whether the region can continue buying as much LNG as it wants.
With that said, LNG shipments have become Europe's new baseload supply, replacing the role that Russian state-owned Gazprom played in the past. According to the International Energy Agency, LNG accounted for two-thirds of the region's imports through the crucial 2022-2023 winter season. A small but vital fraction came from Russia itself, as Europe continues to purchase Russian LNG.
Unfortunately, for Europe, a lot of good news has been priced in while risks are building. To quote Javier Blas:
For now, China still isn't buying much LNG, freeing cargoes to go to Europe. Wael Sawan, the chief executive officer of Shell Plc, one of the world's biggest LNG suppliers, put it succinctly last week, saying that "prompt" LNG demand was "weak." But Sawan warned Europe about the short-termism of "for now," noting that Chinese consumption was "starting to really pick up."
[...] This may last for a few more months, giving Europe enough time to replenish its gas storage and averting a crisis in the winter. But punting on good luck is never a good long-term strategy.
Related to this, McKinsey & Company highlighted five factors influencing LNG storage (and prices).
- An increase in Asian LNG demand could lead to higher prices and potentially reduce European gas supply by up to 35 bcm.
- Complete stoppage of Russian piped gas could result in a sustained supply reduction of 25 bcm.
- Colder winter weather in 2023 could add another 15 bcm to Europe's gas demand.
- Increasing nuclear availability in Germany and France could offset five bcm of gas consumption while reducing power demand by 5% could reduce gas demand by an additional 14 bcm.
- Continued behavioral changes in building heating and industrial shutdowns could potentially save Europe approximately 39 bcm in gas demand.
Furthermore, the research article highlights the rapid expansion of Europe's import capacity of LNG.
Beyond these signposts [the ones in the overview above], an additional LNG regasification capacity of 70 bcm per annum is expected to come online over the next two years in Europe, which may further help Europe achieve a supply-demand balance without price spikes.
Cheniere Remains In A Terrific Spot
With a market cap of $36 billion, Cheniere Energy is one of the largest energy companies in North America. It's also the largest LNG exporter.
Founded in 1996, the company operates the Saibe Pass and Corpus Christi terminals, which dominate US LNG exports, and are expected to do so for a very long time.
Energy Information Administration
In its 1Q23 earnings call , the company confirmed a global trend of tight supplies. It noted that global LNG production reached record highs during Q1 2023, with 36 million tonnes exported in March alone. The increase in production was significant in Norway, Australia, and Qatar, where plants that were offline or undergoing maintenance last year resumed operations.
Despite these tailwinds, Cheniere warned that limited overall supply growth was expected this year, as few new projects were set to come online in the next 18 months.
As a result, supply and demand are expected to remain precariously balanced, with any supply disruptions, weather shocks, or demand shocks potentially impacting prices.
Hence, Cheniere believes that the US will continue to be a critical source of flexible supply in the market. The company's US sites continued to deliver approximately 80% of all cargoes to Europe during Q1.
However, global gas benchmarks remained elevated, with the TTF (Europe natural gas) monthly settlement prices averaging approximately $19.50 per MMBtu in Q1 2023, 35% lower YoY, and the JKM (Japan (North Korea)) average settlement price decreasing by 16% YoY to approximately $26 per MMBtu. Please note that these prices are visible in the slide above.
With all of this in mind, Cheniere is doing a number of things that younger LNG-focused companies with high capital requirements cannot compete with - at least not yet.
- It expands its business using internal cash flow.
- It reduces debt.
- It rewards investors through dividends and buybacks.
Most companies cannot do any of this as they need external cash flow to expand. While this is how Cheniere started, I prefer mature companies that do not come with high funding risks.
In the first quarter, Cheniere paid down nearly $900 million of debt and bought back over three million shares for about $450 million. The company is now on pace to reduce its net leverage ratio to 2.4x by the end of this year. Earlier this year, the company got a BBB- credit rating.
As I wrote in my last article , the company applies a one-to-one target ratio, which 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.
Cheniere also declared its seventh quarterly dividend of $0.395 per common share for the first quarter and intends to follow through with its previous guidance of growing its dividend by approximately 10% annually into the mid-2020s through the construction of Stage 3 with the next hike planned for later this year.
For now, this dividend translates to a yield of 1% with a payout ratio of less than 5%, which shows how much dividend potential this company has. Using the expected 2023 free cash flow, the cash payout ratio is 10%.
Furthermore, and related to its expansion plans, the company funded approximately $550 million of CapEx at its Corpus Christi Stage 3 project during the quarter, using cash on hand. It also updated investors on its progress, which - as usual - is ahead of schedule.
- Corpus Christi Stage 3 construction is ramping up with over 7,000 piles driven and completed soil stabilization.
- Early construction activities are tracking ahead of schedule, with the entire 7 Train project potentially completed by the end of 2026, months ahead of the guaranteed schedule.
- Corpus Christi mid-scale trains 8 and 9 are in the FERC process, with a full application submitted to FERC in late March, and Bechtel already mobilized on site.
- SPL expansion is in prefiling with FERC, and Cheniere has signed a contract with Bechtel for the FEED work, including the carbon capture component.
- Cheniere has signed an SPA with an investment-grade Asian end-user for LNG volumes delivered through 2047, subject to the FID of Train 1 of the Sabine Pass expansion project.
- Cheniere Energy is committed to long-term value creation and continues to target market-leading project returns on a risk-adjusted basis.
Valuation
Cheniere Energy is expected to see declining EBITDA in the years ahead. That's not a bad sign. It's caused by a normalization after a spectacular year in 2022, which is unlikely to be repeated anytime soon. Now, analysts are pricing in normalization in prices, despite rising volumes.
The same goes for free cash flow, which is expected to contract by double digits.
However:
- All of this has been priced in. The market knew that LNG prices would come down. Given the fundamentals of global LNG, the risk is to the upside, indicating a favorable risk/reward for LNG prices (and Cheniere's financials).
- The company has hiked its guidance. On a full-year basis, it now expects between $8.2 and $8.7 billion in adjusted EBITDA, $200 million more than previously expected.
Shares are currently trading at 9.1x NTM EBITDA.
In my prior article, I wrote that Cheniere should be trading between $215 and $235. The current consensus target is $200.
Takeaway
Cheniere Energy is the largest liquefied natural gas exporter in North America, supplying much-needed energy to Europe and Asia. While the stock has been struggling due to warm weather, long-term demand is expected to accelerate, and the mid-term case for higher LNG prices is strong.
The company is set to benefit from decades of rising demand and favorable pricing, and investors can benefit through distributions. LNG has replaced Russian state-owned Gazprom as Europe's new baseload supply, with LNG accounting for two-thirds of the region's imports through the 2022-2023 winter season.
Furthermore, Cheniere remains attractively valued. It has a healthy balance sheet and major internally-funded projects that are ahead of schedule.
Going forward, I expect Cheniere shares to do well and benefit from accelerating dividend growth and buybacks for many years to come.
For further details see:
Cheniere Energy Saves The World