NFE Builds To Break Out
New Fortress Energy (NASDAQ:NFE) concentrates on established LNG terminals in the international markets and introduces FLNG in its portfolio. After a quiet 2020, the company's baseline is transforming following the Hygo and GMLP mergers, which expanded its operating reach as it stepped into operating FSRUs (Floating Storage Regasification Units). Also, during the past couple of months, it has strengthened the natural gas supply operations and LNG terminal building in Brazil and Sri Lanka.
While the company's management estimates operating profit to increase manifold in the next two years, investors should keep in mind the economic growth factors in the countries NFE is setting foot on. Also, such expansion plans can tilt its already leveraged balance sheet, as evidenced by recent debt issuance. Also, on top of that, its cash flow from operations has remained negative in 1H 2021. Investors might want to buy the stock as it will offer significant upside in the medium term. However, they should also be aware of the financial risks.
Natural Gas Price And NFE's International Projects
Investors need to understand the current dynamics in natural gas prices and pricing outlook. Natural gas price (Henry Hub) averaged $4.07 per million Btu in August 2021, or up by 6% in a month. A growth in liquefied natural gas exports and domestic natural gas consumption led to the price rise. The EIA expects natural gas prices to remain nearly unchanged at the current level in Q4 2021. However, the price can decline gradually in 2022 due to rising US natural gas production and slowing growth in LNG exports. If the domestic natural gas price increases, NFE's competitive advantage in relative pricing in the international markets diminishes.
Therefore, NFE's key strategy is to focus on international markets, such as Jamaica, Puerto Rico, Mexico, Nicaragua, Brazil, Ireland, Sri Lanka. These countries already have established LNG terminals and are expected to see significant growth. For example, in Puerto Rico and Mexico, a few power plants can switch to natural gas. Also, new power plants are being built in Brazil. A CHP plant supplies electricity to JPS (Jamaica Public Service) under a long-term contract. A CHP or combined heat and power plants use the waste heat from electricity production for heating purposes. NFE's second strategy involves the introduction of FLNG in its portfolio. The management believes that the liquefaction of LNG will step up around the world. The company already has a cost advantage of having cheaper feedstock stock that it can provide in the host countries to help develop power and economic activity.
Operating Margin Growth Is The Aim
Source: Company Presentation
NFE's operating margin has come off a long way in the past year, clocking nearly 8x growth. The company's management believes that the momentum will continue and estimates it will increase by 62% in Q3 compared to Q2. Two of the most potent drivers of this increase would be the LNG terminals coming online and the diversification of income sources. As I discussed above, the company has hands in the pie of all - terminal operations, shipping, third-party contracts, gas sales, and merchant power operations. In Q4, however, the operating profit can decline by 19%.
I discussed in my previous article that in 2020, NFE's marketing strategy was focused on Central America, South America, Africa, and Asia. It closed a few final investment decisions (or FIDs) during the year, targeting five to 10 such deals. By 2025, the company planned to undertake terminal construction in 20 to 30 terminals. Based on the considerable growth potential in LNG, it now estimates 2023 operating profit to zoom to ~$1.2 billion, although such growth would sound optimistic at this point. It also forayed into the clean energy power projects, as I discussed in my previous article.
Volume Growth And Recent Projects
In aggregate, in Q2, the company averaged 1.5 million gallons per day, which was nearly unchanged compared to a year ago. However, compared to Q1 2021, its revenues increased by 54%. In the Terminals & Infrastructure segment, the operating margin was up by 28% versus Q1, while the operating profit was slightly higher in the Ship segment.
In April, following the Hygo Merger and GMLP Merger, NFE acquired one operating FSRU terminal in Brazil. Plus, it also acquired a 50% interest in a power plant and two other FSRU terminals in development in that region. Also, during Q2 2021, NFE's operating results have been positively impacted by robust performance in the Montego Bay Facility, Old Harbour Facility, San Juan Facility, and the Miami Facility.
During the quarter, it struck a few significant deals. In August, it executed two agreements to supply natural gas to a couple of fertilizer plants in Brazil. Following the transaction, it plans to deliver ~1.4 million gallons of LNG per day for a five-year term starting 2021. In September, it finalized deals to supply natural gas to a refinery in Brazil for 15 years. NFE expects to provide ~1 million gallons of LNG per day to the refinery. Also, in September, the company finalized the contract with the Sri Lankan government for LNG terminal and investment into the 310 MW Yugadanavi Power Plant. Following the agreement, it will acquire a 40% ownership stake in the power plant and plans to build an offshore receiving, storage, and regasification LNG terminal near the coast of Colombo.
Ownership Concentration And Risk Factors
As of April 23, 2021, insiders (or affiliates of the original investors) owned ~54% of its shares. Wesley R. Edens (the CEO), Randal A. Nardone, and Fortress Investment Group LLC own 35.1%, 12.7%, and 6.5% of the voting power, respectively. Investors may note that beneficial ownership of greater than 50% of the voting stock means the owners can significantly control or direct the decision-making process. Such concentration of power is typically considered to be opposed to the concept of fair corporate governance.
Debt Burden And Cash Flows
In September, NFE disclosed that it borrowed $430 million while borrowing can go up to $725 million under a three-year term loan. The proceeds from the loan will be used to fund the development and construction of its various energy infrastructure projects. Currently, the company is managing its working capital to support LNG cargo purchases, asset-level financing, and the Jamalco power plant sale-leaseback transaction. Investors may note that the company had restructured and refinanced its debt structure a year ago after issuing senior notes and raising $1 billion from the market.
Although revenues more than doubled in the past year until 1H 2021, a steep working capital requirement continued to weigh on cash flows, deteriorating an already negative cash flow from operations. As a result of the rising investments and capex during the year, free cash flow, too, depleted significantly and stood at a negative $346 million in 1H 2021.
Its debt-to-equity (1.7x) is much higher than the peers' (OIS, HLX, FTI) average of 0.53x. A steep rise in capex, a negative FCF, and an overly leveraged balance sheet reflect poorly, especially when there is uncertainty following the pandemic and the economic revival.
Linear Regression Based Forecast
I have observed a regression equation based on the historical relationship among natural gas production, the LNG export price, and NFE's reported revenues for the past six years. I also observed the previous four-quarter trend. Assuming the short-term and the long-term factors will equally on revenues while the short-term factors will gradually lose their potency, I expect revenues to increase sharply in the next couple of years. The growth rate can decelerate in 2023.
Based on the regression model using the average forecast revenues, I expect the company's EBITDA to increase in the next two years. However, in NTM (or next 12 months) 2024, the model suggests decreasing EBITDA.
According to data provided by Seeking Alpha, nine of the sell-side analysts rated NFE a "bullish" or "very bullish," while one of them rated it a "neutral." None of the sell-side analysts rated a "sell." The sell-side analysts' target price is $43.25, which, at the current price, yields 55% upside.
NFE's key strategy is to focus on international markets, especially in countries that are expected to see significant growth. Its second strategy involves the addition of FLNGs. Investors may note that the company has a cost advantage with cheaper feedstock stock. The company's baseline is transforming following a few critical projects in recent times. In April, following the mergers, the company stepped into operating FSRUs. In September, it finalized deals to supply natural gas to a refinery in Brazil and an LNG terminal in Sri Lanka.
However, investors should keep in mind some of the critical challenges ahead. Based on the considerable growth potential in LNG, it now estimates operating profit to increase manifold in the next two years. However, such expansion plans have changed the company's debt structure also. Recently, it has tapped into new loans that would increase borrowing by up to $725 million, which would fund LNG cargo purchases, asset-level financing, and the Jamalco power plant sale-leaseback transaction. Its cash flow from operations, one of the principal indicators of operational health, has remained negative in 1H 2021. The balance sheet is also leveraged compared to its peers. These explain why the stock underperformed the SPDR S&P 500 Trust ETF (SPY) in the past year. So, despite the strong growth drivers and robust returns potential, I think investors should also be aware of the financial risks.