2023-04-29 03:32:10 ET
Summary
- GTT is a leader in cryogenic membranes.
- Growth in LNG demand, ageing LNGC fleet, decarbonization are company's key growth drivers.
- The record order backlog and lack of shipyard capacity protect the business from a potential recession.
Business overview
Gaztransport & Technigaz SA ("GTT") ( OTCPK:GZPZF )( OTCPK:GZPZY ) is a leader in containment systems for LNG carriers, floating and land terminals as well as fuel tanks for vessel propulsion. It provides cryogenic membranes to >75% of the global LNG fleet currently in operation. When looking at new orders, this dominant position is even more pronounced, with close to 100% market share . Such dominance is the result of the superiority of its patented technologies (Mark and NO) which has been developed through extensive R&D investments. Indeed, the company spent ?7% of sales in R&D, has ?30% of its workforce working in R&D-related activities and owns >2400 patents (of which 421 patented inventions).
In the absence of bringing notoriety to the general public, being the leader in this niche market offers many positive attributes. The business model is asset-light as most of the revenues (>90%) are derived from royalties paid by shipyards while using GTT’s containment technology for building LNG carriers. Royalties are based on a fixed rate per square meter, thus larger the membrane size, higher the royalties. Besides, royalties also offer a good protection against inflation because they are indexed to the labour cost of the French engineering industry (employees are almost all located in France). Margins are very elevated (>95% and>50% gross and EBIT margin, respectively), return on capital is impressive (100%+ ROIC) and cash generation is very strong given limited capex needs and structurally negative working capital . Being highly cash generative enables the company to pay out? 80% of net income in dividends while still being net cash positive (net debt to EBITDA of -1.29x).
Economic moats
The attractiveness of this industry will most likely prevail for many years because GTT has built an excellent track-record, a strong reputation around the quality, reliability, and efficacy of its products, longstanding relationships with shipyards, and even more important, with shipowners and gas companies. Shipyards do not decide about vessel requirements and specificities, shipowners do under the influence of gas companies. Gas companies tend to first prioritize safety when selecting LNG carriers in order to minimize reputational risk. Then, they look for operating performance in order to maximize the profitability. Performance and safety are two criteria that bode very well for GTT.
Financial incentives for switching to other technologies are also limited given that royalties associated with GTT containment systems account for only 3% of the overall price. Indeed, it represents $ 6/10 million (depending of discounts related to order size) of the $ >240million total cost of building a 174,000-m3 LNG vessel. It is also interesting to note that royalty payments come on top of the construction costs of the membrane (estimated to be around $ 20/25 million). Despite being the most expensive solution, GTT technologies enable to reduce construction and operating costs over time, offsetting the initial premium paid. Indeed, for the same LNG capacity, GTT’s membranes are smaller and lighter, requiring less aluminium and steel during the construction phase. The lower weight enables to reduce fuel costs while the membranes enable to reduce the boil rate.
A demand for LNG vessels driven by a growing LNG market
LNG demand was expected to grow >3% CAGR over the period 2022-2040, from 396 to 700 mtpa (million tonnes per annum), driven by the energy transition. Energy transition pushes many countries to reduce coal in their energy mix to the benefit of renewables and natural gas. Natural gas is a good solution because it is complementary to renewable energies, enabling to deal with power generation intermittency.
Besides, following the war in Ukraine, European countries are moving away from Russian gas (delivered by pipeline) to alternative solutions, which further strengthens LNG demand. Many governments have decided to build gasification terminals in order to overcome the reliance on Russian gas. For instance, the German government announced a plan for its fifth Floating Storage Regasification Unit (FSRU) as part of its effort to replace the gas that it previously imported from Russia whereas the country had no regasification facilities prior to the invasion of Ukraine. The French government approved a floating regasification terminal in Le Havre that will be operational in 2023 and many other examples can be found.
Within that context, new liquefaction capacity are set to expand by at least 220 bcm by 2030 , which is equivalent to ?160 mtpa of LNG. This new capacity will mainly come from the US and Qatar, which will require additional vessels for transporting the LNG in importing countries (Europe, China, South Korea, and Japan account for roughly 75% of total imports). As a r ule of thumb , one mtpa of LNG produced in the US requires ? 1.3 LNG carrier for transporting the cargo in Europe and >2 for Asia, which implies a need for at least >200 LNG carriers related to these new LNG export capacities.
A replacement market fuelled by an ageing fleet and environmental regulations
The existing vessel fleet is ageing as highlighted by the 165 15+-year-old LNG tankers that are currently in operation (over a total fleet of 641 LNG tankers). These vessels use out-of-date, inefficient and environmentally unfriendly steam turbine propulsion systems. Furthermore, they have smaller LNG capacity (125k/150k bcm vs >170k bcm) and higher boil rate than most recent vessels. In short, they are expensive to charter, thus it is highly likely that they will be replaced once charter contracts expire in the coming years.
The International Maritime Organization ((IMO)), an UN agency overseeing international shipping, issued a new regulation that aims to reduce GHG emissions. This new regulation , which came into effect on November 2022, introduced carbon intensity measures that will prevent the most polluting vessels (rated E) to be operated without modifications. According to GTT, 240 LNG vessels will be rated E by 2030 and 400 additional LNG carriers could potentially enter in that category between 2030 and 2040. Besides, among the 240 vessels to be rated E before 2030, roughly 170 ships have limited modification options for complying with the regulation due to outdated propulsion systems. As a result, the replacement market should add at least 20/25 new orders annually in average for at least the next decade.
LNG as marine fuel is the second leg of growth
In January 2020, a new IMO regulation came into effect. This regulation, which aims to cap sulphur emissions on marine fuels, offers new growth opportunities for GTT. Indeed, LNG as marine fuel is a good alternative to decarbonize the maritime industry as it generates less CO2 and sulphur oxides (SOx) emissions than traditional marine diesel oil and alternative fuels such as methanol and ammonia. Besides, LNG as fuel is more affordable, safer, has a longer autonomy for a given tank space, and benefits from a greater density of refuelling infrastructure than other alternative fuel solutions.
Among large containerships ordered in 2022, 56% of them are fuelled by LNG (versus 0% in 2016 and 30% in 2019/2020). Within that market, GTT owns 44% market share. The addressable market consists of large vessels such as oil tankers, cruise ships, container and bulk carriers and is estimated at 3500 vessel newbuilds globally over the next ten years, which represent roughly 350 units per year in average. As a rule of thumb, the revenue generated for 10 LNG as fuel units is equivalent to one LNG cargo, thus the LNG as fuel business could add the equivalent of 35 LNG carriers of revenue per year.
Strong business momentum with multi-year revenue visibility
GTT is uniquely positioned to benefit from the increasing need for LNG transportation capacities, stemming from the steady growth in LNG production. As a result, order intakes have accelerated since 2017 and reached extraordinary levels in 2022 (and the first quarter 2023). Since the shipyards had the capacity to build around 55/60 units per year before 2021, order intakes exceeded deliveries, resulting in a growing backlog and longer delivery times. As of today, new order intakes will not be delivered before 2027 because shipyards are now running at full capacity and are fully booked for the next three years.
As a result, Chinese shipyards are getting new business, which will increase industry capacity to >80 units by mid-2025. For instance, GTT worked with three Korean shipyards (Samsung Heavy Industries, Daewoo Shipbuilding & Marine Engineering and Hyundai Heavy Industries) and one Chinese (Hudong) shipyards historically and started to work with four new Chinese yards over the last twelve months (Jiangnan, Dalian, Yangzijiang and Juangsu).
Regardless of the economic situation, GTT has a strong visibility on its revenue stream in the long- and short-term. Structural growth opportunities, tight LNG market and high barriers to entry are supportive for long-term prospects. The company upgraded its 10-year cumulative orders estimate in July 2022 and now expects to provide cryogenic membranes for 400/450 LNG carriers over the coming decade, equivalent to an annual average of 40/45 LNG vessels. Our analysis suggests that this target is reasonable and could even be too conservative.
We also believe that GTT is protected from any potential short-term economic slowdown thanks to its record order backlog. Indeed, regardless the macroeconomic conditions, GTT will deliver 42 and 72 units in 2023 and 2024. In the eventuality of an order cancellation, we are confident that shipyards will be able to deliver LNG cargoes to the next customer on the list. These deliveries are estimated to generate USD 335m and 504m revenue in 2023 and 2024. These revenues are already above 2022 total revenue of USD 307m while they do not factor revenues from the service business (training, maintenance, assistance, digital, technical studies...) and Elogen (Electrolysers). Moreover, revenue growth is going to accelerate meaningfully for the next couple of years because of the increasing number of ships under construction. Revenue estimates for 2023/2024/2025 are expected to be EUR 405m, 555m and 598m, which compare positively to the EUR 307m generated in 2022.
Valuation
GTT share price reached EUR 136 at the end of august 2022 before declining to its current EUR 95 level. We believe that two major headwinds are behind this correction. Firstly, the decision of the Seoul High Court that rules against GTT, followed by the decision of the Supreme Court of Korea to reject GTT’s appeal. The appeal decision confirms the obligation to separate the technology licence and the technical license, if requested by Korean shipyards. Then, GTT announced that it stops its operations in Russia and cancels the revenue related to 15 icebreaking LNGCs and three GBS, equivalent to a total of $ 86 million of future revenue.
We think that even if a shipyard asks to separate the technology and technical licenses, GTT will most likely renegotiate royalty fees higher in order to be sure to earn as much money as under previous agreements. Besides, given that GTT considers that the technical assistance and engineering services are essential to ensure the safety and performance of its solutions, it is highly unlikely that shipyards decide to opt for another solutions. Regarding the Russian business, we think that the war in Ukraine has more positive impacts on GTT than negative due to the willingness of European countries to diversify their supply of gas, which bring new LNG demand in the market.
As of today, the stock is trading at 17x earnings and 12.6x EBITDA, which is not expensive for a company in a monopoly, with solid growth prospects, strong visibility, and impressive profitability. Besides, it is recession-proof for at least the next three years. In terms of EV/EBITDA, GTT is trading in line with its historical average despite enjoying much stronger positioning and brighter prospects than it used to be. Finally, GTT is trading at lower valuations than a list of high-quality industrial companies despite having much higher profitability, stronger balance-sheet, and stronger earnings growth over the coming years.
We know that GTT is able to deliver 45 LNG tankers per year (25 from the growth in LNG demand and 20 from the replacement market). In order to build a margin of safety, we assume 0 deliveries for all other categories. Then, LNG as a fuel has a market opportunity of 350 newbuilds per year. Assuming that 50% of these vessels opt for LNG solutions and a 50% market share for GTT, it implies 88 new orders, which is equivalent to the revenue of 9 LNG carriers. Given the historical revenue of EUR 8M per vessel, royalties amount EUR 432M. On top of that, we can easily add EUR 20m of revenues for services, thus, we end up with EUR 452m of revenue. Assuming a 45% net income margin and 37m of share outstanding, we derive a net income of EUR 203m and an EPS of roughly 5,50. Using a P/E of 19x, in line with the list of comparable, suggests a share price of EUR 105, which implies 10% upside. On top of that, the stock is paying a 3% dividend yield that will grow significantly in the short-term as the company targets an 80% payout ratio and that earnings are expected to grow from EUR 3,46 in 2022 to EUR 8,5 in 2026.
This valuation is conservative because 1) revenue expected from the order book for 2024 and 2025 are close to EUR 500m, higher than the EUR 450m from our conservative scenario, 2) we assume 0 deliveries for other categories, no revenue for Elogen and no growth in service revenue, and 3) consensus forecasts EPS of EUR >7 in 2025 and EUR >8 in 2026. As a result, we believe that current share price offers an attractive entry point and that the stock should do well in any economic conditions.
Risks
Business cyclicality: The market for LNG carriers can be cyclical because new orders can be delayed for a couple of years due to the long life of vessels.
Disruptive technology: A competitor could develop a better technology and/or GTT could fail to maintain leading technologies.
Regulation (1): Given GTT operates in a monopoly, it is subject to regulations on anti-competitive practices.
Regulation (2): A change in some maritime regulations (related to CHG emissions and environmental pollution) could have a negative impact.
Client concentration: In 2021, one customer contributed 21% of total sales, and five customers contributed 85%.
Product defect: A membrane defect could significantly impact the reputation of the company, and eventually lead to a loss of market share.
Engie’s stake: Engie still owns ?10% of the company although it has already reduced its stake. An accelerated bookbuild offering could pressure the share price but has no impact on the intrinsic value of the company.
For further details see:
GTT: A High Quality, Very Profitable And Structurally Growing Company Immune To Short-Term Economic Conditions