GasLog Ltd.: World-Class LNG Shipper Offers Recession Hedge Alongside Solid Growth

Dec. 13, 2019 1:46 AM ETGasLog Ltd. (GLOG)15 Comments13 Likes
Alex Behrens profile picture
Alex Behrens
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Summary

  • GasLog operates a modern fleet of liquid natural gas transport ships, with a large majority of its ships signed to long-term charter agreements.
  • LNG demand has been, and will remain, robust for at least the next decade, offering investors a hedge against recession alongside both income and growth.
  • As supply and demand growth for LNG smooth out, shipping operators become more like utilities that must guard against idle capacity.
  • Investors should buy GLOG now while downside risk is low in anticipation of growth in share prices and income distributions.

Introduction

GasLog Ltd. (NYSE:GLOG) operates a fleet of liquid natural gas (LNG) shipping vessels. Currently comprised of 13 ships, GLOG will add seven ultra-modern new vessels to be delivered in 2020 and 2021. GasLog Ltd. is the general partner in an agreement with GasLog Partners (GLOP), who operates older vessels "dropped down" from the GLOG fleet. In June 2019, GLOG made a cash payment to terminate an incentive distribution rights agreement (IDR) in exchange for shares of GLOP to be paid out gradually until 2025. GLOG aims to sign its vessels to long-term charters with LNG consumers. Of the 20 ships in its planned 2021 fleet, all but five are signed to long-term charters, with an additional two ships on short-term charters of one year or less. The company delivers predictable, steady revenue growth, with some variability coming from the few spot vessels in the fleet, but even those are slated to be signed to longer-term agreements if management can find the right customer. The business adds revenue by adding additional ships to its fleet.

The LNG market is expected to remain strong for at least the next decade as more regions of the world, particularly China and India, seek to shift their energy mix away from fuel sources like coal or oil to natural gas. GLOG cites Woods Mackenzie in its Q3 investor presentation (page 12) for an anticipated CAGR for LNG demand of 6% through 2025.

GLOG Mid-Term Outlook

Debt Refinancing

In November, GLOG successfully refinanced an NOK-denominated bond with a new maturity of November 2024. Management offered “sometime in the middle to early second half of 2020” for anticipated refinancing of $900 million of balloon payments with maturities in Q2 and Q3 2021. $325 million in senior notes due Q1 2022 will also need to be refinanced.

Spot Fleet Charters

Management says they are looking into Floating Storage Unit (FSU) projects for their existing steam vessels. Priority will likely be given to GLOG’s single steam ship if it is not dropped down sometime in the next two years to help finance upcoming new builds, with potential to capture some new long-term business for GLOP under the correct conditions.

New Builds

Five of seven new ships are set to be delivered in the second half of 2020, with the two remaining being delivered in mid-2021. Compared to some competitors, GLOG already seemed to have positioned itself as a more stable, "utility-like" business through its use of long-term charters. But management also seems to be more thoughtful than some others when it comes to the LNG vessel supply-and-demand equation. Here’s CEO Paul Wogan on the most recent earnings call:

“I think we for some time have been saying we need to be careful in terms of newbuildings in the industry, [and looking] forward to that '21-'23 period, where right now there's not a lot of new [LNG production] capacity due to come on stream. And I think... as an industry on the shipping side in the past, what we have done is have the ships arrive at the wrong time... If you get the timing wrong, you can have two or three years where you have new ships coming out waiting for new capacity to come on. And so, I think from our point of view, to continue to order into a period where we don't see new production doesn't make a whole lot of sense for the industry. So, especially the people who are going out and ordering speculatively into that market, I think should be weary.”

To say "not a lot" of LNG production will come on-line between 2021 and 2023 is a bit of an overstatement, as roughly 48 mtpa new capacity is planned so far for that period. Compared to 2018 to 2020, however, when about 75 mtpa came on-line, growth will be over 1/3rd lower, with well over half of the new capacity coming on-line in 2023. Here's Paul Wogan again:

“I think the other thing that happens if you have a strong balance sheet [and] good cash flow, it gives you opportunities for M&A, consolidation opportunities which going into a period if there is a softening market, we want to be in a strong position where we could possibly take advantage of those.”

I am very encouraged to see management making these types of statements. They indicate a strategic consideration of the market that should help GLOG trade at a premium to peers and potentially lead to purchases that offer growth at a discount compared to the industry.

LNG Shipping

LNG supply and demand will both be robust over the next decade. This fact seems well-established by many others, and I would refer readers to slides 11 through 15 of the Q3 GLOG presentation to relieve any lingering doubts. The particular geographics of distribution, from the US to India or from northwest Australia to China, will have an effect on ton miles (or the utilization multiplier from greater shipping distances) and will flow into the much more important consideration, vessel supply and demand. I credit James Catlin’s excellent piece on LNG shipping for helping shape much of my thinking on this topic and will use one graph from that presentation:

Source: James Catlin, Awilco

Once facilities are constructed and energy providers have integrated natural gas into their grid, their demand becomes much less elastic, giving producers and shippers something to smile about. On the other hand, price shocks and volatility stifle the growth in natural gas infrastructure construction and upgrades, because price still trumps environmental considerations in all but the most affluent regions of the world. No matter how frightening and shocking the second half of 2015 was for shareholders and suppliers with too many ships, far more adverse long-term conditions existed in the 2012-2013 period. Even if the market didn’t complain because returns were as healthy as they had been in a decade, management at LNG shipping companies understood the negative implications of high prices, and many took action to address it. As others have noted, it takes 2 or 3 years for newbuilds to be laid down after being ordered, so it was the high prices during these years that drove the wild oversupply and price drops that followed.

On the other hand, a business with a strong balance sheet and good cash flow would be in a position to acquire ships in the event of a capacity oversupply, not unlike that potentially projected by GLOG for Q2 and Q3 (spring and summer) of 2021. This is also the period during which new LNG supply capacity additions will be at their lowest, so what limited arbitrage opportunities might exist will be further restrained by relatively low additional LNG supply. It seems possible, or even likely, that some or several operators will have to idle part of their fleets during this time, and if finances are particularly tight, some could seriously consider sale of vessels (especially those lacking long-term charters) to generate cash. Even if those vessels are smaller and older, the dropdown arrangement with GLOP could make such deals attractive to GLOG and offer fleet growth at a discount compared to building brand new capacity.

Source: Q3 GLOG Presentation

Valuation

LNG shipping companies can be difficult to value, partially because the business is somewhat new on the timescale of energy companies. As with many commodities- or utilities-focused companies, it is difficult to identify traits that would justify a premium over the value of the infrastructure, or the book value, in the long term. One differentiator is investor confidence that management might slowly grow the business over time, or at least not lose business or fail to keep pace with inflation. Operational excellence is frankly the baseline, and premiums to the industry means come only after extended, uninterrupted periods of quality performance. In my view, we are just not there yet, but the outlook is good as we enter a period of greater stability in LNG shipping.

In early 2016, when the LNG shipping market seemed in chaos, GLOG was priced at less than half its tangible book value and almost precisely at 1 P/B when including intangibles like charter backlog. P/B plus intangibles in the very cold worldwide winter of 2017-2018 peaked a bit above 3, and P/B less intangibles never made it above 2x. Since then, P/B multiples have fallen to where they now sit around 1x. The market says that GLOG is worth essentially the value of its vessels and immediate earnings. I am inclined to agree, especially considering several competitors are priced below their own book values. Looking over the history for GLOG P/B, the market has slowly reduced the premium on book value from above 9x in 2013 to prices we see today. I think these high multiples were driven by the expectation that LNG shipping would largely be a game of arbitrage, with much more agency and profit/loss attributed to cunning management activities. Perhaps at one time this was true, but as vessel supply and demand efficiency improves, arbitrage has given way to fairly predictable annual demand and revenue growth, not unlike many traditional utilities. The game is changing from scoring big wins by intelligently allocating limited supply to matching as efficiently as possible the organization's supply of infrastructure to the demand for its use. I believe GLOG trades closer to its book value than competitors because management seems to recognize this as well, seeking long-term charters to stabilize the business and pursuing growth at a reasonable cost.

Newbuild charters (using management’s 2019 guidance of $15,000 opex per ship per day) are for around gross 71k per day or 56k per day after expenses for $20 million annual revenue per vessel. A 15 percent discount from the existing 1-year charter rate in the Q3 presentation is reasonable to me, given pricing volatility over the past two years when the long-term charters were booked. Management expects $144 million in added EBITDA from the 7 newbuilds, and the FSU charter adds another $20 million annually for $164 million by 2022. To be conservative, I will not add in any potential FSU charters for the remaining spot vessels.

Actual

Projected

3 new ships

2 new ships

5 new (half year)

2 new (half year)+5

All full year

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

157.2

328.7

415.1

466.1

525.2

618.3

670

740

840

870

Y/y Growth

52.18%

20.81%

10.94%

11.25%

15.06%

7.72%

9.46%

11.90%

3.45%

Source: The Author

I model $670 million in revenue for 2019 based on a strong Q4 spot market and the addition of ships in 2019, actually giving the lowest growth rate in five years. Five new ships halfway through the year should deliver about $50 million additional EBITDA or about $70 million in additional revenue at the 70% gross margin for 2020. 2021 adds an additional $100 million sales for the expected 70 million in EBITDA ($50 million from full year of 2020 builds and $20 million from a half year on two new ships), and 2022 adds just $30 million from an additional 6 months on two 2021 builds. This assumes no additional builds or purchases and, importantly, does not account for the approximately $50 million outstanding share repurchase authorization.

To see how this projection impacts pricing, I’ve applied the annual revenues to price-to-sales models, which closely tracks P/B that I use in my analysis. My expectation is mapped in green, with orange being least likely, in my opinion.

GLOG P/S Model

Source: Author's own

I think GLOG is fairly valued given existing conditions of low and stable gas prices and steady growth in LNG supply and demand balanced against the need to show the capacity for extended periods of operational excellence. The last five years have set the foundation, but as the industry has matured and stabilized, the market has seen fit only to continue to lower the premium on book value. From 1x there’s not much downside risk, and GLOG is positioned to show it has what it takes over the next five years. I could see the market adding a premium up to 3x on book value by 2024 if the company can continue to execute.

Risk Factors

Failure to refinance debts coming due in 2020 and 2021 would be catastrophic for GLOG, but since charter backlog is well above the debt load, I think this is very unlikely. Political risk is a threat in the US, but only if political will shifts even further in the direction of completely eliminating fossil fuels from the energy mix, including exports. I think that’s unlikely on a practical and social level, because gas is so clearly the best alternative to other FFs and because there is just not that much further left to go, socially. LNG will be a player until 2050 at the very least, and has the potential to meet the needs of all but the most intensive hydrocarbon-driven industries that currently have few alternatives.

Gas from Russia comes up often when thinking about energy mix. As others have noted, using pipelines versus tankers is not without cost, and political pressure from the US will ensure NATO members diversify appropriately. The truth is the world is awash in natural gas, and low prices will continue to drive strong demand for years to come, regardless of how much Russia can pump out.

I think the biggest risk to this relatively young industry is that of a serious accident. While the environmental costs of such an event are lower than with many fossil fuels (LNG just boils off and evaporates into the atmosphere), the psychological implications would be devastating for regions and nations thinking about how best to secure their energy supply. The effect would be considerably compounded if the accident were to significantly damage or destroy LNG processing or distribution facilities in an emerging market like India, where LNG supply lines are long and competing alternatives relatively abundant.

Conclusion

GasLog has not been particularly kind to investors hunting for growth in the energy sector. If you bought at or near the IPO, you are underwater at today’s prices, and dividend growth has been basically stagnant since 2014. Compared to peers, management has been meticulous about limiting downside risk in idle capacity. In doing so, revenue growth has not been as high as it might have been with additional ships, but that is what I want my dividend stocks to do - grow steadily over time and avoid risks that can erode shareholder value.

GLOG has been playing the long game and positioning itself defensively in an industry that still has some shaking out to do, but that still offers less-volatile growth prospects compared to other energy-related industries like hydrocarbon refining or electrical distribution. The potential for added revenues and multiple expansion from bargain purchases of idle vessels over the next few years offers an attractive catalyst for those seeking a good mix of growth and income. GLOG also strikes a good balance for those like myself uncertain about a recession, offering limited downside and consistent demand with growth driven as much by environmental factors as financial ones. Investors should buy now while downside risk is about as low as it can get, and anticipate improved share prices and growing dividends as GLOG shows itself to be a world-class operator in LNG shipping.

This article was written by

Alex Behrens profile picture
353 Followers
I'm a freelance writer and analyst with experience at Fortune 500 companies and startups. I do part time equity research and enjoy writing about cutting edge technology.Ithaca College BA in Finance 2014
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Disclosure: I am/we are long GLOG. 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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