Golar LNG's New Contract Is A Double-Edged Sword

| About: Golar LNG (GLNG)

Summary

Golar is investing in the new technology of FLNG.

The new agreement could significantly boost Golar's profitability.

Massive capital expenditure requirements mean Golar is putting all the money on the success of FLNG.

A deal that could boost a company's EBITDA by six times, who wouldn't want that? It may sound too good to be true, but that is exactly what happened to Golar LNG (NASDAQ: GLNG). Golar is an energy company that provides midstream services for liquid natural gas, or LNG for short. Activities include transportation, regasification, and liquefaction.

The new contract was signed with Societe Nationale de Hydrocarbures and Perenco Cameroon for the a floating liquefied natural gas export project in Cameroon, set to commence in 2017. The agreement is expected to bring in anywhere from $170 to $300 million EBITDA annually, representing a significant increase from 2014's EBITDA of $48 million.

The financial profile of the ongoing operation is rather troublesome. The company did not achieve a positive operating margin for the past two years if we normalize the non-recurring gains. The company is not breaking even on a cash basis either. Over the past fiscal two years, the company has spent $2 billion on capital expenditure and received only $93 million in cash from operations. In addition, the company plans to spend $2 billion more over the next year and half. At a glance, this may seem alarming; but, the company had something big cooking up.

There is a good reason for the high capital spending. Golar is in the process of converting three of its vessels into GoFLNG vessels. What exactly is a GoFLNG vessel? GoFLNG vessel is a term used by Golar to describe a ship that is capable of liquefying natural gas offshore. Under conventional technology, liquefying natural gas for transportation purposes requires large on-shore facilities. This drastically decreases the viability of many potentially productive reserves, as the initial capital investment required for the on-shore facility may outweigh the value of the future cash flows gained from the sale of natural gas. Golar is at the forefront of the newest technology of making floating liquefied natural gas possible, and GoFLNG is the answer. The agreement signifies that there is strong interest in the company's technology and the high capital expenditure that the company has incurred could be well worth the reward. The company also announced another agreement that will bringing similar profits, though the project will start somewhat later in 2019.

Possible Risks

Perhaps the most obvious aspect of this agreement is that it will bring in massive amount of revenue in a couple of years and finally make Golar a profitable business. But it is in fact a dual edged word. The success of these contracts has cemented management's plan to steer the business towards GoLNG, as evident by the conversion of a third vessel to GoFLNG. This means significant capital expenditure in the coming years without any immediate return. During the construction period, the company is also susceptible to commodity risk indirectly. If the price of natural gas continues to deteriorate, there is no guarantee that the projected volume will be achieved.

Floating liquefied natural gas still is a very new technology; and as always, such investments bear significant uncertainty. The profile of the company has shifted from a stable midstream company to a more speculative new venture. Investing in Golar right now means that you are a firm believer in the future of floating liquefied natural gas. The company is even selling assets in order to finance the massive capital required to build GoFLNG vessels, so while contracts do represent significant interest and a successful launch could generate a lot of profit, any failure would be catastrophic.

Disclosure: I/we 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.

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