Tag Archives: LNG

Gaztransport (GTT), Cheniere (LNG), Swatch

Gaztransport – Dodged the bullet..

Well, that was quick. 2 weeks after I reviewed Gaztransport, they have dislosed the following:

2016-01-29

Paris, 29 January 2016 – GTT (Gaztransport & Technigaz) announces that it received today a notification from the Korea Fair Trade Commission informing the company that an inquiry has been opened into its commercial practices with regard to its Korean shipyard clients.

The result: The stock price dropped  ~20% in two days:

Read more

Gaztransport & Technigaz (GTT.FP) – Wide Moat at a bargain price ?

Imagine you could invest into a company with the following characteristics:

– Global market leader with 70-90% market share (95% new built)
– Net margins after tax of 50% or more
– business protected by patents
– almost no capital requirement, negative working capital
– a potentially huge growth opportunity
– conservative balance sheet (no debt) and “OK” management
– at a very reasonable price (11x P/E, 7,8% dividend yield)

At a first glance, Gaztransport et Technigaz (GTT) from France seems to be the ideal cheap “moat company”. What do they do ?

Gaztransport is the global leader for “LNG containment systems”. LNG is liquified natural gas and is the predominant method to transport natural gas over long distances. In order to become liquid, natural gas has to be really cold,at least -162 degrees celsius. GTT’s technolgy is required to safely store and transport LNG on ships.

Problem Number 1

Before going into more details, it is pretty clear that GTT is an energy related company. But looking at this chart from their investor presentation we can clearly see what the real problem for GTT is:

gtt sales profit

Ultracyclical sales. We can see that within 4 years sales dropped -75% only to quadruple again in the next 4 years. Although the overall strength of the business model clearly shows in the fact that even after a -75% drop in sales, they still earned a 30% net margin.

So what do they actually do (The Moat) ?

Gaztransport has been IPOed in 2014 in France (although it was technically more a “carve out” as the company itself did not need any money. They have extremely good English language investor material, for instance the Q3 2015 report.

I try to summarize their businessin my own words:

– if you want to build ship to transport LNG, there are effectively only 2 technologies available to ensure that the LNG is contained safely, one of them is owned and patented by GTT. From inside it looks like this:

lng-containerment-tanks
– there is a relatively large moat with regard to technology. GTT has developed that technology over the last 50 years or so and it is superior to the only competitor (“Moss”), both in price (for the total ship) as well as in utility (ships are lighter, easier to maneuver, overall cost is cheaper)
GTT charges royalties, both, for the technology and “consulting” during the building of the ship. After the ship is finished, there are no royalties. Service is currently only a single digit percentage of sales
Sales therefore directly depend on the number of LNG tankers being build
So the future of GTT clearly depends on the future of LNG. More LNG means more ships and more money for GTT and vice versa.

The Moat vs. new competitors

There are potential new competitors, mostly the handful of Korean companies who actually build the ships. The Koreans for some time now try to develop or copy their own version of the technology. I assume that they clearly know how much money GTT makes with the patent and that they woul love to cut GTT out of the process.

GTT themselves think that the threat is not so big in the near future. The ship certification companies would need to approve first as well as the oil companies who are finally responsible for the LNG tankers and the administrators of any harbour or docking station.

So far in the 50 year history both, Moss and GTT have a 100% safety record with no accidents. The cost for GTT technology within the overall price of a LNG tanker is around 4-5% of the total constructon price. So the question is really why should any energy company take on the risk for a new unproved technology when the potential cost savings are pretty low ? LNG Tankers do carry the equivalent “firepower” of dozens of nuclear bombs, so risk aversion is pretty high especially in developed world harbours.

The LNG market

There is a lot of material on LNG but most of them are very optimistic, some links:

BG LNG Global market outlook
McKinsey LNG study

Again in my own words my thoughts on LNG:

– LNG is considered “clean fuel” compared to oil and coal and should benefit from climate issues
– Natural gas is abundant and in many cases cannot be transported via pipelines
– A lot of the natural gas comes from “stable” countries like Australia and the US and is therefore strategically interesting

But clearly, low energy prices take a toll on LNG as the liquification, transport and regsification are expensive. A year ago I looked at Seth Klarman’s investment Cheniere Energy and I was not convinced. However a lot of money has been now invested into liquification facilities especially in the US and Autralia, so it is not unlikely that the amount of LNG to be transported might rise as projected and the need for transport and storage increases.

So just some rosy LNG projections alone would not be enough to make GTT interesting for me.

The “carrot on the stick”: Bunker fuel

Big Ocean going ships burn a fuel called “bunker” which is extremely filthy:

As ships get bigger, the pollution is getting worse. The most staggering statistic of all is that just 16 of the world’s largest ships can produce as much lung-clogging sulphur pollution as all the world’s cars.
Because of their colossal engines, each as heavy as a small ship, these super-vessels use as much fuel as small power stations.
But, unlike power stations or cars, they can burn the cheapest, filthiest, high-sulphur fuel: the thick residues left behind in refineries after the lighter liquids have been taken. The stuff nobody on land is allowed to use.

In the meantime however, stricter requirements for ship fuel have been installed. Current caps are mostly effective in Europe and North America, but starting 2020, globally much tighter rules will come into effect.

There are several possible solutions to the problem:

– using cleaner fuel which is however more expensive and limited
– cleaning the exhaust with expensive technology
– use LNG as alternativ fuel

If LNG would become popular in the future, GTT’s technology would suddenly be required everywhwere, from every port and every big ship, which would mean much more steady business than in the past and a strong structural growth over many years.

However, at current prices this is far from a sure thing, so in any case as an investor I would not want to pay for this at the moment.

Click to access 213-35922_LR_bunkering_study_Final_for_web_tcm155-243482.pdf

Stock Price

For an energy stock, GTT has held up quite well since their IPO until late 2015 but then got hammered, howevr as we can see less than TGS for instance:

gtt chart

 

 

How to value GTT ?

The problem is the following: GTT is a cyclical company and we are most likely at or near the top of the cycle with regard to the “core” business. One could argue that with an overall size increase of the LNG tanker fleet, the replacement requirement increases but with an expected life of around 40 years, the replacement cycle  for the current fleet is a long way off in the future.

So using current profits and saying” Wow the stock is cheap” clearly doesn’t help. Comparing it for instance with a less cyclical stock like G. Perrier and saying: 11x PE is better than G. Perriers 15x PE is nonsense.

As I said before, I would not be willing to pay for the “Option” of LNG powered shipping so I need to come up with a way to value the company based on the cyclicality of earnings.

So what I did is that I tried to “simulate” future earnings with roughly the same kind of cyclicality that we have seen in the past 10 years. This is the resulting “Model” for the next 35 years:

gtt earnings

I have “modelled” somehow similar cycles as the current one, with the peaks increassing first and then trailing of somewhat in the future.

We can then discount this cyclical earnings stream by our “required rate of return” to see if GTT is a real bargain or not.

Under those assumptions my results were the following:

10% discount rate: 20,80 EUR per share

15% discount rate: 14,26 EUR per share

So now one could clearly challenge my “model” and tweak it somehow, but in general it looks like that GTT is not a bargain at current prices (34 EUR). To me it rather looks like that the current valuation already implies a certain value for the LNG ship fuel “option”. Therefore GTT at current prices is not interesting to me as an investment.

One important learning experience for me is that I guess one should value all cyclical stocks like this, i.e. really model the cycles and discount those cashflows instead of just looking at current multiples and say “wow that’s cheap”. I think I made that mistake to a certain extent with TGS Nopec.

Summary:

Overall, GTT is a very interesting, unique company. It combines a “wide moat” with regard to technology and patents with a very cyclical business.

Although the company looks cheap at current multiples, over the cycle there is more downside than upside at current prices in my opinion.

If LNG will become the dominant fuel for ships in general, than the investment case might change significantly to the upside but for me this is not given at current energy prices.

In the future, I will need to analyse and value cyclical companies the same way as I did here: With actually modelling cycles instead of (implicit) constant growth assumptions.

 

 

 

 

 

 

 

 

 

 

 

 

Why on earth is Seth Klarman investing 1,7 bn USD in Cheniere Energy (LNG) at 7x P/B ?

In my book review “The Frackers”, I mentioned one of the stories in the book was about Cheniere Energy:

Finally, there is a fascinating side story about the guy who is running Cheniere Energy, Charif Souki. His great idea was to import natural gas into the US and he raised several billion USD to build a huge gasification plant on the gulf coast. He clearly did not see fracking coming and his investment was worthless. Nevertheless, he was able to raise another few billion bucks and retool the facility in order to export natural gas.

This “double or nothing” gamble seems to have paid off. Seth Klarmann by the way, has just doubled its stake in Cheniere, making it their biggest public listed position at around 1,7 bn USD.

Seth Klarman

Seth Klarman is a famous value investor running Baupost Group a 25bn USD hedge fund. In contrast to Buffett, Klarman very seldom gives interviews and his fund commentaries are hard to get. Hi is considered to be the “heir” of Benjamin Graham and still sticking to the “cigar butt” approach of deep value investing. Two years ago in a Charlie Rose interview, Klarman made the following comment:

Baupost’s leading man says that he buys “cigar butts” at cheap prices. Warren Buffett used to also do this. The difference between the two legends is that Klarman stayed focused on cigar butts while Buffett’s process morphed into buying great companies at great prices and then into paying so-so prices for great companies.

Klarman does many things ordinary investors can’t do, like buying defaulted Lehman stuff etc. Not many of his investments are public and not all of his public investments are successes. Nevertheless it is clearly interesting to look more deeply into his biggest public position, Cheniere Energy.

Cheniere Energy

Cheniere’s stock chart shows the “unusual” history of the company:

Just as a side remark, somehow this chart reminds me of this funny animal:

Looking at Cheniere’s latest quarterly report, we can clearly see that Seth Klarman’s days as Graham style “net-net” investor seem to be over. Cheniere has currently around 7,5 bn net debt and 2,3 bn equity. Based on a market cap of around 17 bn USD, this is a P/B of roughly 7 times so hardly a bargain investment based on this metrics.

On top of that, the company never made a profit in its life as this table with EPS since 2004 clearly shows:

      EPS
02/21/2014 FY 13 12/13   -2,2
02/22/2013 FY 12 12/12   -1,6
02/24/2012 FY 11 12/11   -2,6
03/03/2011 FY 10 12/10   -2,3
02/26/2010 FY 09 12/09   -3,8
02/27/2009 FY 08 12/08   -6,0
02/27/2008 FY 07 12/07   -3,6
02/27/2007 FY 06 12/06   -1,5
03/13/2006 FY 05 12/05   -0,9
03/10/2005 FY 04 12/04   -0,6
N.A. FY 03 12/03   -0,4

So the question is clearly: What does Seth Klarman see to make this his biggest publicly disclosed investment ?

The best analysis I found was the one at Value Investor’s Club (accessible with guest login) from 2013, where the stock was trading at a third of the current price (Klarman bought between 60-70 USD). There is also a good article in Forbes from 2013 about the story behind Cheniere from 2013.

I try to summarize the case in a few bullet points:

– natural gas is very cheap in the US due to fracking and multiple times more expensive especially in Asia
– despite high costs, it is a pretty good business to liquify natural gas in the US and ship it to Asia in order to earn the spread
– Cheniere is in the process of finishing its first gasification plant by the end of the year 2015 and will then start to produce reliable cash flows as it has already contracted out its full production capacity for 20 years to major energy companies

The most important point is however the following quote from Forbes:

Cheniere’s Sabine Pass facility got its approval from the Department of Energy to export to any country in the world two years ago. It is so far the only facility to be cleared to export to countries that do not have a Free Trade Agreement with the U.S. And getting a non-FTA permit is a make-it-or-break-it approval for these projects, because there’s only one big gas-importing country (South Korea) with a free trade deal with the U.S. Unless a facility can export to the likes of Japan, China and India, the economics likely won’t support a multibillion-dollar build-out.

Cheniere had the luck to be the first to get this license. Later on, mostly due to the pressure of US based energy users, the US Government declined to issue further LNG “non FTA” export licenses for some time. According to Cheniere’s latest investor relation presentation, in 2014 two more “non FTA” licenses have been granted but Cheniere clearly has a head start.

Many more export facilities in the US would lead to higher prices in the US and to lower spreads compared to Asia, but for the time being, Cheniere’s primary LNG facility could be viewed as the typical “toll bridge” for US natural gas on its way to off shore destination as the other two licensed projects are still to be completed in several years time.

Cheniere itself is trying to further expand its current facility by 50% and they are projecting another site, but both projects have not yet received their license.

Valuation:

Replacement value

Despite buying at 7 times book, the question is: Could it be that Klarman is buying below replacement value ? I think it is unlikely. EV is around 25bn, stated book value of the assets is around 8 bn. Liquification facilities are not that hard to construct. all you have to do is to call someone like Bechtel and sign a turn-key project. Ok, you need the land and the permission, but overall this seems to be manageable in the US. So without going into more detail, we can assume that the current valuation of Cheniere is clearly above replacement value.

Valuation based on future cash flows

The VIC author estimates around 4-6 USD per share distributions for Cheniere’s shareholders going forward based on the first 4 trains of the initial liquification project. I have not double checked this but I will assume this number of being correct.

Reading through the roughly 15 pages of risk factors in Cheniere’s 2013 report, I would not call this a risk free business.There are still a lot of moving parts and operational risks even if the whole facility is up and running. Cheniere’s public bonds in the operational subsidiary trade at around 5,5% yield p.a. So discounting equity cash flows at the HoldCo level should be higher than that.

A) Existing facility and licence & contracted cash flows only

Cheniere has fixed contracts for 20 years. In the following table I have calculated NPS for the above mentioned EPS range and different discount rates, based on the assumption that one gets those earnings for 20 years and after that nothing (for instance any future earnings have to be applied to retire the debt):

eps/discount rate 4 5 6
6,50% 44,07 55,09 66,11
7,50% 40,78 50,69 60,83
8,50% 37,85 46,73 56,08
9,50% 35,25 43,17 51,81
10,50% 32,92 39,96 47,95
11,50% 30,84 37,05 44,46

We can clearly see, that the contracted amounts at the existing facility will not be enough to justify the current valuation of around 70 USD.

B) Existing facility, indefinite cashflows

This is the table with an indefinite stream of earnings at various discount rates:

eps 4 5 6
6,50% 61,54 76,92 92,31
7,50% 53,33 66,67 80,00
8,50% 47,06 58,82 70,59
9,50% 42,11 52,63 63,16
10,50% 38,10 47,62 57,14
11,50% 34,78 43,48 52,17

Even with an indefinite time horizon, Cheniere does not look like a “bargain stock”.

C) Existing facility + 50% capacity increase, contracted cash flows only

eps/discount rate 4 5 6
6,50% 66,11 82,64 99,17
7,50% 61,17 76,03 91,24
8,50% 56,78 70,10 84,12
9,50% 52,87 64,76 77,71
10,50% 49,39 59,93 71,92
11,50% 46,26 55,57 66,69

D) Existing facility +50% capacity increase, indefinite cash flows

eps 6 7,5 9
6,50% 92,31 115,38 138,46
7,50% 80,00 100,00 120,00
8,50% 70,59 88,24 105,88
9,50% 63,16 78,95 94,74
10,50% 57,14 71,43 85,71
11,50% 52,17 65,22 78,26

The 4 scenarios show relatively clearly that only with including future non-contracted cashflows and additional, not yet approved capacity, the stock looks interesting. In order to satisfy the return expectations of Klarman, which should be 15-20% p.a.based on his track record, he must assume further cash flows for instance from the second site Cheniere wants to contruct at some point in the future in Corpus Christi. Plus, there should be no dilution etc. from raising the rquired gigantic amounts of capital.

Maybe he is betting that the stock will trade like a bond if the company starts paing dividends ? Or is he leveraging the investment with addtional debt ?

In any case, he seems to be paying a lot for future, uncertain cash flows, which contradicts his “we still do cigar butts” statement. This is not that different from what Buffett is doing when he is paying rather expensive prices for great companies. At least for a guy with a portfolio size like Seth Klarman, the time of “cigar butt” investing seems to be over. Even he must feel th pressure that you cannot charge 2/20 for holding cash.

So to answer the question from the beginning:

Why on earth is Seth Klarman investing 1,7 bn USD in Cheniere Energy (LNG) at 7x P/B ?

I have no real idea but it might be the case that Klarman somehow need to put money at work and he expects this investment to be uncorrelated to general market as he has been quite pessimistic on equities for some time.

Summary:

For me, Cheniere at current prices is clearly one for the “too hard” pile. Klarman of course can spend a lot of money and time to fully analyze the energy markets etc. although as we know now, most energy experts have a hard time to make meaningful forcasts. But still it doesn’t look like a bargain and clearly no “cigar butt” or “net-net” kind of investment.

Funnily enough, analyzing Cheniere makes me much more confident in my Electrica investment. At least to me, the risk/return relationship there is some magnitudes better than for Cheniere. I think I will upgrade this to a full position over the next few days.

P.S.

Some other stories I found about Cheniere
http://www.alternet.org/fracking/how-powerful-friends-and-cozy-relationships-helped-cheniere-energy-cash-natural-gas-exports
http://www.octafinance.com/baupost-group-doubled-stake-cheniere-energy-still-bullish-us-lng/
http://www.mailtribune.com/article/20150125/Opinion/150129835