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I put on the Cheniere Energy short trade during market hours on 8/24. I didn’t have time to actually dive deeper into the business and make the case for why it’s obviously overvalued.
Let’s dive in.
Cheniere Energy is the largest producer of LNG in the United States and the second largest LNG producer globally, based on its total production capacity of 45 million tonnes per annum. In addition, the company is adding 10 mtpa of capacity with the Corpus Christi Liquefaction Stage III expansion. Cheniere is also the largest consumer of natural gas in the US on a daily basis.
Breaking down the business model
The company sources domestically produced natural gas from US and Canadian oil companies like EOG Resources and Tourmaline Oil
The natural gas is liquified into LNG at its Sabine Pass or Corpus Christi LNG terminal
The LNG is loaded onto LNG carrier ships and sent to a re-gasification facility of the customer’s choosing, primarily to Europe or Asia
The company supplies LNG under two types of long-term contracts: SPA and IPM.
The Sale and Purchase Agreement (SPA) is similar to the take-or-pay agreement common in the oil industry. The company contracts to sell a fixed annual volume of LNG to a customer. The customer pays a fixed fee for the entire volume, regardless of whether they want delivery. In case they do want to take delivery, they pay a variable fee on top of the fixed fee, plus an inflation adjustment component. The variable fee is generally equivalent to 115% of the Henry Hub price. According to the company, “the variable fees under our SPAs were generally sized with the intention to cover the costs of gas purchases and variable transportation and liquefaction fuel to produce the LNG to be sold under each such SPA”.
Under an SPA, the customer is guaranteed delivery of LNG and sourcing feed gas to honor the contract is Cheniere’s problem. The company solves this problem by using IPM contracts.
Under the Integrated Production and Marketing (IPM) contract, Cheniere will contract to purchase a fixed annual quantity of natural gas, convert it into LNG, and sell the LNG using its marketing arm. The gas supplier receives an LNG-linked price for its gas after deductions for fixed LNG shipping costs and a fixed liquefaction fee. This means the company will almost certainly earn a gross profit excluding depreciation of at least the fixed liquefaction fee.
As of Q2 2022, the company had contracted out 95% of its total LNG production capacity, via SPA and IPM agreements, for an average duration of 17 years. The SPA annual fixed fee component is $3.3 billion at Sabine Pass and $1.8 billion at Corpus Christi. This means that the company will receive $5.1 billion a year even if all its SPA customers refuse to accept LNG from Cheniere.
In the most profitable scenario, customers pay the fixed fee and take no LNG cargo, which means the company gets to idle its plants and not have any costs associated with natural gas procurement or plant operations. In that scenario, the fixed fee of $5.1 billion over 17 years at an 8% discount rate equates to $46.52 billion in present value (PV). The company’s total debt as of Q2 2022 was $42.5 billion. Doesn’t this support equity value? Not so fast.
Cheniere only has a 48.6% interest in Sabine Pass, and most of that contracted fixed revenue (64.7%) is at Sabina Pass. The debt is on the consolidated balance sheet – separating out the debt and present value accruing to Cheniere and non-controlling interests is not a task that interests me. Besides, even on a 100% basis the excess of PV over debt is just $4.02 billion, of which $1.37 billion goes to cover the working capital deficit, leaving a surplus of a mere $2.65 billion. I can afford to be wrong by +/- 10-20% because the market cap is $43.1 billion, giving me a wide margin of safety on my short position.
The above analysis omitted the value of the IPM contracts, but however profitable they are, they cannot change the equity value much. The $2.65 billion equity value above assumes that the company idles its LNG plants and enjoys the fixed fee indefinitely. That’s obviously not going to be the case as global LNG demand continues to skyrocket. The company will actually have to earn its fee by delivering LNG. In the first half of 2022, the company earned a gross margin, defined as revenue less cost of sales, of 15.5%. For 2021, the margin was 13.2%.
In 2021, the company sold 40 million tonnes at an average price of $400/ton. Let’s say the company sells 45 mt in 2022 at the same price. The gross profit, assuming the same 13.2% margin, works out to be $2.35 billion. This margin has to pay for operating costs, interest expense, depreciation and SG&A. Even netting out just depreciation and operating expenses will change the gross profit into a net loss.
The gross margin needs to be well over 35% to give the company even a sporting chance of equaling the $5.1 billion fixed fee for no delivery scenario. Also, these numbers are pre-tax.
Is it any wonder then that the company is unprofitable? It is not easy for a revenue generating company to accumulate an equity deficit.
Cheniere’s current forecast calls for ~$14 billion in cumulative distributable cash flow through 2024. I just don’t see it happening, not even if maintenance capex is zero and the billion dollars a year in depreciation expense adds to the cash balance.
If I change the contract duration from 17 years to 20 years, the pre-tax PV-8 of equity rises from $2.65 billion to $6.2 billion. That’s still 86% below the current market cap, equivalent of a share price of $24.82.
No matter how optimistic I make my model assumptions, I just don’t see the shares being worth more than 25% of their current price.