2023-10-10 03:00:59 ET
Summary
- The EU is reducing its imports of Russian LNG, and the US is benefiting from Europe's decision to shift away from Russian LNG.
- North America, particularly the US, has become a major investor in LNG production and has increased LNG exports to Europe by 30%.
- FLEX LNG's charter rates are expected to decline due to lower gas demand from the EU, impacting the company's revenue and EBITDA forecast.
Investment thesis
Although Russia remains one of the largest LNG suppliers, the EU has already begun to develop mechanisms to limit future imports of Russian LNG. And since North America, especially the United States, has gradually become one of the largest investors in LNG production in recent years, and given the increase in LNG imports by the European Union, the United States has strengthened its position as the main supplier of gas to Europe, the United States benefits from Europe's future decision to abandon Russian LNG.
But we still believe that it is too early to invest in FLEX LNG ( FLNG ) stock due to market sentiment, driven by high gas storage utilization in the EU, is currently weighing on spot freight prices and, as a result, on FLNG shares. Rating is HOLD.
Beneficiary of EU's shift away from Russian LNG
As part of the strategy to phase out Russian fuel by 2027, the EU is reducing its imports of oil, coal and pipeline gas, but still relies on Russian LNG. In order to substitute gas supplies from Russia, the EU has ratcheted up LNG imports by more than 25% from a year earlier. The volume reached a record 94 billion cubic meters during the 2022/23 heating season, with Russia still one of the largest suppliers. LNG, including imports originating in Russia, is becoming a key resource in replacing pipeline gas from Russia. However, the EU has already started to develop mechanisms to limit Russian LNG imports in the future, so other players will eventually take over Russia's share in this market.
Over the past years, North America, particularly the US, has emerged as one of the biggest investors in LNG production. Final investment decisions ((FID)) in North America were made for a volume in excess of 30 bln cubic meters in the first half of 2022, while the rest of the players had nothing to report. According to Bloomberg, the US plans to take the lead in building up LNG production capacity by 2026.
In light of increased LNG imports by the European Union, the US has increased LNG exports to Europe by 30% from a year earlier, solidifying its position as a major gas supplier to Europe.
Given the rapid development of LNG production and US leadership in supplying LNG to the EU, the US stands to gain from Europe's future decision to shift away from Russian LNG.
FLEX LNG's charter rates
In 2Q 2023, average forward 5-year rates fell from the record levels of around $135 thousand per day to $128 thousand per day because much of the EU storage capacity was filled, which reduced gas demand and put pressure on long-term contracts. However, prices of new ships have jumped by more than 30% over the last two years due to higher LNG demand, along with capacity constraints and lack of available slots at shipyards. We continue to expect newbuild prices and, consequently long-term charter rates, to be rising through the end of 2024, and then decline as the market gradually becomes saturated with new ships.
As we have written earlier, FLNG charter rates are sensitive to spot charter prices, which follow the industry's long-term rates, taking into account quarterly seasonality. We expect average charter rates for ships with the capacity of carrying up to 165 thousand tons of LNG to decline from $99.6 thousand to $88.9 thousand per day in 2023, and from $102.1 thousand to $100.4 thousand per day in 2024 due to lower gas demand from the key importer, the European Union.
Financial results
We are lowering the forecast for FLEX LNG's revenue from $384 mln (+10% y/y) to $380 mln (+9% y/y) for 2023, and from $396 mln (+3% y/y) to $382 mln (+0.4% y/y) for 2024 due to the decline of average charter rates for ships with the capacity of up to 165 thousand tons of LNG from $99.6 thousand to $88.9 thousand per day for 2023, and from $102.1 thousand to $100.4 thousand per day for 2024.
We are lowering the EBITDA forecast from $306 mln (+12% y/y) to $297 mln (+9% y/y) for 2023, and from $314 mln (+3% y/y) to $296 mln (-0.4% y/y) for 2024 due to:
- the reduction of the forecast for revenue in 2023 and 2024 due to projected cuts to FLEX LNG's charter rates from $84.5 thousand to $81.5 thousand per day for 2023, and from $83.5 thousand to $80 thousand per day for 2024;
- the increase of the forecast for vessel operating costs from $77.9 mln to $82.8 mln for 2023, and from $82.6 mln to $85.6 mln for 2024 on account of estimates for oil prices going up from the average of $82.5/bbl to $84.6/bbl for 2023 and from $93.2/bbl to $100/bbl for 2024.
Valuation
We are lowering the target price of the shares from $33.4 to $32 due to:
- the reduced EBITDA forecasts for 2023 and 2024;
- the shift of the FTM valuation period forward by one quarter. The valuation period now is from 3Q 2023 to 2Q 2024.
We are maintaining the status of the shares at HOLD. The upside is 10%.
We evaluate the company using two methods: the EV/EBITDA multiple method and the EV/market-value-of-the-fleet method. The second method shows the enterprise value is too low compared with the market value of its fleet. The share price target of $32 is the average value of the prices that have been computed according to the two abovementioned methods.
Conclusion
Thus, the freight market will remain alluring through the end of 2024: Prices for new LNG tankers will be rising due to a shortage of available capacity and slots at shipyards. FLEX LNG is a promising LNG shipping company. The company operates the youngest fleet, compared with its competition, and is also distinguished by low capital expenditures, which provides it with a very strong competitive advantage over the rest of the players in the industry. But we still believe that it is too early to invest in FLEX LNG stock due to market sentiment, driven by high gas storage utilization in the EU, is currently weighing on spot freight prices and, as a result, on FLNG shares. Rating is HOLD.
For further details see:
FLEX LNG: Lower Spot Freight Rates Weigh On Share Price