Today I have the pleasure to publish an interview with Gabriel Castro (GC), portfolio manager at a Spanish investment boutique called RSR Inversión & Patrimonios EAF, focused on Golar LNG Limited (NASDAQ:GLNG) - a highly intricate company that has also been extremely punished by the market recently.
Gabriel has devoted hundreds of hours to analyze and follow the company and its industry in order to get a deep understanding on the different businesses it encompasses, the market perception regarding Golar’s valuation and why he disagrees with that, as well as the contextual macro or structural energy landscape trends that the company will be affected by. He makes a big effort attempting to explain what GLNG really is and why he is so bullish on it as a long-term play in the energy sector.
Hope you enjoy my interview with Gabriel.
GC. We were looking for ways to take advantage of the LNG structural trend.
Nowadays, a big anti-pollution movement has arisen around the world and is not limited only to developed countries; the entire world is aware of the damage our planet is undergoing and even China and India have both committed to emissions targets under the Paris agreement.
As you can see in the following charts, oil and coal are still the main primary energy sources of consumption, especially in developing countries. According to BP Energy Outlook 2019, coal share in the energy mix in China will fall from 60% in 2017 to 35% in 2040 while the oil market share will go down slightly. The decline in coal use will be replaced mainly by Renewables and Natural Gas.
Source: BP Energy Outlook 2019
Of course, we believe in the important role renewable energy will play, but we also know its limitations. It would be naïve to think that it will fully replace the hydrocarbon industry over the next 30 years. What’s more, due to gas power plant flexibility, it is the best energy to combine with renewables.
After an extensive and deep analysis of the potential scenarios, we reach the conclusion that switching from coal to gas is a must, especially in developing countries like China. In fact, according to Shell LNG Outlook 2020, Natural Gas will be the fastest growing source of energy over the next 20 years, even more than renewables (see chart below).
Source: Shell LNG Outlook 2020
Moreover, we also learnt about the global energy imbalances. Asia will have a huge deficit in the coming years because of its strong economic growth and lack of natural resources, while the US will have a high surplus, mainly due to shale gas. In fact, at present, there is a huge gap between gas prices in the US and China. It would make sense that China would increase its imports of cheaper American gas, especially after the Trump/China agreement. It should be noted that the cheapest way to transport gas is by converting it into LNG. For this reason, global LNG trade is expected to increase approximately 70% by 2030 according to BP Energy Outlook.
Source: Teekay Investor Day
Thus, answering your question, our first approach was mainly due to our interest in Golar’s LNG Carriers (LNGC) fleet, trying to profit from the global trade energy imbalance and LNG structural trends, but we soon discovered what an amazing business Golar is and we left aside the shipping segment.
Source: Golar LNG website.
GC. The main problem with Golar LNG, as evidenced by the figure above, is that it is quite a complex company and business. There are many moving parts and it is easy to get lost. FLNG technology is very recent (2017) and not a lot of information is disclosed about Golar Power because it is not fully consolidated (joint-venture structure). The Hilli oil bonus generates noise in each earnings report, same with the UK tax leases, the TRS Swap…
We’ve been following the company since 2016 and I have to admit that I’ve spent more hours with this company than any other in order to get the same level of knowledge that I have on other companies. Thankfully, they are aware of the complexity of the company and are now seeking to simplify the business structure in order to make its value more evident.
In all honesty, people at Golar do the impossible to explain their business. They do more presentations than any other related company and Stuart (Golar’s Investor Relation) has extensive knowledge about the company and is always easily accessible.
I reiterate that Golar as a company is not easy to explain, but I’ll try.
Golar works along all the LNG chain, from upstream to downstream, as the figure below shows. We should differentiate the Production & Liquefaction business (FLNG), the Shipping business (LNG carriers) and the Regasification and the downstream business (Golar Power). Moreover, Golar is the General Partner and owns 31% of GMLP and has a 22.5% stake in Avenir LNG.
Source: Golar LNG Presentation.
Regarding the Shipping business, Golar owns 10 LNGC, eight of them are TFDE (Tri-Fuel Diesel Electric) built in 2014 and two steams, Golar Arctic (2003) and Golar Viking (2005). As we’ve seen recently in Gaslog annual results, steam ships are not very popular right now, so Golar is converting one of its steamers into a FSRU for Croatia. The deal is very good because the customer will fund all the conversion, remove Golar Viking debt and Golar will make a net profit close to $40M by the end of this year.
Golar LNGC fleet is trading on spot. It means that EBITDA is volatile and highly seasonal. LNG rates are usually low from early February until April-May and very high in the last quarter when it usually peaks in early December. It is a seasonal pattern that occurs yearly. It would be foolish to misinterpret LNG rates changes, the same happens with Dry Bulk rates or Oil Tanker rates. It is essential to keep in mind seasonal patterns and compare the current rates with those of the same period in previous years, not month to month.
Actually, we initially became interested in the company because of the LNG shipping fleet. The fleet is trading on spot, so it means that we should be rewarded if rates go up. What’s more, Golar LNGC fleet is operationally and financially leveraged (10k increase in time charter equivalent (TCE) rates equates to an increase of approximately USD 40m in EBITDA), so it intensifies any movement. We thought that LNG rates had to rise because of the new liquefaction capacity coming to the market in 2018-2020, the world demand of gas, especially in China, and the scarce availability of LNG ships.
We were right. 2018 and 2019 were good years for LNG rates, however, shipping managers are greedy, and they ordered many new ships in 2018 that should come to the market in 2021. Adding that we won’t see more liquefaction capacity until 2024, we expect a decent 2020 (with the coronavirus’ permission) but the market should be tougher from 2021 until 2023.
Source: Bernstein report.
Golar knows that the LNGC fleet is its weakest part and it brings a lot of volatility to the company’s earnings. They want to deconsolidate to show the market how stable its core earnings are, but they can’t sell ship by ship because there is no market for them. When an owner asks for a ship, he usually keeps the ship until the end, when it is scrapped. There is no market, which is different from other shipping segments like the oil tanker market or the bulker market. Moreover, Golar owns TFDE ships and these are no longer raising customers’ interest, who are nowadays requesting MEGI or DFDE ships.
I still believe that the LNGC fleet makes sense in the long term. However, while it makes sense for other pure-play companies, I think it is a distraction for Golar and I support them as they work on an alternative structure. I expect to hear news after the summer.
Golar also owns a FSRU (Golar Tundra). This FSRU is working as an LNG carrier because rates are going well, but Golar expects to find a FSRU long-term contract within the year. It makes sense because the current depressed gas price intensifies the switching from coal and oil to gas and supports the FSRU business.
To be clear, I should explain what a FSRU (Floating Storage Regasification Unit) is. LNG carriers transport the LNG (Liquefied Natural Gas), which basically is natural gas that has been cooled down into liquid form for ease and safety of non-pressurized storage or transport, however it can’t be transferred to the pipeline system. LNG needs to be heated up to its original gaseous state before the gas is pumped into its storage systems. This process is done by the FSRU ship which also acts as LNG storage in order to optimize the process. The current environment is perfect for the FSRU business as the cheap LNG from an oversupplied market leads to more countries being enthusiastic about the prospects of importing LNG for energy usage. The cheaper LNG trades, the better the economics for FSRUs.
Let’s move on to explain Golar Power. Leaving aside the ships, Golar’s downstream business is named Golar Power. Golar Power is a 50/50 joint venture with the private equity firm Stonepeak Infrastructure Partners. Golar Power owns 1 FSRU, 2 LNGC and 50% ownership in Sergipe Power Plant and the future Barcarena Power Plant.
I think it is worth it to spend time going into some detail project by project.
Sergipe Power Plant is owned 50/50 by Golar Power and EBRASIL. Sergipe is a 1.55GW gas-fired thermoelectric power plant being developed in Barra dos Coqueiros, Brazil. The Commercial Operation Date (COD) is expected by the end of March, only 6-8 weeks late, not a big deal considering that it is a five-year project. It will be the largest gas-fired power plant in South America. The plant will deliver power to 26 committed offtakers (utilities) via a 25-year Power Purchase Agreement that is expected to generate $78M of annual EBITDA for Golar. What’s more, Sergipe owns the attached land which can hold an additional facility of the same size. In addition, the cost of expansion would be relatively low because it can share equipment like pipelines, water treatment, FSRU capacity… It is essential to know that Sergipe expansion depends on the ability to win a power auction from the government, which I think is very likely because Brazil’s government is promoting gas and replacing expensive oil and diesel based generation. Additionally, the region has no other thermal power facilities with environmental licenses and fuel supply, so there will likely be very little, if any, competition for the future auction. However, the potential expansion would not start operations until 2025.
Picture: Sergipe, Latin America’s largest thermal power station. Source: Golar LNG Presentation.
Moreover, Sergipe will be assisted by Nanook (Golar Power FSRU). Nanook is fixed on a 25-year charter. Golar Nanook should generate around $21M EBITDA, however Sergipe only needs the FSRU partially, therefore the FSRU can work for other customers and sell the excess gas increasing the earnings.
On the other hand, Golar Power was awarded last year for a 25-year Power Purchase Agreement (NYSEARCA:PPA) for the construction of a 650MW combined cycle thermal power plant in the Brazilian city of Barcarena in partnership with Centrais Eletricas Barcarena. The LNG-to-power project will be developed by CELBA (Centrais Elétricas Barcarena SA), which will be 50% controlled by Golar Power. The PPA is expected to earn $174M for 25 years, indexed to inflation and with a fuel cost pass-through. It is expected to start in January 2025.
As we’ve seen on Nanook, Golar Power was awarded for a 25 years contract for a FSRU. While the Barcarena terminal is expected to start in 2025, the FSRU is expected to commence operations by mid-2021 because it is located in a strategic entry point in the northern region of Brazil, which will be used as a hub to allow for the distribution of LNG and supply of natural gas for electricity generation, commercial and industrial customers.
Therefore, we should consider at least $99M annual EBITDA from Sergipe and Nanook starting from the end of Q1 2020. Moreover, Golar can considerably increase earnings by investing minimal levels of capex. It is key to know that there are many opportunities to increase earnings without waiting for too long before seeing results. For example, Golar can sell production of merchant power through the Sergipe power plant in non-dispatch periods or use the spare capacity on FSRU Golar Nanook. In fact, Golar recently announced a partnership with Petrobras Distribuidora for the development of an LNG distribution business in Brazil. Petrobras is Brazil’s leading fuel supplier with more than 7,600 gas stations and a large truck fleet which will be used to promote switching. Therefore, the combination of utilizing the FSRU for other businesses and the potential of sourcing low-cost cheap gas could drive up Golar’s EBITDA well above the estimated $99M from Sergipe.
In case our readers haven’t understood Golar Power business well, I’ll try to make it even easier. Golar Power operates Sergipe and Barcarena, two thermal power stations which burn natural gas to generate electricity. Those power plants have a long-term contract guaranteeing an attractive minimal return, but Golar can take profit of the non-dispatch periods and sell power into the grid at the spot price.
Source: Golar LNG Presentation.
On the other hand, Golar also operates the FSRU assisting the Power Plants. As I told before, the LNG from the LNG carrier can’t be pumped into the system, therefore they need an FSRU to transform the LNG into its original state. Moreover, because the FSRU will only be partially utilized supporting the terminals, the FSRU can assist other nearby customers and enhance Golar’s returns.
Golar Power is an extremely profitable business. It makes >20% return on equity before leverage. Due to the length of the contracts, indexed to inflation and with a fuel cost pass-through, they can leverage those assets up to 4-6x EBITDA and improve the ROE to 50% per year.
Golar Power creates an integrated gas-to-power platform in order to capitalize on low-priced gas and high electricity prices creating a resilient moat in Brazil. It is undeniable that Golar Power is a growing company. In fact, Golar Power is pursuing at least five different projects in Brazil and more than 10 around the world. Actually, Golar expects to announce a third terminal before the end of the year, likely close to Portuário de Suape, Pernambuco. The partnership with Petrobras is speeding up Golar Power growth.
Last but not least, let’s explain Golar’s FLNG segment, which is the most interesting one. Golar owns three FLNG vessels: the Hilli FLNG that is currently operating, the Gimi FLNG which is under construction, and “Gandria", which is waiting for a future FLNG conversion.
Floating Liquefied Natural Gas, or FLNG, is a disruptive technology that makes the production, liquefaction and storage of natural gas at sea possible. The traditional liquefaction method needs a huge investment, as it requires long pipelines from the gas field to the liquefaction unit, compression units, dredging, jetty construction and of course, an onshore LNG processing plant. However, the FLNG technology is much cheaper because there is no need for these facilities, as the processing is carried out at the gas field. Moreover, it is environmentally friendly as it interferes minimally with the environment, while in the traditional way the coastal landscape gets very deteriorated. It also reduces the political risks involved with onshore projects; for example, major gas fields are in African countries, which are more prone to conflicts that might require to take your FLNG in a rush. However, this wouldn’t be possible with the traditional liquefaction structure. What’s more, a traditional onshore facility requires several years before its construction due to the existing regulations, while an FLNG just needs 3 or 4 years. Finally, the FLNG facility can easily be redeployed in another field because it is standardized, contrary to the FPSO business.
The FLNG technology opens gas resources from underwater gas fields that were economically or environmentally challenging to obtain, especially fulfilling the ESG criteria. Basically, the FPSO only extracts and processes the gas from the field, while the FLNG liquifies and offloads it into an LNG carrier. The whole process is carried out on the field.
Golar’s FLNG model is a disruptive concept as it is able to access to low-cost reserves and deliver them to Asia at prices well below the U.S. land-based terminals (the lowest-cost producer). At the same time, Golar FLNG showed advantages over its FLNG competitors. While Golar was not the first FLNG operator (Petronas NR Satu in 2017), Golar developed the best FLNG currently operating. Golar FLNG is much cheaper and faster than others. The Hilli FLNG’s $500/ton liquefaction is far below the Petronas FLNG Satu and Prelude, at ~$2,250/ton and ~$3,400/ton, respectively. At the same time that Prelude couldn’t do any cargo during a year, Petronas did 8 in 800 days, in contrast to Hilli FLNG, which did 6 cargoes in the first 300 days.
Golar owns a 45% stake in the Hilli Episeyo FLNG unit, which is the world’s first successful LNG carrier-to-FLNG unit conversion. The Hilli FLNG is processing 1.2 mtpa annually in Cameroon. The Hilli FLNG unit offers some of the lowest modern liquefaction costs globally across both land-based and floating liquefaction terminals. It was structured in four different trains to provide flexibility to Perenco, and currently there are only two trains online which secure the 8-year agreement with Gazprom.
Golar has a fixed rate that is unrelated to the gas price. Moreover, for every dollar of Brent oil price above $60 up to $100, Golar obtains an additional $3M bonus. Therefore, Golar can generate up to $120M (with $100 Brent) in addition to the fixed contracted EBITDA. (Of course, this oil-price bonus is worthless currently, but in an 8-year timeframe this may not always be the case.) What’s more, Perenco could activate trains 3 & 4 and could add $150M fixed EBITDA (without considering the oil bonus) with no extra capex. It is worth noting that Perenco is doing a drilling campaign in order to prove up additional reserves and increase production without risking having enough gas to meet its 8-year 1.2 mpta commitment to Gazprom. At the Hilli naming ceremony in 2017, Perenco described this field as one that ‘keeps on giving’, so there should be no problem.
Many doubts have arisen around the T3, which was expected to be online a long time ago. It should be known that Perenco is an oil company, this is their first LNG project and they don’t have an LNG trading desk able to constantly scour the market for new customers yet. It is understandable that they are going slowly, but we know that Perenco’s economics are a non-brainer and they are making money even at current LNG prices. Purchasing and getting feed gas in West Africa is much cheaper than Henry Hub and we expect that Perenco’s cost is less than average ($1.4) as they have owned the field for decades, so their costs will be limited to the costs of a small platform, pipe and land-based processing facility and Golar’s toll. Despite Perenco being an oil company, it is sited in a gas field that supports at least 20 years at full production at a very low cost as we will notice after Perenco's drilling by the end of this year.
Since the Hilli Episeyo FLNG began the operations, its performance has been outstanding with 100% up time. The Hilli FLNG is proof of Golar’s skills. Golar FLNG works when traditional LNG technologies do not. In fact, after tracking the Hilli performance, BP decided to order an FLNG named Gimi to work in a gas field between Mauritania and Senegal. Golar owns 70% of Gimi, while Keppel owns the rest. Gimi is contracted for 20 years from the delivery in 4Q 2022. It is expected to contribute to Golar with $171M each year despite gas price fluctuations and $100M of FCF after debt service.
If the Hilli FLNG was the proof of Golar’s concept, BP’s deal is the best of the best. It opened many doors. For example, we know that companies like Shell are reviewing its gas fields portfolio which weren’t economically viable before Golar’s technology. It is essential to know that it requires time and there is no need to rush because of the current depressed gas price. However, Golar’s demand of new FLNGs is a matter of time since Golar’s technology generates the lowest-cost LNG production in the world and can be profitable even at low energy prices.
As you can see, Golar’s fully integrated LNG supply chain model is fairly balanced. If the current environment remains, Golar will benefit greatly through Golar Power business because gas will become the first source of energy consumption sooner than expected. However, if the gas price springs back, Golar will take an enormous profit from its FLNG concept.
GC. In my opinion, the company is not properly valued by the market. Golar is the perfect bet if you really believe in the LNG structural trend.
As we already explained, Golar has three different businesses: Production & Liquefaction business (FLNG), Shipping business (LNG carriers) and Regasification and Downstream business (Golar Power).
LNG Supply Chain
Source: Golar LNG website.
FLNG and Golar Power businesses are infrastructure businesses. The company gets 20/25-year contracts at fixed rates with top clients such as BP, Perenco or EBRASIL. Those projects generate returns above 15% without leverage. Moreover, since those projects are resilient and generate stable cash flows (even during a crisis), Golar can easily leverage up those projects up to 4-6x EBITDA, thus improving the returns to 35-45%.
It is remarkable that companies which own projects similar to those of Golar are trading at higher multiples, especially in the current low interest environment. Golar is primarily being valued and perceived by the market as a shipping business, which is cyclical, volatile and unpredictable and should make 8-10% cash return in a mid-cycle. However, it should be regarded as an infrastructure business, therefore, there is a big potential rerating. What’s more, I think we have some catalysts coming in the short term which might improve the market perception of Golar.
First of all, Golar Power starts to generate earnings starting this year, which will improve the overall stability of earnings of the company, because Golar will have $82M EBITDA coming from Hilli (excluding the Brent oil bonus) and $100M EBITDA from Golar Power, while its volatile shipping business should make at least $152M EBITDA based on a TCE of $54k per day. Remember that in its infrastructure business, Golar generates the same amount each month whatever happens. Moreover, you should know that the Gimi project will bring $150M EBITDA each year starting in 2023. Hilli T3 and T4 should contribute with $150M and Barcarena and other small projects with $100M more, but it will happen over the next few years. My point is that 2020 will be the first year where EBITDA from the infrastructure side of the business will be higher than shipping EBITDA and it will smooth out earnings going forward.
Secondly, Golar is working on the LNG Carriers (LNGC) shipping spin-off. If they find a way to separate the shipping business from the infrastructure business, the market will appreciate it very quickly. I have to admit that it won’t be easy, especially in the current environment, since Golar LNGC fleet is highly leveraged and shipping companies remain hated by the market. However, Golar management said during its last call that they are making good progress on this topic.
Moreover, Golar wants to sell a small stake in Gimi at fair multiples in order to prove to the market how good their assets are. Brookfield is one of the most interested and, why not? Who would not be interested in a 25-year fixed contract with BP? That being said, Golar management stated they would wait until the COD is closer because they will get a better value and also they don’t need the liquidity right now.
Finally, we can also see a Golar Power IPO in the short term. It will unlock a lot of value because it will make valuing the Power business easier. Just look at how NFE (New Fortress Energy) is trading at. It is a good comparison to the Golar Power business and it shows how the Golar Power real valuation is not being considered in the current share price.
It is worth noting that Golar has not always been as cheap as it is now. After extensive research, we first bought shares in September 2017, around 23 dollars per share. We had been following the progress of Hilli and Fortuna FLNG projects and we were pretty bullish on LNG rates. After seven months, the stock rallied more than 40% up to 33 dollars per share without any relevant news. The market sympathized with the FLNG business prospects and expected many FIDs in a short-term period. Of course, we knew the market was too optimistic at that moment. Despite the fact that we firmly believe in the advantages of the FLNG business over the traditional business, it is essential to consider that a FLNG project requires high equity contributions and takes several years to develop.
J. Mintzmyer from Value Investor’s Edge, who is doing an excellent coverage on the stock, warned us that Golar Partners (GMLP) could experience some dividend coverage problems and that could affect Golar stock sentiment, so we decided to sell before Q1 2018 results. Mintzmyer was right about the GMLP problem, but the biggest impact was Schlumberger leaving the OneLNG joint venture. OneLNG joint venture was created by Schlumberger and Golar in order to develop global FLNG solutions. The first project was the Fortuna FLNG, where they would work for Ophir Energy. Fortuna was supposed to be one of the lowest cost LNG projects in West Africa.
Source: Golar LNG 2017 Presentation
However, Schlumberger decided to leave the project and the joint venture and Golar stock crashed 26% in one day. To be honest, we were very lucky as we hadn’t foreseen such an event. The market rationale was simple, if the FLNG business was so attractive, why didn't Schlumberger want to get in? Schlumberger is an oilfield services provider and Brent oil was above $70 at that time. They weren’t comfortable with the FLNG business, so they decided to focus on its core business. The explanation was understandable, however, the market didn’t share it, there was a shift in perceptions.
For the rest of 2018, Golar raised the dividend and announced the Gimi FLNG FID, but it didn’t improve the sentiment around the stock. The market wasn't - and still isn't - really aware of the Golar Power business. It was perceived as a disruptive and growth company because of its FLNG business. Investors were in love with FLNG prospects and Schlumberger wrecked it. Since then, the market has been valuing the company as just another shipping company. It is fair to say that the current low LNG price is delaying some FLNG projects. However, I want to highlight the word delay since I’m sure we will see a renewed interest during 2021-2023. In fact, Exxon contacted Golar and Exmar for a FLNG solution for the Israeli offshore Leviathan gas field. We should know more details at the end of this year, but as far as I know, Golar design and financial capacity is much better suited for this project than Exmar. I would like to highlight that in case the project goes ahead, Golar target price will increase between 7-10 dollars per share.
Despite the current LNG depressed price, Exxon’s interest is mainly because LNG will become essential to meet global energy needs and the FLNG solution is the best option available. FLNG works when traditional LNG does not. It is absolutely necessary to understand that Fortuna failure has made no impact on Golar's ability to win new FLNG business. Hilli operating with 100% commercial uptime, Gimi FID and Exxon’s interest are good proof of that.
Nevertheless, Golar’s market value only contemplates one of its segments - FLNG business - leaving aside the other components of this conundrum and consequently not recognizing Golar Power progress. Just take a minute to research Golar Power's latest developments. For example, Golar announced a partnership with Petrobras for the development of an LNG distribution businesses in Brazil through more than 7,600 fuel stations and an extensive customer base. Moreover, Petrobras intends to replace its current truck fleet of approximately 5,000 trucks with vehicles that employ LNG for their operation which will be used to promote switching. Golar Power is creating a resilient moat in Brazil and it is very profitable.
I firmly believe that Golar's business model is unique. Just take one minute to reflect on the following argument: if gas prices remain low, Golar Power business should greatly benefit because countries accelerate coal/oil transition to gas and will demand Power solutions. On the other hand, if gas prices go up, the FLNG business will be very popular because it is the most efficient and quick way to produce LNG.
In essence and in response to the initial question, the market is not valuing Golar's assets and fundamentals properly. I feel there is a huge divergence between the stock performance and its economics. Golar is trading at a 10-year low despite the company having never been in a better position. Golar FLNG and Golar Power were only a dream 5 years ago, and now Golar keeps a $7Bn earnings backlog, meaning EBITDA backlog and not revenue backlog like most peers show.
I’m confident that If Golar successfully tells investors the growth story of Golar Power and can convince the market that the FLNG’s growth story is intact, albeit at a slower pace than what was expected a couple of years ago, the company will be priced as a growth stock again and we can see the stock trading above $25 in the short term.
It is nearly comical how the stock market is the only place where you can buy quality assets from Golar at ridiculous prices. If Golar was private, I’m sure nobody would value it at today’s price.
GC. As previously mentioned, Golar is formed by several companies and, as such, my valuation is carried out through the Sum of the Parts (SOTP) method which I will proceed to sum up as simply as possible.
According to Vessels Value, the Golar LNGC fleet is worth $1.3bn. To keep it conservative, I cut that valuation to $1.15bn. Given this, if the fleet is worth $1.15bn and there is $900M net debt, the LNGC fleet is worth $250M. In other words, 2.5 dollars per share.
Golar Power business should be worth between $2.5bn and $3.5bn considering New Fortress Energy market valuation. If Golar Power is worth $2.5bn (lower-end valuation), Golar stake is worth $1.25bn or 12,7 dollars per share. I would emphasize that I’m not taking into consideration any potential growth. As we said before, cheap gas supports further downstream growth. Golar Power could easily have 15 FIDs in the next 3-5 years. In fact, during the latest earnings conference call, Golar management said they have a third terminal currently in the advanced stages that should be announced by the end of 2020.
We value Golar Gimi FLNG project based on an 8x EBITDA multiple. Despite the fact that we believe it deserves a higher multiple, we consider 8x is fair as it won’t be generating cash flow until 2023. Golar stake is worth $720M or 7.3 dollars per share. I will increase Gimi’s value up to $300M extra or 3 dollars per share once the COD (Commercial Operation Date) is reached.
Golar’s Hilli T1 and T2 stake is worth $220M based on 8x EBITDA multiple and let's say $540M from Hilli T3. We are 100% confident that Perenco will activate Hilli T3 and extend its contract period over the next two years as we explained above. Therefore, Hilli FLNG project is worth $760M or 7.75 dollars per share.
We value Golar Partners (GMLP) at the current price and Golar Avenir LNG stake at book value. It adds $100M or 1 dollars per share. Moreover, we should add $200M from Golar Tundra and the steam ships Golar Viking and Artic or 2 dollars per share. I think Golar Tundra should be worth even more, but we need to see a long-term contract attached. I expect Golar to be announcing a 15-20 year contract within this year.
Source: Own elaboration from Gabriel’s estimates.
The figure above summarizes and puts together the numbers from the SOTP analysis. Therefore, in my opinion, Golar's current target price may be about $2.5bn or $26 per share based on 98M shares. I would like to highlight that only 2.5 dollars from the 26 target price are derived from the shipping part, so is it logical to see Golar as a shipping business?
I would like to highlight that the valuation only considers Golar's current backlog. Present upside potential, however, is not the most important thing here. I firmly believe Golar will increase its value between 5 and 10 dollars each year. Golar Power and Golar FLNG businesses make Golar a potential compounder. We are invested in a growing business with huge competitive advantages which will benefit from the LNG structural trend. In fact, based on our long-term LNG prospects, it is fair to say that Golar might be worth about $100 per share over the next 10 years.
GC. It is easy to blame management when the stock is trading at 10-year lows. It may seem that Golar management hasn’t created any value and they should be fired, but I don’t agree with this view despite the price performance.
Management is very good, especially its Chairman, Tor Olav Trøim. For people who don’t know him, Tor Olav Trøim and John Fredriksen are considered the best shipping investors in history. They made a 22% CAGR, converting $300M into $17Bn in 20 years.
Trøim is a visionary. He was the first person to understand that the LNG shipping business shouldn’t be the core of the company as it had been since its inception. Returns on capital weren’t enough, so he decided to invest in the FLNG and downstream businesses. It is essential to keep in mind that Golar did the world’s first FSRU conversion in 2008 and the world’s first FLNG conversion in 2018. In our view, Golar should be valued as a technological and disruptive company, in fact, according to BP, Golar is three or four years ahead of other competitors.
Tor Olav Trøim. Source: NTB Scanpix.
We have had the privilege of meeting Trøim face to face. He told us his personal experience in China and Brazil and confirmed our suspicion that switching from oil and coal to gas is an unstoppable trend. Brazil and China are building a revolutionary LNG-fuelled truck fleet, cheaper and cleaner than any others. The reduction of CO2 emissions is approximately 30%, particles by 70% and sulfur by 100%. Moreover, the Diesel-to-LNG switch will save ~50% of fuel costs.
During the meeting, he shared with us very interesting ideas and we saw first-hand why he is one of the best managers in the sector. Moreover, we observed his frustration in regard to the stock price performance. Despite his long-term view, he suffers as a shareholder when the stock is trading so poorly. I’m quite certain that he will come up with some solutions in order to unlock further value within the coming year.
We also met the CEO, CFO and some of Golar Power management. Of course they are not perfect, they made some mistakes like the Total Return Swap in 2014, however, I think they are doing a good job and this will be reflected in the stock price in the medium term. You should take into consideration before criticizing them that they built a $7bn earnings backlog out of nowhere in just five years and Golar Power and Golar FLNG have significant first-mover advantage thanks to their skills.
What’s more, legendary investor Peter Lynch is a shareholder as well. He is still managing his personal assets and Trøim confirmed that they are in regular contact. Actually, Lynch’s suggestion is not to lose track of target, to create value for shareholders, and to take his eye off from the current price performance; the market will end up recognizing its real value.
Owning Golar in our portfolio, we have one of the best managers in charge with skin in the game (Trøim owns more than 5% of the company) and we are invested alongside one of the best fund managers ever. What could go wrong?
GC. Coronavirus is not only affecting but also altering the entire energy sector and for this reason we could discuss whether the stock movement has been exorbitant, but it is undeniable a temporary headache for most energy companies. I would emphasize that there are some exceptions like Teekay Corp (TK) or Teekay Lng Partners (TGP). I haven’t found a reason for TGP plummeting yet other than the possibility of people selling/shorting the sectors which are suffering the most from the Chinese slowdown and the Oil price war, such as shipping or energy sectors, without going into detail company by company. Having said that, I can explain the reason why Golar LNG has sold off.
The market is focusing on Golar liquidity and may be pricing a capital raise. Golar's cash position is not substantial, at least until 4Q 2022, when Gimi FLNG will be delivered and leveraged to 5x EBITDA. It will free up at least $330M of cash. Moreover, Golar's reported net debt seems high, but you need to remove $431M because it includes 100% of Hilli and Gimi debt while Golar only owns 44.5% and 70%, respectively. What’s more, it is key to know that $900M (44%) of net debt relates to 8 TFDE vessels, mainly structured through variable interest entities (VIEs), that may be separated in a different company in the coming months.
The big problem in this reasoning is that, while the market is well aware of Golar’s capital scheduled outflows - these basically being Gimi equity contributions, interest and debt repayments -, it doesn’t take into account inflows at all. On the one hand, the scheduled capital outflows are funded with the current cash position, Viking inflows, Hilli cash flow generation and the Golar Partners dividend (we are assuming a 50% dividend cut that we believe is conservative). On the other hand, Golar Power is self-funded, so Golar does not need to contribute with more capital. After taking everything into account, we arrive to the conclusion that the only possible concern might be regarding the volatile shipping business; if it burns a lot of money and can’t attend the scheduled debt repayments like in the past, Golar will need some extra capital.
So, let me focus on the shipping segment for a moment. Golar’s shipping business needs around 55k average annual TCE in order to breakeven (including debt amortization, interest expense and OPEX), while they achieved 44k TCE during 2019. The market believes that 2020 rates cannot be as strong as in 2019 due to coronavirus and we actually have this concern, too. LNG carrier spot charter rates strengthened in 4Q19 but have fallen rapidly in recent weeks due to a combination of bloating inventories, newbuilding deliveries and decreased demand as a result of the Chinese New Year and the coronavirus. A slowdown in Chinese gas demand will not only impact domestic gas companies, but also have an impact on global LNG prices. China is currently the second largest LNG importer globally and will be the largest contributor to incremental LNG demand growth. LNG prices have fallen to record lows of <$3/MMbtu in Asia (from $5/MMbtu a month ago), <$2.50/MMbtu in Europe and <$1.8/MMbtu in the US. As a result, LNG shipping rates remain under pressure as liquefaction facilities reduce production and the arbitrage between geographies narrows.
However, in my opinion, the market is wrong to believe that Golar will have a problem. People are taking 2019 TCE as a starting point and it is not fair. On the one hand, it is important to know that Golar did 8 TFDE vessel dry-dockings with 5 weeks off-hire period each. This means Golar shipping underwent 40 weeks off-hire. We expect much less off-hire days and boil costs in 2020. On the other hand, Golar got some market-linked charter contracts that will increase utilization. Therefore, when you understand that all TFDE vessels have now completed their scheduled five-year dry-dockings and all are currently on charter, it is easy to arrive to the conclusion that Golar will experience a higher TCE per day and will reach at least breakeven in 2020, despite the fact that LNG market rates could be worse than in 2019.
Concerns relating to a potential capital raise began last year when Golar “suspended” the dividend. Golar decided to suspend two quarters of dividend ($30M) in order to eliminate the Total Return Swap (TRS). The TRS was a huge mistake they made back in 2014. The stock had crashed more than 50% in a few months in 2014 and shareholders compelled the company to take steps, but they didn’t have cash because they had just funded 10 TFDE ships. Through a Total Return Swap, they showed how confident they were about the long-term prospects by buying shares without deploying capital. Therefore, they took the obligation to buy 3M of shares at $45. It caused a stir in every earnings report since then, so in order to simplify the balance sheet and reduce earnings volatility, they are using two quarters of dividend ($30M) to remove the TRS and buyback 3M shares reducing the total amount from 101 million to 98 million shares outstanding. It was seen as a sign of weakness; however, they took advantage of this outflow to buy back shares and removed earnings noise. Be aware of the fact that they could have just closed the TRS and accept the loss, but they preferred to buy back and cancel the shares. In my opinion, it was a smart move despite market reaction. However, I think Golar management won’t bring back the dividend as it is more intelligent to employ it in a buyback program at the current price. In fact, this issue was raised during the latest conference call and the CEO made it clear that at the current price, paying dividends isn't the preferred option compared to the alternatives.
Thankfully, Golar confirmed our view when their latest earnings report was released. The company sent a powerful message that revoked cash concerns and led the stock price up. Golar management did an excellent job. They nailed it titling the presentation “The power is on, cash flow is coming”. What’s more, they started to tell investors about the Golar Power growth story, as we suggested to them some time ago. They showed many excellent projects Golar Power is working on which will generate cash flow pretty quickly, as elaborated in a previous question. Finally, Golar explained the improvement in the shipping business, as we had estimated. Golar expects 60k TCE for Q1 2020, substantially higher than the 39K achieved for 1Q 2019. Golar management reiterated that all projects are completely funded and market fears have calmed down.
Other folks may argue that Golar sell-off is due to LNG prices, which are very depressed, and that the FLNG growth story might be dead. As we said before, Golar is benefiting from this environment through Golar Power as cheaper gas incentivize accelerating the switch from other energy sources to gas. Therefore, we think Golar Power’s real value is not being considered in the current share price.
JKM Futures (Asia gas price):
However, gas prices will not stay low forever and I am confident a price recovery will occur towards the end of 2020, given the limited new capacity additions which will come online over the next 3 years and should lead to a tightening of the global gas market. While spot prices were already under pressure due to an oversupply of LNG in the market, the recent outbreak of the coronavirus has pushed prices down to record-low levels. It should be noted that Asian spot LNG prices are now trading at a level which is below the US LNG producers' cash-breakeven costs. However, the impact will only be on the near-term LNG price, as the virus will unlikely lead to structural change in China's gas demand, and I remain positive on China's long-term gas demand growth.
Therefore, it is a matter of time to hear about renewed interest in liquefaction solutions, especially in Golar FLNG business, given the highly competitive cost compared to traditional onshore solutions.
Last but not least, Golar is incorrectly correlated with oil. In fact, Golar is a constituent of the Oil-field Services index (OSX). I think the vast majority of the poor performance in the past two years is a result of the correlation to this index. Algos are programmed to short all companies related to oil & gas without having enough knowledge about what the company actually does. In fact, Golar has no downside risk from direct exposure to the oil price. Hilli oil bonus only adds value when the Brent oil is above $60 (as explained above), but it doesn’t cause an outflow when Brent oil price is below. However, it is fair to say that there is an indirect correlation because oil and gas companies are connected. Being this the point, I would like to refer again to what I said above: Golar is benefiting from the current LNG depressed price from its Golar Power business and Golar FLNG solutions are the best since they work where traditional solutions do not.
Source: Golar LNG Presentation.
Thus, in summary, I think the market misunderstands Golar business and the sell-off is not justified. Moreover, market concerns about potential shareholder dilution is not fair at all because the market is misinterpreting Golar's cash flow generation and net debt. Moreover, raising capital will not only be against Trøim’s track record, but it will also not make sense given that they have many valuable assets that they can monetize like Gimi FLNG or Golar Power.
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Disclosure: I am/we are long TK. 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.
Additional disclosure: Gabriel Castro is long GLNG, TK and TGP.