Cheniere’s Q4 Is Another Blowout (Surprise!), Reveals Massive Sabine Pass Expansion
Cheniere’s Q4 Is Another Blowout (Surprise!), Reveals Massive Sabine Pass Expansion
Analyst Note | by Stephen Ellis Updated Feb 23, 2023
Cheniere’s fourth-quarter results were well above expectations, as it captured the last few months of extremely wide spreads before the market weakened during 2023. Full-year EBITDA of $11.6 billion was more than double expectations entering 2022, as it captured huge marketing spreads given the significant increase in demand from the EU. Resetting 2023 expectations to market levels, where gas prices and LNG spreads have declined over the past few months, lowers our 2023 EBITDA forecast by about 17% to $8.4 billion. Outstanding capacity is about 50 trillion British thermal units (Tbtu), representing less than $500 million in EBITDA once under contract. The uncontracted capacity helps explain the difference between the low and high end of Cheniere’s guided range of $8 billion-$8.5 billion in 2023 EBITDA. These results still imply wider-than-normalized spread levels, as our long-run EBITDA forecast is about $7.1 billion.
Despite the lower near-term forecast, the combination of higher cash already earned in the fourth quarter, plus adding Midscale 8-9 trains to our model, increases our fair value estimate for Cheniere Energy. Our fair value estimate is now $161 per share from $143, while our wide moat rating is unchanged. The Midscale trains with about 3 million tons capacity add about $400 million in annual EBITDA to our longer-term estimates beginning in 2027. While the trains are still in the pre-filing review process with the Federal Energy Regulatory Commission, Cheniere already has about 3 million tons of capacity under contract beyond its existing capacity and construction plans. Thus, we see the two trains as already an easy decision to move forward.
Cheniere also announced a massive 20 million-ton expansion at its Sabine Pass complex, where ownership is shared between Cheniere Energy Partners (49.4% ownership) and Cheniere Energy (50.6%). We do not include this expansion in our fair value estimate because of the uncertainty over whether it will move forward.
Business Strategy and Outlook | by Stephen Ellis Updated Feb 23, 2023
Cheniere is well positioned to be the exporter of the incremental liquefied natural gas supplied to the global market over the next few years, particularly as demand ramps up from China. We expect Cheniere to have about 45 million metric tons per year LNG capacity on line in 2022 and 58 million tons in 2026. We expect the bulk of China's LNG demand growth to be met by U.S. gas supply, given the United States' ability to increase gas and therefore LNG supply significantly.
That said, volatility in the market should provide ample opportunities for Cheniere to take advantage of wide LNG differentials at different hubs around the world. This paid off in 2022 with LNG spreads at record levels given huge EU demand for LNG. The benefits are sizable, and we estimate Cheniere reaped almost $6 billion in excess marketing profits in 2022.
Cheniere is adding more capacity with a final investment decision on Corpus Christi Stage 3, a 10 million metric tons per year-plus expansion in mid-2022. We model this expansion as contributing materially in 2026 after a late 2025 start. Cheniere is also fully permitted on two smaller trains, 9 and 10, for about 3 million metric tons per year, which we expect will eventually obtain a final investment decision and be active in 2026, as well. While the trains are still in the pre-filing review process with the Federal Energy Regulatory Commission, Cheniere already has about 3 million tons of capacity under contract beyond its existing capacity and construction plans. Thus, we see the two trains as already an easy decision to move forward with a final investment decision.
The massive 20 million ton Sabine Pass expansion, announced in early 2023, will likely require almost 30-35 million tons of contracts, assuming optimization opportunities at existing trains, and it is uncertain whether it will eventually move forward. The three-train expansion (or about 6.7 million tons per train) was decided in part, due to the need to source power from Texas and likely coal-fired power generation. This meant that larger trains were needed to improve the overall per-train economics versus using gas-fired power generation and the resulting lower emissions.
Economic Moat | by Stephen Ellis Updated Feb 23, 2023
We think Cheniere Energy and Cheniere Partners have wide moats due to an intangibles moat source. The intangibles moat source is derived primarily from the 20-year take-or-pay contracts that both entities have signed with multiple customers to liquefy natural gas that essentially put Cheniere in an incredibly strong competitive position as a pure toll-taker with no commodity price risk. We don’t see any contract renegotiation risk due to the attractive features of the contract, and to date, only non-Cheniere contracts have been challenged, mainly because of the oil-linked status and current poor economics. About 88% of capacity on the Sabine Pass terminals (operated by Cheniere Partners) are under contract and 93% at Corpus Christi (operated by Cheniere Energy), with the remainder available for marketing purposes. These contracts provide Cheniere with a fixed fee ranging from $2.25 to $3.50 per thousand cubic feet plus a variable fee set at 115% of Henry Hub to cover the cost of acquiring natural gas and operating the terminals. Cheniere to date has been very efficient from an operating performance perspective (about 112%), thus earning a small margin on the variable fees. Returns on invested capital at midcycle will be around 14%. We expect the source of economics rents from a contractual perspective for Cheniere is due to its assumption of construction, gas procurement, operational, and long-term export viability for U.S. gas risk.
To assess the strength of Cheniere’s moat, we primarily consider asset and contract quality. In Cheniere’s case, we consider contract coverage to be the most important factor influencing its moat. The entity’s asset quality is very good, given its sizable position as an owner (directly or indirectly) of LNG facilities in the U.S., but it does not benefit from an efficient scale or cost advantage moat source.
Cheniere’s contracts are highly unusual in the LNG market and provide numerous advantages. Historically, LNG contracts have been linked to oil prices either via S-curve or slope pricing. In recent years, contract pricing has shifted more toward hub pricing to the detriment of companies such as Gazprom but to the benefit of Cheniere, given the significant growth in low-cost U.S. gas (and therefore Henry Hub pricing), making U.S. LNG exports an important driver of global LNG pricing. Typical LNG contracts contain clauses that allow price revisions either after a certain period or if oil prices rise or fall outside of a certain range, allowing customers to flex the amount of LNG delivered in any given year while holding them to the contracted quantity over the full contract, and they have restrictions on where the gas can be shipped. Customers are also responsible for the procurement of gas.
In contrast, Cheniere’s contracts do not have clauses allowing price revisions, do have complete freedom on destinations (allowing the gas to be shipped to the most profitable market), and are linked to Henry Hub instead of oil (thus cheaper), and Cheniere takes on gas procurement and operating risks. These contracts are similar to what U.S. peers such as Cove Point and Freeport have signed. From an operational perspective, Cheniere has been performing well, and it has linked short- and long-term contracts with pipelines such as Williams’ Transco to supply all of the gas needed for the terminals.
We do not think Cheniere earns an efficient scale or cost advantage moat source for a few reasons. From an efficient scale moat perspective, we consider the LNG market to be global; Cheniere has exported gas to over 40 different markets to date, and within 10 years, it expects to reach 60 markets. The global nature of the market means that Cheniere has to compete on new greenfield and brownfield capital costs, availability and cost of gas, and transportation costs. The U.S. market and by extension Cheniere have generally attractive brownfield investment opportunities but suffer from higher-cost gas compared with Qatar and West Africa, as well as unfavorable transportation economics to key demand centers such as China and Japan. The biggest advantage that Cheniere has here is the significant amount of U.S. gas production coming on line over the next decade, versus competing production from stranded offshore projects internationally, letting it compete more effectively for incremental gas demand. As a result, we expect the bulk of new LNG global demand to be met by U.S. gas supply. We would also consider the fact that the global LNG market is currently oversupplied as indicative of a lack of efficient scale moat source. Competing pipelines transporting gas to, say, China from Russia would also be considered competition for LNG. The large market size means that there is no efficient scale moat source in play. Further, while there are hurdles to overcome from a regulatory approval perspective (environmental, permitting, state and local issues, non-free-trade agreements), and capital costs (terminals can cost $7 billion-$10 billion), we do believe they can be overcome. Cheniere’s 45 mtpa makes it a sizable player, but the market will continue to expand. Due to the lack of cost advantage on the actual feedstock and the more fleeting advantages around capital intensity (around brownfield mainly because of the greenfield capital investment already spent) and transportation costs, we find it difficult to assign a cost advantage moat source.
Cheniere and Cheniere Energy Partners have yet to lay out any material ESG-related targets. Cheniere is working on collecting greenhouse emissions data across the LNG value chain in order to proactively address new European Union methane rules coming into force in a few years.
Fair Value and Profit Drivers | by Stephen Ellis Updated Feb 23, 2023
After updating our model for Cheniere's fourth-quarter results, our fair value estimate has increased to $161 per share from $143 per share. Despite the lower near-term forecast in 2023, the combination of higher cash already earned in the fourth quarter, plus adding the Midscale 8-9 trains to our model, increases our fair value estimate for Cheniere Energy. The Midscale trains with about 3 million tons capacity add about $400 million in annual EBITDA to our longer-term estimates beginning in 2027. While the trains are still in the pre-filing review process with the Federal Energy Regulatory Commission, Cheniere already has about 3 million tons of capacity under contract beyond its existing capacity and construction plans. Thus, we see the two trains as already an easy decision to move forward with a final investment decision at some point.
Our fair value estimate implies a 7 times 2023 enterprise value/EBITDA multiple and about 10 times normalized 2027 EBITDA. We use a 9% cost of equity for Cheniere. Our model forecasts EBITDA of $5.7 billion in 2025 as marketing spreads normalize prior to the Stage 3's material contributions in 2026, which is materially below 2022's $11.6 billion with extremely wide spreads. Corpus Christi Stage 3 EBITDA as well as the two new Midship train 9 and 10 starts to contribute in 2026, and we expect EBITDA of $7.1 billion on a normalized basis once active.
For investors considering whether to invest in Cheniere Partners or Cheniere Energy, there are a few items to keep in mind. First, Cheniere Energy is a corporation, while Cheniere Partners is a master limited partnership, which adds tax complexities. Second, Cheniere Energy should share any marketing fees generated from Sabine Pass gas with Cheniere Partners with a 20/80 split; however, any marketed gas from Corpus Christi terminals will flow 100% to Cheniere Energy. Third, Cheniere Energy only receives part of the cash flows generated by Sabine Pass LNG terminals, given its ownership stake in Cheniere Partners, whereas it receives 100% of any cash flows generated from Corpus Christi terminals. This dynamic is why the Corpus Christi Train 3 earned a final investment decision before Sabine Pass Train 6, at the expense of Cheniere Partners unitholders.
Risk and Uncertainty | by Stephen Ellis Updated Feb 23, 2023
Cheniere Energy and Cheniere Energy Partners both earn a Morningstar Uncertainty Rating of Medium. Cheniere faces risks from a construction, operational, and market perspective. Its biggest risk is simply any change in global LNG demand, which is outside its control. Delays and cost overruns at its remaining trains under construction would prove challenging. Poor operational performance from its facilities would also weaken the entities’ cash flows, perhaps due to hurricane damage. From a market perspective, North American gas has to remain viable on an economic basis for Cheniere to benefit from increased LNG demand. At $3.30/mcf, North American gas is not some of the cheapest gas on the global cost curve, meaning that without the contracts in place, Cheniere would struggle. In a difficult scenario, Cheniere’s marketing operations would face an uphill battle obtaining wide enough differentials to export gas, while over the long run, Cheniere’s facilities would not be fully utilized after contracts expire. We would expect Cheniere’s marketing operations to be fairly volatile even in a reasonably healthy environment, given the spread-based nature of its business and the substantial volatility in the global LNG market, exposing the company to potential losses.
From an environmental, social, and governance perspective, Cheniere's main risk is managing its carbon emissions profile. We believe Cheniere faces fewer ESG risks than most U.S. midstream entities because of its reduced exposure to community protests and legal challenges from affected communities and its better safety record, according to federal safety data. It does face more challenges monitoring its scope 3 emissions, given the more complex value chain, which is why we think its efforts to offer this value chain data to customers, beginning in 2022, are a good way to start addressing the issue.
Capital Allocation | by Stephen Ellis Updated Feb 23, 2023
The Cheniere entities merit a Standard capital allocation rating, in our view. We believe Cheniere has pursued highly attractive projects that generate value for shareholders, is moving to shift its balance sheet to a prudent stance, given expected free cash flow, and has ample opportunity to return capital to shareholders going forward.
From a capital-allocation perspective, we have no issues to date. The trains have been completed ahead of schedule, operational performance is very good, and the remaining trains under construction look to be completed ahead of schedule as well. Cheniere wisely is exploring smaller trains that might be easier to contract and move forward on.
Cheniere's new capital allocation plan is largely positive. We think the biggest news is the larger commitment to the dividend with a 20% increase immediately to $1.52 per share and 10% annual increases through 2026. We would prefer to see this effort with the stock trading well above our revised fair value estimate. Share buybacks are expected to be $4 billion, or net $3.5 billion over the next few years, as Cheniere rolled in its existing buyback plan, which we would consider more of a positive if Cheniere waits for the stock to be undervalued to rebuy.
Incremental debt and share buybacks are expected to take place on a 1:1 basis, though management has suggested 2022 and 2023 share buybacks could be larger (perhaps $2 billion) as more debt paydown has occurred to date. The credit agencies have recognized Cheniere’s improved financial health by boosting both Cheniere Energy and Cheniere Energy Partners to investment-grade ratings over the past few months.
For debt, the firm already paid off $5.4 billion in 2022, compared with earlier expectations of $1 billion annually. The new plan envisions at least $3 billion in new net debt reduction over the next several years, allowing for some new debt associated with the funding of Corpus Christi Stage III (trains 1-7) and its new midscale trains 8-9. We think this is easily achievable. Overall, we think Cheniere can easily achieve and exceed its expected leverage target of 4 times, while funding the new train investments.
Cheniere Energy Partners is now pursuing a base/variable distribution policy to allow it to return excess cash to unitholders as the business performance allows it to do so without committing it to a too-large payout. We think this is a fine approach. Cheniere Energy Partners guided toward a distribution range of $4-$4.25 for 2023, compared with 2022’s $4.25 payout, which as a reminder, is a mix of both a base and variable dividend. If the Sabine Pass expansion moves forward, we expect the variable component, currently $1.18 annually, to be eliminated to fund the construction efforts.
The Corpus Christi Train 3 came on line in 2021 and the Sabine Pass Train 6 was on line in early 2022. We model the Corpus Christi Stage 3 modular capacity contributing materially in 2026 after a late 2025 start as Cheniere has moved forward with a final investment decision in mid-2022. Similarly, we model the two small trains 9 and 10 to eventually earn a final investment decision and enter service in 2026 as they are already under contract with customers.
We believe further simplification of the existing complexity in the Cheniere entities would be welcomed. Cheniere Energy attempted to acquire Cheniere Holdings in late 2016 but was unable to agree on the price; it was successful in a repeat attempt in late 2018. In August 2020, Blackstone agreed to sell an estimated 42% stake in Cheniere Energy Partners to its own infrastructure affiliate (Blackstone Infrastructure Partners) and Brookfield Infrastructure Partners. Bloomberg has reported the transaction price was $34.25 per share. Both parties own a 50/50 stake in the venture, essentially making each 21% owners of Cheniere Energy Partners. Still, over the long run, we think it’s likely that Cheniere Energy Partners will cease to exist.
Cheniere's more aspirational target, in our view, of 90 million tons per year, or mtpa, from the current expected 58 mtpa in 2026, is unlikely to be achieved within the next 10 years but shows the firm has ample capacity to expand for decades.
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