Description

This write up is probably a little shorter and less detailed than I would like it to be, but I think the entry level is extremely good.

In the recent energy sector meltdown, a variety of stocks have been sold without a lot of discrimination.  While it is true that many of these companies are not yet cheap enough if oil is going back to $30 and natural gas is going back to $4, that is not true in all cases.

I am not an expert in this sector but one of these companies appears to me to be Cheniere Energy.  Cheniere is a development stage company that is building LNG (liquefied natural gas terminals) terminals.

Cheniere is currently trading at about $26.  Not counting an out of the money convertible note (which I am counting in debt) there are about 56 million shares

Currently it has a 30 percent equity interest in a terminal called Freeport and is constructing a 2.6 bcf/day facility at Sabine Pass.  It also has been permitted by the FERC to build two more terminals. 

In 2004 Cheniere reached agreements with Total and Chevron to provide a total of 2 bcf/day of capacity at Sabine pass at 32 cents per mmbtu for 20 years.  This works out to about $245 million dollars a year of revenue coming from strong investment grade credits.

I believe that year-one-through-fifteen profitability of Sabine assuming no further contracts will look as follows:

Thereafter the tax shield disappears and discretionary cashflow falls to 90 million a year.

Underlying these numbers are the assumption that Cheniere will have a little over 900  million in debt (which follows from the cost to complete Sabine plus some interim interest costs), that the blended interest rate on the debt will be about 5.4% (part of it is a low coupon convert) and that they will be able to depreciate the plant for tax purposes straightline across fifteen years.  Consequently based on current contracts with investment grade companies, Sabine at an eight percent discount rate is worth about $20 a share assuming that Sabine starts production in early 2009.

In addition, the company has stated that it expects to receive $15 million a year from its equity interest at Freeport.  Adjusting this for taxes and putting a mid teens multiple on it suggests that the Freeport interest is worth about $2 today.

With the stock under $26, that means the market is currently putting a $4 value on anything else the company can do.  About two months ago, it was putting about a $20 value on that optionality.

Briefly the pieces of that optionality are as follows:

1)      The excess .6 bcf/day at Sabine

In the spring of this year, Cheniere marketing signed a contract with Scottish power to provide up to .6 bcf/day on a best efforts basis if Cheniere could make effectively what amounted to about a 50 cent spread on the deal.  If Cheniere could succeed in providing .2 bcf/day at its minimum profit margin each year (i.e. if it could run at 33 percent of capacity) then the value would be about $4 a share.

If it could run at 2/3 capacity, the value would be about $8 a share.

2)      Expansion at Sabine

The FERC has approved an expansion of Sabine from 2.6 bcf/day to 4 bcf/day.  The cost of the project is estimated at about $550 million dollars as versus $950 million for the first 2.6 bcf/day.  This is slightly more expensive as construction costs are up quite a bit since the first project was started.  By my estimates, the expansion would be profitable at somewhere around 70 million in revenue, which corresponds to being able to get the about a quarter of the capacity delivered on merchant terms similar to the Scottish contract or the equivalent of TUAs in the low to mid teens (the latter Cheniere can’t actually do because of a matching provision in the Total agreement).

In the odd circumstance that Cheniere could get similar tolling contracts to the ones that it got with Chevron and Total, (part of the reason the stock is down is its inability this spring to get a third tolling contract at original economics) this project would be worth about $12 per share.

3)      Sites at Corpus Christi and Creole Trail

Cheniere has two additional green field LNG sites that I understand to be among the better available sites around.  I hesitate to put any value on them at this time but I would note that in a variety of analyst reports that are not that old, that significant values were placed on them.  For instance during the summer, JP Morgan placed the full value of Corpus Christi at in excess of $20 a share. It is true that the reality on the ground with regard to the timing of LNG supply has changed somewhat.  But that reality could change again. 

There are a variety of other places that Cheniere could potentially have additional value.  It is expecting to build a pipeline from its Sabine facility, which would earn a regulated rate of return.  Without the expansion of Sabine, it will have 10 BCF in storage.  If it can use 5 of those to hold gas from September to December each year, there is another $10 million or so in pre-tax profit assuming a $2 spread across that time, which would be worth about $1 a share.

In short, it seems relatively implausible that the non-guaranteed value in Cheniere is less than $4 a share.  Under certain circumstances it is less than crazy to think that the option value could be in excess of $20 a share.

Catalyst