Cheniere Energy Partners Offers Little Good And The Bad Could Get Ugly

Sep.17.13 | About: Cheniere Energy (CQP)

Cheniere Energy Partners (NYSEMKT:CQP) is a small-cap company ($8.9 billion) controlled by Cheniere Energy (NYSEMKT:LNG). It is developing a group of natural gas and LNG terminal facilities, including regasification plants, transport systems, and storage. Contracts with several international purchasers and resellers provide commitments for the full capacity of five and one half of its 6 planned trains (modules) (see table 1).

The success or failure of this debt financed venture is highly dependent on the macroeconomic environment of the natural gas industry projected far into the future for the next 30 years and more. It is heavily dependent on future development and production of reserves in North America, particularly the U.S.A., that will need to be derived almost entirely from unconventional resources. Success is also dependent on production outpacing demand such that the U.S.A. becomes a net exporter of gas so as to maintain downward pressure on domestic gas prices.

The share prices are propelled by a wholly debt financed dividend and promises of a rosy future yet to come. These future visions are hinged on pro forma projections of cash flows from future developments coupled with an over reliance on very cheap gas. It is an example of the unbridled exuberance that brought us the Enron bust, the silver bubble, the housing bubble, the dot.com bubble, and all those other testaments to the folly of turning a blind eye to value while chasing the latest fad-de-jour -- NGL exports in the case of Cheniere.

Is CQP another Enron?

  • It is in the natural gas business. CQP's parent, Cheniere Energy is in the LNG and natural gas marketing business and a developer and operator of LNG terminals. LNG has a debt/equity ratio in excess of 228/1. CQP has a debt/equity ratio exceeding 301/1.
  • It has complex interlocking relationships between its parent and daughter companies as well as to debt, revenue, contractual performance triggers. (see Figure 2)
  • Equity ownership participations and conversions are largely tied to metrics of cash distribution rates and net operating cash which can be subject to manipulation by management. This has the potential to be to the disadvantage of common holders with resultant risk shifting and potential very significant common share dilutions. (See figure 3)
  • CQP pro formas show that the 13.1% equity share of the LNG terminals dilute to 9.6% in 2016 (Figure 1).
  • The pro forma cash flow projections are based on price assumptions significantly out of sync with U.S. Energy Information Agency outlook for natural gas prices. Even these EIA price forecasts are likely to under estimate US gas demand and Henry Hub prices. (see Figures 4 and 5).
  • The disparity between EIA Henry Hub price projections and those used by Cheniere pro formas are enough to virtually eliminate any projected pricing margin advantages of the CQP models and could very well fall short of servicing debt (Figure 6 - attention to note 1 assuming $6 Henry Hub Pricing compared to $8 - $9 EIA forecasts during life of debt).
  • Many EIA forecast test scenarios based on higher conversion of US electrical energy generation to natural gas feedstock and/or slower growth of unconventional gas reserve development and production rates could leave the entire Cheniere pro forma margins upside down.
  • The entire viability of the Cheniere pro formas is based on forecasts above the EIA median case scenarios for development of gas reserves and production. Shortfalls to these future increases in production rates and reserves would likely create upward price pressure on Henry Hub and could leave CQP cash flow insufficient to service debt.

Table 1 - Contracted Purchasers

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Figure 1 - Common share dilution in 2016 Click to enlarge

Figure 2 - Ownership Structure Places Risks in CQP While Some of the Potential Rewards Transfer to Related Companies

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Figure 3 - Organization Structure Places Debt Risk within CQP While Cross Related Companies Receive Some of the Rewards

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Figure 4 - Cheniere Pro Forma Price Assumes $3.40 to $6.90 Margin over Current Henry Hub Prices

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Figure 5 - EIA Henry Hub Price Forecasts Show These Margins Shrink & Disappear During The Projected Contract Periods

Figure 6 - Cheniere Pro Forma Uses $6 Henry Hub Pricing in Analysis of Debt Service by Cash Flow (up to 50% below EIA estimates)

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Apple (NASDAQ:AAPL), with its P/E of 12, yield of 2.4%, Price/Book multiple of 3.62, and slow revenue growth of ~ 1.0% may be subject to arguments as to its value. Reasonable people make defensible arguments on both sides of that index staple.

Cheniere EP has no such vagaries. With a forward P/E of 660.50 and a Price/Book ratio of 4.98 there is more blue sky in CQP than over the entire Pacific Ocean.

The company has attracted public investors with a large annual cash dividend of $1.70 per share that is being paid 100% from borrowed funds since its inception in 2007. This alone raises a red flag that should draw the attention of any investor performing due diligence and asking what reputable business model could account for such fiscal policy.

Speculators and unwary dividend income investors have bid the price up and yield down to 6.43%. This is an MLP yield equaling or less than that offered by such aristocrats as Linn Co (LNCO) at 11.2%, Mid-Con Energy Partners (NASDAQ:MCEP) at 8.9%, Calumet Specialty Products (NASDAQ:CLMT) at 9.1%, LeHigh Gas Partners (LGP) at 7%, CVR Energy (NYSE:CVI) at 6.8%, and an overall MLP energy industry average yield of over 7.5%.

CQP Chart CQP data by YCharts

Conclusions and Recommendations:

Is Cheniere another Enron? It is too soon to say, but the potential for catastrophic collapse which wipes out all share value and investor equity in the blink of an eye certainly exists.

I do not wish to imply in any way that Cheniere is involved in any criminal practices, frauds, nor any deceptions. My concerns are the over inflated expectations based on what I believe are its risky pro forma assumptions that are likely to result in actual cash flows significantly underperforming. Coupling this with the overly inflated share prices propelled by a large dividend ($1.70 annually, 6.3% yield) completely financed by debt to date and unlikely to be sustainable in the future, a strong likelihood of a major collapse in share prices unless the future evolves along the near perfect performance of multiple factors needed to meet the pro formas that are the sole basis of current investor enthusiasm.

With sound companies in the natural gas and LNG marketing and terminal business offering even better yields from existing actual operations and a long history of sustainability, Cheniere shares represent unnecessary risk and speculation in pursuit of sub-par performance compared to those alternatives.

Will CQP achieve and maintain cash flows to service debt and maintain its dividend? Given the headwinds enumerated above, at best it will be difficult. Even if the macro environment meets the rosy forecasts and company operations are as efficient as pro forma scenarios, the shares are over priced.

A feeding frenzy of the sharks should not be far off.

  1. Investors are advised to avoid these shares.
  2. Traders are advised to short the shares.
  3. Speculators are advised to sell the calls.

I am not a licensed securities dealer or advisor. The views here are solely my own and should not be considered or used for investment advice. As always, individuals should determine the suitability for their own situation and perform their own due diligence before making any investment.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.