Liquefied Natural Gas Limited (ASX:LNG, OTC ADR: LNGLY) is an Australian (with US ADR) listed LNG export play with a A$1.55bn market capitalisation. The stock operates in a similar business but should not be confused with Cheniere Energy which also has the same "LNG" ticker. Its key development projects include the flagship Magnolia LNG project in Louisiana, its recently acquired Bear Head LNG project in Canada and the Fisherman's Landing LNG project in Australia (which remains on hold for now).
While guru investor interest in the U.S. gas export story via holdings in Cheniere is well documented, fewer investors may have noticed that ASX-listed LNG contains a quality share register of US hedge fund value investors – so naturally we take notice. U.S. investors make up >40% of the register and include Baupost (Seth Klarman (Trades, Portfolio), Third Point (Dan Loeb), Valinor (David Gallo), Claren Road and Fairview.
As the stock is already up a whopping 10x over the last few months, I am naturally wary and generally averse to chasing hot names. However, removing the bias associated with historical price performance anchors and focusing on the fundamentals, the buy thesis still remains strong, and coattailing the likes of Seth Klarman (Trades, Portfolio) could still be a wise move over the long-run.
Despite the large multi-bagger price rally, Seth Klarman (Trades, Portfolio) has continued increasing his stake in ASX:LNG and now owns 8.8% of the company with disclosed purchase prices ranging from 55c to $2.60 per share. So why might Seth Klarman (Trades, Portfolio) be interested in this stock, and is it still worth getting on board at current prices of $3.50 per share?
It is important to note that earnings and cash flow are unlikely to be generated until mid-2018, and so the traditional historical financial analysis will be of little help – the investment case for LNG is a little more conceptual in nature. The key investment issues are listed below:
1. Competitive advantage – lowest capex per tonne
LNG has developed and patented a liquefaction process (Optimised Single Mix Refrigerant – "OSMR") which results in the most cost efficient LNG terminals to build and operate. Compared to conventional liquefaction plants, LNG's capital costs are 50% lower at $500-600/tpa versus conventional players at $1000-1200/tpa. Energy efficiency is also 30% better. This makes LNG a low-cost operator and the patent makes this advantage difficult to replicate.
2. Low capital intensity – LNG is a "technology" company
While LNG appears to be in the business of developing LNG infrastructure, its core business is really the provision of its OSMR technology in exchange for equity stakes in LNG infrastructure projects. Other parties provide the project capital funding and construction is outsourced – making this a very neat arrangement. Aside from costs to manage the paperwork (identifying sites, dealing with regulators, tolling agreements, and overseeing the construction process), the business has very low capital costs.
3. Relatively lower risk – a mid-scale off-the-shelf construction solution
LNG positions itself as a mid-scale player – its OSMR process works well for 2mpta train sizes compared to the conventional 4mpta train sizes. Additionally, construction is largely a modular off-the-shelf build which should result in a short development and construction cycle which lowers the risk around timing and capex overruns relative to larger bespoke projects. It is also worth noting that the flagship Magnolia LNG project takes on no commodity (gas) price risk under binding tolling agreements which are currently being secured. Management believes it has a 90% probability of success for the Magnolia project.
4. Low incremental capital intensity + valuable growth – replicate via copy and paste
New LNG projects are fundamentally a replication of its existing processes which means it can fast-track growth with relatively low additional investment. Depending on the size of future projects, the level of investment required would be relatively small in comparison.
To illustrate, consider the economics of a 4mtpa train (based on the Magnolia LNG project). A 4mtpa train generating EBITDA of $100m/mtpa or $400m in total could be conservatively valued at 7x EBITDA or $2.8bn less attributable debt of ~$1.54bn gives a valuation of $1.26bn. As LNG owns 50% of the project its equity stake would be worth $630m. This gives us a rough sensitivity of $160m of value per mpta.
Now LNG recently raised $40m to fund its Bear Head LNG project, which is a 4mtpa project. Based on our sensitivity, we could guess this might be worth $630m to shareholders over time. This would be a wonderful internal rate of return on the $40m investment over any reasonable timeframe. Put another way, each $1 spent on deals could potentially result in $15 of value creation to shareholders over time depending on the funding/partnership structure. Even if we have grossly underestimated the $40m, there is sufficient buffer to still deem this a wonderful business.
5. Growth runway – North American LNG export outlook favourable
The shale gas revolution in the U.S. with multi-decade reserve capacity coupled export price arbitrage (given higher gas prices offshore), should see the LNG export thematic remain a long-term growth story. Further project opportunities should arise over time, and LNG is looking to diversify its North American footprint with additional sites.
6. Inside ownership – management interests aligned
Directors and employees own 3.3% of the company. At current share price levels, this stake looks to be worth >$50m between shared senior management.
7. Valuation – cheap for a compounder
Valuation is a tricky exercise, so I will try and keep it simple – at current prices of around $3.50/share investors should expect little downside if projects can complete namplate capacity. Valuation estimates can ratchet up to $10-24/shr+ (unrisked) implying 30-50%pa+ returns when assuming realistic assumptions such as nameplate tolling capacity and market multiples of 12x EBITDA and potential for new projects. Clearly, there is a lot of uncertainty regarding upside, but at prices of $3.50/share there is not alot of risk and this upside is largely free.
Upside risk to baseline/nameplate scenarios can stem from 4 areas - (i) project equity ownership could end up >50% as Bear Head could likely be fully retained at 100% if LNG funds projects by raising capital instead of using other funding partners, (ii) the Fisherman's Landing project could be reignited at some point if gas supply becomes available – we have not allowed for this in valuation, (iii) the announcement of new projects/deals could significantly increase intrinsic value accretion and (iv) potential for a U.S. listing could see higher multiples towards Cheniere Energy Partners (CQP) which trades at >30x.
These valuation scenarios suggest there is a significant margin of safety embedded in the potential growth optionality, with investors currently paying up for LNG to deliver a fairly pedestrian outcome – it's an excellent low-risk, high-reward opportunity.
8. Technical considerations – index inclusion
LNG's market capitalisation is around $1.55bn which puts this stock well into the ASX top 200 largest companies. Currently, it is not included in the ASX200 index. If this occurs (which I expect it will come the quarterly rebalancing), the stock could perform well on technical factors as domestic institutional managers remain underweight and try to build a position in a stock that is tightly held with 40%+ U.S. hedge fund ownership.
For investors who can look past the 10x rise in the share price, LNG still appears a rare opportunity in a business with a strong competitive advantage, high-growth optionality coupled with low capital intensity, a bright outlook and a capable management team all available at a fair price. A potential compounder in the making, I am more than happy riding Seth Klarman (Trades, Portfolio)'s coattails on this one.
Disclosure: I own shares in ASX:LNG at the time of writing.
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