Description

This is a very speculative small cap idea. It however, is a simple story – Awilco LNG (ALNG) consists of 2 modern vessels and is a bet on the recovery of the LNG market.

Awilco LNG was incorporated in early 2011 by Awilhelmsen, a private investment company in Norway (included among its holdings is 12% of Royal Caribbean Cruises; the group still owns 33.7% of ALNG), with the purpose of buying three LNG vessels, all built in 1983-1984 with 125k cubic meters each, for a total of $67m.  They also placed an order for 2 newbuilds with Daewoo, 156k cubic-meters each, which were delivered in 2013.

At the time, the outlook was extremely rosy.

From their first presentation (Aug 2011):

Following the Fukushima accident in March 2011, Japan shut down its nuclear capacity and resorted to LNG imports (nuclear power plant utilization dropped to 3.9% in 2012, compared to ~70% before the accident).  LNG prices were $5-7/MMBtu higher in Japan while transportation costs were $2.5/MMBtu simply due to lack of transportation capacity.

The surge in demand, longer distances, and low supply of vessels, provided the perfect storm to cause prices to spike: older vessels were getting $100k/d contracts (in contrast with an opex of just $15k/d) versus pre Fukushima levels of around $40-50k/d. Golar LNG secured a 3-yr contract for a modern vessel at around $150k/d.

The following chart tells the story:

High rates and a very bullish outlook, also fueled by the increase in LNG terminal projects around the world, led to an increase in new orders. Many of these were speculative, without charter contracts in place.

We are all familiar with the strong supply response. While many LNG projects around the world got delayed, from Angola to Australia, the vessels kept being delivered.  (Angola LNG for instance, was supposed to start up in 1Q 2012, producing 5.2 million tons/year – it faced delays, was able to ship limited cargos, had to be shut down again following construction errors, and was supposedly expected to resume in June 2016).

So the following, unsurprisingly happened:

The above chart reflects the dramatic collapse in LNG rates. We can see the spike in vessel availability. For the 3 years following the peak, LNG production levels were flat.  Also probably doesn’t help that the collapse in oil has caused the relative economic attractiveness of LNG to diminish – when oil was at $113, the LNG discount to Brent was 30-80% (depending on the region).  Rates made new lows.

Utilization for its older vessels suffered and in order to pay for the delivery of the new vessels, ALNG entered into essentially a sales-leaseback agreement for both newbuilds (WilForce and WilPride) with Teekay LNG (TGP): the financial lease is for four years plus a one year option in ALNG’s favor (for WilPride; WilForce is for 5 plus 1), staring at the end of 2013. The repurchase obligation is $130.9m after four years and $123.5m after five years. The bareboat rate is fixed during the entire period at $49.1k/day (terms similar for WilForce). TGP acquired each vessel for $205m less a $50m upfront prepayment of charter hire by ALNG (in addition to the daily bareboat charter rate).

ALNG was able to sell one of its older vessels in 2Q15, and recently (6/1/16), it announced it was selling its two remaining older Moss-type vessels, for which some analysts estimate to be around $32m USD. It will now consists of just the 2 2013-built vessels. Note the expected residual life for each vessel should be at least 27 years (the company believes could be even longer, with useful lives of 40 years). Transaction should close in Q3.

WilForce is in long term contract until January 2017, while WilPride is exposed to the currently challenged spot market. It reported an EBITDA of $4.9m in 1Q16 vs $11.8m in 1Q12.

In the current environment, ship-owners not in hurry to take delivery. There has been no new orders since October 2015. On the demand side, 46m tons of LNG supply are scheduled to start-up in 2016, and total production capacity in 2020 is estimated to be 450m tons/year (80% higher than the production in 2020).  As per Simpson Spence & Young, a leading independent shipbroker, the availability of short-term vessels has decreased, which could point to a gradual tightening: they forecast short-term contracts to end the year at around $50k/d (compared to the current $35k) $60k by ’17, and to continue climbing.

Valuation:

Quarterly leasing payments should be $9m plus little under $1m for corporate opex. WilForce should contribute $5.6m and WilPride is the main variable in the short term, but assuming little better than 50% utilization, it could add ~$2.5m for the remainder of the year.  With the asset sales, ALNG should end the year with almost $33m in cash (NOK 4/sh).

Given the near term lack of profitability for these long-life assets, let’s look at their NAVs:

Assuming $60k rates and 75% utilization in ’17 for both vessels, but improving to $70k, we get an NAV of $336m for both ships. Subtracting a year end net debt of $273m and 67.8m shares, we get a value of $0.94, or NOK 7.80 using the spot rate of 8.36 NOK/USD, vs the current price of NOK 4.24,

Risks:

Supply-demand overhang – global fleet is around 460 ships, and the order book at the end of 1Q16 was for 129 LNG carriers. That is not enough to cover the new LNG production under construction, but as we know from the past, those capacity additions are never smooth.

Cannot sugar coat it – this is a bet that LNG market will recover by mid-2018: Assuming both vessels are subject to the spot market and rates have yet to recover, ALNG has 1.5 years before they run out of cash.

Catalyst

Recovery in the LNG shipping market

Entry of new LNG liquefaction capacity