One of the best ways I know of to take advantage of worldwide secular growth in the production, transport, and usage of LNG from "Well to Grid", Golar LNG remains an attractive investment for the risk tolerant investor.
At the beginning of 2019 I chose the secular growth in worldwide production, transport, and usage of natural gas as my, "Top Idea for 2019". Most of these stocks have done well with the best, Teekay LNG (TGP) up 41%, and the average return a quite respectable +14%.
However, that average is being significantly pulled down by its major loser Golar LNG (GLNG), down 41% YTD. Thus, I thought it appropriate to focus on Golar in this "Top Idea for 2019" update. We need to decide whether we should keep the investment, or cut our losses and move on.
Golar LNG (GLNG) recently made a presentation at the Barclay's Energy Conference. What I found most interesting about this presentation was slide 4.
Source: Golar Presentation
This slide represents all existing major contracted projects. Why I found it so interesting is from it we can calculate both an expected earnings yield and an expected project level return on equity 'ROE'.
Source: Golar Presentation and Author Calculations
The 16.2% contracted earnings yield on major projects shown above is quite attractive. Combine that kind of earnings yield with the ability to leverage projects with 71% debt at a 6.4% average cost of borrowing, and it produces a whopping 48.6% expected ROE. These projects certainly have remaining risk, as there would be in any unfinished projects the size of Sergipe and Gimi, but 48.6% ROE's also represent huge potential benefits to shareholders.
In fact if one assumes these projects go as planned, and the counterparties for the Hilli ask Golar to implement train 3 'T3' before 2023 (likely but not a given), Golar would exit 2023 at a $510 million EBITDA run rate.
Source: Golar Presentation
That climb from $187 million in EBITDA to $510 million over 4 years, represents as 28.5% annual growth rate. This on a stock that currently trades for about 16x trailing EV/EBITDA. With Golar we are getting the EBITDA equivalent of a .6 PEG before including any additional non-contracted projects. Projects such as:
Spin-off of the LNG ships Avenir Full utilization of the Nanook's capacity via smaller bolt on downstream projects in Brazil An additional FSRU in Brazil (or two) An additional FLNG
But GLNG has been a big loser for us so far, and does admittedly have a lot of project risk. This is why we assigned it a relatively low C+ risk rating in our list above. However, those projects which are already contracted plus the reasonably likely enactment of Perenco's option on Hilli T3 also add up to a lot of potential return.
Given these high project ROE's one has wonder what are the negatives? Surely GLNG hasn't fallen 41% YTD for no reason?
Stock Price Volatility:
GLNG has a lot of debt and most of its current cash flows are uncertain either because they result from future projects, or because they are tied to LNG shipping on spot. Thus its stock is very subject to current investor sentiment. Volatility in near term cash flows and share price is something we need to expect here at least until the shipping segment and its corresponding debt load are spun off. After that the volatility should dampen somewhat, which may also help to stabilize and increase the multiple afforded to the stock.
Oil Sector Correlation:
Right or wrong however, the stock will likely remain correlated to the energy sector and price of oil. Currently there are generally low expectations for the energy sector which are affecting ETF's, funds, and by extension Golar LNG. In the case of Golar LNG, there is probably more correlation between GLNG's share price and oil prices than there should be because only a small part of their revenue is dependent on energy prices. However, we can't really expect that correlation to go away. In fact I count on it. When a company's stock price is correlated with the price of oil, but most of that company's cash flows are not tied to this commodities price, a dichotomy periodically exists we can take advantage of. A good time for the informed investor to potentially invest in Golar is when oil prices are low are falling, yet Golar's cash flows aren't.
However, the biggest reason why Golar's stock has fallen most recently isn't the volatile nature of a growth stock, nor the price of oil. No most recently the stock has fallen because they cut their dividend, and right or wrong, a question of liquidity has arisen in investors minds.
Let's deal with the clearer issue, the dividend cut first. Some investors sell a stock when the dividend is cut, period, stop, no need to look further. Indeed for many the reason why a dividend was cut doesn't matter. Not even in cases like this where the dividend is cut specifically to fund share buybacks."We intend to use the cash collateral that we have posted (from a previous swap deal which is now being unwound) and two quarters of dividend to fund the buyback of the three million shares." -Graham Robjohns, GLNG CFOTo be fair however, there's really no guarantee the dividend will be reinstated after two quarters, and I personally don't think it should be. Right now buybacks are a better use of funds than payouts. However, even were the stock to climb in price such that that were no longer true, we have already seen GLNG has a number of good projects with high ROI's that deserve funding. Were I management I would reinstate a token dividend to get past "has a dividend screens" then allocate the rest of cash flow to its highest and best risk adjusted use at the time as measured by expected ROI. Here however I would demand projects have twice the ROI available from buybacks or debt paydowns in order to get funded because they are inherently more risky.
A related and harder to analyze concern is Golar's liquidity. In the Barclay's presentation management spent a lot of time on this concern as have articles here on SA. Anyone considering investing in Golar should analyze these sources as well as reading the last earnings conference call transcript.
Of the contracted projects listed, the Hilli T1 and T2 are already fully funded and producing cash flows. Likewise the currently contracted portions of the Nanook and Sergipe projects are funded and expected to start cash flowing near the beginning of next year.
The remaining major project under contract is the FLNG Gimi conversion. This is also, "fully financed with committed bank financing and available cash" but isn't scheduled to start cash flowing until 2023 (December 2022 contract start date with 20 year duration). As we see in the slide below, Golar's share of the total remaining equity contribution totals $242 million. Source: Barclay's Presentation Appendix
This cash need is spread over the next few years, but already more than covered by the $140 million in free cash Golar had at the end of Q2 plus part of the $180 million in new debt facilities they recently arranged. Thus, all of the currently major projects listed in the ROE section above -- Hilli T1 & T2, Nanook & Sergipe, Gimi --are funded. The question is really where is Golar's source of cash for any new project contracts going to come from. Potential projects such as:
Spin-off of the LNG ships Avenir Full utilization of Nanook capacity via bolt on downstream projects in Brazil Contracting an additional FSRU in Brazil (or two) Contracting an additional FLNG
First given some comments I have read previously, I think it necessary to point out the obvious. Namely Golar doesn't have to do any of these additonal non-contracted projects. Furthermore, at its current stage and stock price, it is unlikely to sign new contracts unless it also is very confident in the corresponding funding. Thus the real liquidity concern her isn't one of solvency, but rather the ability to fund future projects over and above those already contracted. GLNG does have the choice to simply hunker down and and focus on completing the existing contracted portfolio. If they were did so, they would still have 28% average annual expected EBITDA growth for the next 4 years.
But realistically I don't expect Golar to just hunker down. Instead I expect Golar will successfully take advantage of one or more of its various potential sources of cash, and thus be able to fund additional attractive LNG projects.
Potential Sources of Cash:
Golar has stated a goal to spin-off their LNG ships by the end of this year. They said as much in their conference call, "we remain on track to spin out our ships before the year end". Roughly $1 billion (38%), of Golar's debt is attached to these ships and thus would go with the spin-off. Were that to occur successfully without a cross guarantee of the debt by Golar, it would improve GLNG's debt ratios quite a bit, and likely resulting in an increase in general funding availability. We have no way to handicap how likely that is, but I wanted to point out increasing overall cash availability is clearly an important part of this goal.
The equipment necessary for Hilli T3 is already in place and tested with management indicating, "basically we're ready to go. We have a vessel that's able and capable of producing anything up to 2.4 million tons per annum now." So implementation of T3 would be cash flow positive. Indeed if it occurred concurrent with an extension of the contract for T1 and T2, that would likely allow a refinancing of Hilli debt which would provide significant additional liquidity. It however is impossible to judge how motivated their counterparty Perenco is to implement T3. Perenco is a private firm with no obligation to put out any press or disclosures on the matter and negotiating incentive to keep quite. Golar management indicates they, "remain optimistic that (Hilli) capacity will be utilized and we stick to our target (of) hopefully (having) something in place by the end of the year", but we really aren't going to know much more than that until it either happens or doesn't.
This may not be what investors would like hear, but then again if we already had a contract implementing Hilli T3 and extending T1 and T2, GLNG wouldn't be trading anywhere near the low levels it currently is now would it? In fact, I suspect any investor waiting to take a position until after Hilli T3 is announced may be sorely disappointed in how quickly GLNG's price rises following that announcement. I'm pretty confident Value Investors Edge alone has numerous investors representing millions of dollars in purchasing power who can act quickly on that announcement. If you are not a VIE member, ask yourself do you really think you can act before they do?
Management can also get cash needed for future project funding by sharing the economics of future projects with a private equity 'PE' firm, or by part of an existing one to various infrastructure funds that are likely to be very interested in owning them. Indeed in an answer to an analyst question regarding future major FLNG funding in the conference call, the CFO hinted they may already be in discussions with somebody, "We have infrastructure funds interested investing in our existing assets, if you like, existing contracted assets. And equally, we have infrastructure funds and the like interested in working with us in future projects and sometimes overlap. It's the same entity and sometimes they're different."
These are the sources of major funding currently in process but I thought I'd point out there are also other smaller potential sources of capital including:
Net 2020 Sergipe cash flows (I suspect most Sergipe cash flows will be go to self-funding smaller downstream projects that increase Nanook demand) Sale of the FSRU Viking (end of 2020) or potentially the 16 year old Arctic along with relief on its corresponding debt (comes due this year). Drop-down of a ship to GMLP (the equity portion would be funded by GMLP units that are then borrowed against or support the existing margin loan) Sale and leaseback of a ship or two The release of Hilli's letter of credit Not reinstating the dividend
Now I will say if none of the major potential sources of cash listed above - Golar spin-off, Hilli, PE or Infrastructure funding- occur, cash may be tight until the Gimi achieves COD with additional project adoption negatively affected. However, I don't see this as too major of a concern simply because their are at least three major options any one of which would solve the issue. Thus, I consider any funding question more a concern about the ability to fund additional projects in addition to what's already scheduled, rather than a concern for existing contracted projects and the resulting EBITDA growth.
Golar LNG (GLNG) is a volatile growth stock that has seen its price drop 41% YTD. It is also the poorest performer in Cash Flow Kingdom's "Top Idea for 2019" natural gas transport mini portfolio. Meanwhile, it continues to have very promising projects in the high secular growth LNG sector. Projects which represent an expected EBITDA growth rate that is almost twice its current EV/EBITDA ratio (28% annual project level EBITDA growth vs. 16x EV/EBITDA). These projects represent a very attractive 48% expected ROE and according to management are fully funded; however, they also represent just the already contracted portion of Golar's opportunity. Golar is also working on a number of other projects which are not yet contracted or funded that also appear promising. I assume they would only be taken on if the necessary funding can be secured. But once again, they are not necessary to enjoy a very nice return from current low price. Just completion of the existing contracted portfolio is probably enough to generate a double. If one buys into the general idea of ongoing worldwide long-term secular LNG growth, and is willing to consider a higher risk investment, I can't think of a better choice for one's speculative dollar than Golar LNG.
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Disclosure: I am/we are long GLNG, TGP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This article discusses a risky investment in the LNG sector. I do not know your goals, risk tolerance, or particular situation; therefore, I cannot recommend any specific investment to you. Please do your own additional due diligence.