After writing about GrafTech (EAF, Financial) recently, I have been thinking about companies with set contracts in place as value investments. One of the reasons I was initially attracted to GrafTech as an investment was that the company had its revenues virtually guaranteed through take-or-pay contracts for its graphite electrodes.
One of the more common ways to value a company is to project future cash flows and then estimate a value based on a discounted analysis of this cash generation. With most companies, one can only put together an informed estimate of cash flows in the future. With companies like GrafTech, which had the majority of its revenues contracted for the next few years, it is far easier to work out an intrinsic value.
With that in mind, I have been looking for companies with similar qualities. One company that stands out is Golar LNG (GLNG, Financial).
The market for LNG
Liquid Natural Gas, or LNG, is a clear, colorless, odorless, non-toxic liquid that forms when natural gas is cooled to -162ºC (-260ºF). The cooling process shrinks the volume of the gas 600 times, which makes it perfect for storage and transportation.
The LNG market has been growing rapidly over the past few decades as advancements in technology, as well as the rising demand for energy from growing regions such as China, have enabled operators to develop new and more efficient ways of transporting large amounts of energy to the other side of the world.
Qatar is currently the world's top producer of LNG, closely followed by Australia. Some of the biggest importers are Europe and China, which have limited energy resources of their own.
The interesting thing about this market is that producers cannot just start up overnight. The costs of producing, liquefying, transporting and regasifying natural gas are much higher than the costs in an equivalent oil supply chain. The technology required demands colossal upfront investment, and to achieve the best economies of scale, facilities have to be enormous, once again increasing the cost.
Another reason why LNG is so appealing is that gas has a far smaller carbon footprint than other energy sources. This is why it is the second-fastest-growing energy source after renewables, with the size of the market expected to increase by 50% through 2030.
So, where does Golar fit into all of this? The company owns assets across the LNG value chain. These include floating liquefaction facilities, transportation and regasification. The group is a one-stop shop for LNG production and transportation.
Its size and scale provide substantial economies of scale, especially with rising LNG prices. According to an investor presentation, its two new floating LNG production facilities will cost $1.4 billion. The payback on these assets is estimated to be just two thirds of a year.
The production from these new facilities is already contracted, which gives the company potential to more than double Ebitda over the next three years. Further upside is possible for production sold on the spot market out of contracted volumes. According to the company's projections, it can increase Ebitda from $188 million to around $589 million at current gas prices.
Of course, these are just back-of-the-envelope-type figures, and this is only designed to be a starting point for further research. The market for gas, coal and oil is incredibly tight at this point, and prices are rising dramatically. The best cure for high prices is high prices, and rocketing hydrocarbon prices could stimulate additional demand, pushing prices lower in the long run.
That's probably the most prominent risk Golar faces. Nevertheless, it could be worth taking a closer look at this integrated LNG group considering its contracted growth potential over the next five years.
