Description

I believe that GLOG is a classic “baby with the bathwater” situation which has traded down with the rest of the energy sector despite having very little, if any, sensitivity to crude oil prices. The current market price is baking in a “liquidation”-like scenario for a premier operating platform and financial structure while the company is on the cusp of a transformation that should result in a valuation approximately 80-125% higher than it is trading today. Insiders have been buying shares on the recent pullback and I recommend that you do so as well.

Situation/Synopsis

• GLOG is a pure-play owner, operator, and manager of liquefied natural gas (“LNG”) carrier vessels

• GLOG has transformed itself in the last 12 months – it is now a scale player with an attractive GP/MLP structure which can be used to grow in an asset-light manner going forward

• The LNG shipping market is inherently attractive – the growth in liquefaction capacity will require a massive number of new LNG vessels over the next ~5 years, possibly more than shipyards can build

• GLOG’s value is misunderstood as it is a niche business going through a transformation; furthermore, as an “energy” stock, it has recently traded down with the rest of the sector despite having very little, if any, sensitivity to crude oil prices

• In a downside case, GLOG should at least trade at its asset-derived NAV of $14-20/sh

• In a base/upside case, GLOG should trade as a high-growth, asset-light manager, at $31-39/sh

• Catalysts exist from the flow through of existing strategic actions into cash flow, as well as continued dropdowns, a recovery in the LNG spot market, and additional asset purchases

Business Description

GasLog Ltd (“GLOG”) is a pure-play owner, operator, and manager of liquefied natural gas (“LNG”) carrier vessels. These vessels are large, complex, and expensive and are chartered out to LNG producers either on the spot market or on multi-year long-term contracts. GLOG’s largest shareholder is Ceres Shipping which is effectively controlled by Peter G. Livanos. The genesis and timeline of the company is as follows:

Following this series of events, GLOG has the following assets:

1. 10 LNG vessels, 9 of which operate on long-term charters (7 to BG Group, 2 to Shell)

2. 10 contracted newbuilds with delivery dates ranging from Q4 2014 to Q4 2017, as well as priced options for additional vessels

3. 10.4M shares of GLOP (~42% of outstanding units) which owns 5 LNG vessels

4. Incentive Distribution Rights (“IDRs”) in GLOP which pay out additional distributions to GLOG if GLOP distribution thresholds are met

5. Contracts to manage an additional 5 vessels owned by BG Group

6. 25% share in a JV that manages a vessel for Egypt LNG

The following is a summary of GLOG’s fleet, split between GLOG-owned, GLOP-owned, ordered, and managed:

Going forward, GLOG expects to continue to grow with the LNG market (GLOG & GLOP vessels make up ~4% of the global LNG fleet) through its scheduled newbuild program as well as through opportunistic vessel acquisitions from BG Group or other owners. Of note is that management recently expressed a goal of growing the fleet to 40 vessels by 2017 (including GLOP drop-downs) which would imply an incremental 15 vessels beyond those currently operated or on order. Vessels with long-term contracts will, in general, be dropped-down to GLOP (which has a right of first refusal on all contracts of 5 years or greater) given its lower cost of capital and attractiveness to a more yield-oriented investor base. Meanwhile, GLOG will transition toward being a capital-light entity, generating cash flow primarily from its holdings in the GLOP common units and IDRs, as well as from management contracts for ships owned by GLOP, BG Group, and other vessel owners. Cash flow will also be generated from a small number of vessels that will likely remain at the parent level, operating on spot or short-term contracts.

We believe that the attractiveness of this asset-light model will be appreciated by the market as additional vessel acquisitions and drop-downs drive real cash flow growth at both GLOP and GLOG. By 2017, we expect “Cash for Distribution” at GLOG to grow to $1.50/sh and for GLOG to be valued at ~$39/sh which would reflect a 26x multiple of distributable cash – a very reasonable price given further high single-digit growth potential. Discounting this price back to the present yields our price target of $31/sh.

LNG Shipping Market

The LNG shipping market is inherently an attractive one. Natural gas is one of the fastest growing primary energy sources given significant global reserves and relatively cleaner air emissions from combustion as compared to other hydrocarbons. Furthermore, natural gas can be produced at very low prices in certain geographies (e.g. U.S., Qatar, Saudi Arabia), in quantities far in excess of local or regional consumption which creates significant disparities in the pricing of natural gas globally. This effect has been magnified recently with the U.S. domestic shale boom – while global seaborne LNG prices have continued to be priced on an oil-equivalent basis (~$10-12/mmbtu at $70/bbl Brent), U.S. shale gas is being produced in significant enough quantities to warrant prices at Henry Hub in the ~$4/mmbtu range. In addition, it is uneconomic to transport natural gas long distances (i.e. globally) by pipeline, leaving LNG as the only viable option for exploiting this price differential.

Note that this trade remains viable even at very low oil prices – the sensitivity table below indicates the net shipping spread available to an LNG shipper operating between the U.S. and Japan. At a $4/mmbtu Henry Hub price, the trade is viable even at long-term Brent of $60/bbl – a price which while only ~$10/bbl lower than current spot prices, is $20-30/bbl lower than the forward curve over the longer-term, which is the timeframe that LNG shippers will be using when deciding whether to build liquefaction capacity and/or commit vessels to long-term contracts. Further note that the below table is for a “greenfield” LNG shipper (i.e. an entity that is deciding whether to pay for the $3/mmbtu in liquefaction capacity) – for an entity that has already signed on to a take-or-pay liquefaction contract, the $3/mmbtu is a sunk cost and the viability gets pushed down even lower into the $40/bbl range for Brent.

As a result of the attractive spreads between natural gas prices and other secular trends toward natural gas, there has been a recent increase in investment in LNG infrastructure (liquefaction, regasification facilities) that will support an increase in the volume of LNG trade over the next few years. To illustrate the magnitude of this investment, note that as of September 2014, there are 16 new LNG liquefaction projects with total estimated capacity of 108 million tonnes under construction – this represents a 37% increase to current production capacity of 293 Mtpa. Furthermore, there are another 27 projects with capacity of 223 Mtpa that have received Final Investment Decision (“FID”) or are at the Front-End Engineer and Design (“FEED”) stage, with start-up dates ranging from 2015 to the start of 2020.

In order to facilitate this dramatic increase in LNG exporting capacity, significant numbers of new LNG carriers are required. GLOG estimates that if all of these projects were to go ahead, 66 additional LNG carriers would be required by the end of 2016, with another 256 additional LNG carriers required by 2020. This is in comparison with a current fleet of 399 vessels and a current order book of 135 vessels. Of particular note is that current shipbuilding capacity for LNG carriers is limited to ~40-50 ships per year, meaning that if a significant portion of currently-planned liquefaction projects were to come online, it is reasonably likely that there will be a shortage of vessels toward the end of the decade.

While the longer-term supply/demand picture is relatively clear, over shorter periods of time the market for spot and short-term time LNG time-charters can be quite volatile. Throughout 2011, dayrates increased dramatically, due partially to a dearth of ships ordered throughout the GFC, but also due to increased demand for LNG from Japan following the shut-down of nuclear reactors following the 2011 earthquake. Spot day rates subsequently fell off considerably and bottomed at ~$40k/day in July/August 2014 (see chart below), driven by a temporary shortfall in demand as due partially to production issues at the Angola liquefaction facility as well as a weaker onboarding schedule for liquefaction projects. However, it should be noted that day rates have subsequently improved to ~$55k/day in October indicating that the market may have bottomed, and that GLOG has minimal direct exposure to the spot market – only one of their vessels is being chartered on a spot basis, and that vessel was recently renewed at rates in excess of the “market” spot rate given good operating performance.

It is our belief that over a longer time period, LNG vessel day rates will be driven by required rates of return on newbuilds. At newbuild prices of ~$210M (consistent with prices over the last ~4 years), we estimate that dayrates required will be ~$75k/day. In a situation where shipyard capacity is limited and the cost of new builds rise (in late 2008 they were as high as $250M), equilibrium dayrates could reach $80-85k/day. To the right is our estimate of equity yield at various dayrates after opex, incremental G&A, drydocking reserves, replacement capex reserves and interest expense assuming 50% debt financing at a 4% interest rate. Supporting our belief that the outlook for longer-term day rates is positive is management’s expectation that management is currently pursuing new tender opportunities and in their words, would be “disappointed” if the new vessels didn’t “meet or beat” the rates on their current fleet, which range from ~$65-80k per day.

Why is it Mispriced?

1. GLOG is a niche business, without any pure-play public competitors

While the LNG vessel market is relatively fragmented and there are a multitude of players, much of the fleet is composed of state-owned players (20%), oil majors, industrial, and utility companies (12%), and South Korean & Japanese owners (28%). Of the remaining 40% of the fleet, GasLog is the second largest operator. Other major public operators are Teekay LNG (TK, TGP), Golar LNG (GLNG, GMLP) and Dynagas LNG (DLNG), although none of these entities are directly comparable to GLOG. Many are MLP structures like GLOP (TGP, GMLP, DLNG), while others have more diversified operations (TK has exposure to a wide variety of crude oil and gas vessels while GLNG is driven primarily by their FLNG project).

As a result, while there are a reasonable number of analysts covering GLOG (13 at last count), many are from shipping-focused banks that cover GLOG as part of a broader shipping-focused coverage universe and are focused primarily on the industry rather than the company (e.g. Clarkson, Drewry, Fearnley, Pareto, Platou), while others are from major bulge bracket banks (e.g. Citi, JPM, Morgan Stanley, Wells Fargo). As anecdotal evidence of the quality of coverage, we recently received a report from a covering bank which failed to include the value of GLOG’s stake in GLOP as part of their NAV calculation, impairing their total target valuation by 27%.

2. GLOG is currently a complex situation in the midst of a major transformation

With ~8 major strategic moves made in 2014 to-date (i.e. vessel acquisitions, dropdowns, equity offerings), the GLOG story is far from simple. We believe that the value of these previous moves will become apparent as GLOG’s cash flow picks up considerably in the next couple of quarters. Furthermore, while GLOG will to some extent always be in a state of perpetual change, we believe that these strategic moves will become more routine and better understood by the investor base.

3. GLOG investor base is largely trading-oriented and does not tend to focus on the “right” things – add in energy sector moves

From the beginning of the year, GLOG has traded in a very wide range, starting at ~$17/sh, working its way up to ~$32/sh, and then moving back down to ~$16/sh currently. While the initial move upwards from ~$17/sh was fundamentally driven by GLOG’s decision to create the GLOP structure, subsequent price moves have been volatile and frankly largely unexplainable from a fundamental perspective given that the vast majority of GLOG’s vessels are under long-term contracts and not subject to spot prices. Furthermore, there have been numerous instances of articles and trader “chatter” linking GLOG stock declines to declines in the price of LNG futures, despite GLOG making money through long-term “tolling-type” arrangements (i.e. they are not directly exposed to LNG prices), and the most recent move downwards appears to be related to the decline in crude oil prices despite these prices having very little, if any, impact on GLOG’s future cash flows. Given GLOG’s doubling in price from mid-2013 to mid-2014, it is no surprise that a segment of the investor base is trading/momentum-oriented, but this group should begin to be supplanted by fundamental value investors as the cash flow generation of GLOG becomes apparent.

4. There is no explicit “value” anchor yet from cash flow

With the magnitude of changes taking place at GLOG and the rapid growth in their shipping portfolio, the value of the GLOG model has not yet become apparent. LTM adjusted EPS is only $0.80/sh, far below the $1.50/sh in “distributable cash” that we think GLOG can generate in 2017. Until cash flow generation becomes apparent, the only valuation anchors that GLOG investors have are book value (which does not incorporate the value from attractive long-term contracts or the GP/MLP structure) or NAV, which suffers from some of the same issues.

Valuation

Downside Case – NAV-based valuation ($14-20/sh)

We look at valuation in a number of different ways. As a downside case, we consider a NAV-based approach to valuing GLOG. This approach is inherently conservative as it does not give value for:

• The attractiveness of the GLOG/GLOP structure whereby vessels with long-term contracts can benefit from a lower cost of capital

• The potential value from owning a significant fleet in a period which may see a LNG vessel shortage

• Potential value from future ship acquisitions/builds beyond the current fleet

• Long-term relationships with customers (BG/Shell) as well as shipyards

• The contracts to manage BG’s current fleet of 5 vessels

• Any additional fleet management opportunities which will arise

Even without these material sources of value, we believe that GLOG’s NAV is between $14.30 and $20.40/sh, depending on how much value is ascribed to the IDRs. The value here is comprised of a couple of major buckets:

Existing Assets – we value these at gross BV, which is a reasonable approach given how new the assets were and the fact that some of the assets were arguably acquired at attractive rates (i.e. BG Methane acquisitions and GasLog Chelsea)

Vessels under construction – these are valued based on amount paid towards construction to date. This does not give any incremental value to order book optionality.

GLOP stake – this is simply the number of shares owned by GLOG, at GLOP’s most recent market value

IDR value – based on our detailed dropdown model, we believe that even with no additional asset acquisitions, cash flows from the GLOP IDR could reach a run-rate of $60-65M by 2018 when all of the current ships are dropped down. On a PV basis at 10%, this would imply a $500M valuation. In the scenario where GLOG continues to acquire ~2-4 ships per year and drop them down, the IDR could be worth $800-1,200M using similar assumptions. Note that this acquisition pace is very conservative in comparison to the recently announced target of having a fleet of 40 vessels by 2017.

Base Case – DCF-based valuation ($31/sh)

Under our base case valuation, we look at the total estimated distributions to GLOG shareholders over a 10-year period and discount them back at 10%. The sources of these cash flows include:

• IDRs from GLOP (~45% of cash flow through 2025)

• Cash flow from owned vessels, net of interest expense and capex (~50% of cash flow through 2025)

• Cash flow from managed vessels, GLOP + other (~17% of cash flow through 2025)

• Cash flow from GLOP unit distributions (~11% of cash flow through 2025)

• G&A expense (negative 23% of cash flow through 2025)

This model assumes four newbuilds are brought into the fleet each year from 2016 through 2024, that day rates by 2019 are $75k/day for 155k cbm vessels (most of current fleet) and $84k for 174k cbm vessels (newbuilds from 2016 onwards), and that the vast majority of ships find long-term contracts and are dropped-down into GLOP. We believe these assumptions are reasonable given the prospects for growth in the global LNG fleet as well as day rates required to incent greenfield LNG vessels, but have also run sensitivities on these figures (see “Risks” section below) to assess downside/upside risks to key assumptions.

Note that the $31/sh price target that this analysis implies roughly maps to a ~20x forward multiple, or ~26x future multiple on estimated distributable cash of $1.50 in 2017. We believe this is a reasonable valuation given the strong growth profile for GLOG going forward.

The summary operating model is below:

Upside Case – Multiple-based valuation ($39/sh)

There are a variety of ways in which our estimates could be too conservative, including the possibility of a dayrate surge driven by a shortage of LNG vessels, additional vessel management opportunities, and potential expansion into related vessel management like Floating LNG (“FLNG”) production vessels or Floating Storage & Regasification Units (“FSRUs”). We consider all of these to be free upside options.

Another upside scenario is that we are being too punitive in using a 10% cost of capital for an asset-light business like GLOG. Other similarly-structured MLP GPs have achieved multiples of distributable cash in the 30x range. If we were to take a longer-dated approach and look at 2018 distributable cash, we could conceivably come up with a ~4 year price target of ~$56/sh, or ~$39/sh discounted back to the present at 10%. This would roughly be equivalent to our base case cash flows discounted back at an 8% cost of capital, which while not our base case, is nonetheless plausible given that a significant percentage of GLOG’s cash flows are driven by fixed-price contracts over the medium term.

Catalysts

We believe there are a number of catalysts over the coming months and years for GLOG:

1. Flow through of existing strategic actions into cash flow – as indicated in our base case projections, under the current vessel acquisition schedule, GLOG should start generating “distributable cash” in the $1.10-1.30/sh range for the next couple of years. As this earnings power becomes apparent over the next couple of quarters, we believe this will provide a cash flow “anchor” for valuation.

2. Increased GLOG dividend payout – GLOG announced and paid its first dividend of $0.12/sh in late August 2014. We believe that this represents a relatively small payout ratio (43% on 2015 distributable cash) and could potentially be increased over time.

3. Increased GLOP dividend payout – GLOP currently pays a dividend of $1.50/sh, a dividend level at which no value accrues to the IDR. As a result, we believe investors are heavily discounting the value of this fee stream for GLOG. Concurrent with the first post-IPO dropdown of vessels in September 2014, management recommended that the board increase the annual dividend by 15-17% to $1.725 – 1.75/sh due to the accretion generated by the two vessels dropped down. At this dividend level, GLOG’s IDRs have reached the 15/85 split, and will be only 9% away from the 25/75 split and 30% away from the top split of 50/50. Given the likely dropdown schedule over the next couple of years, we believe top splits could be hit as early as 2016, drawing additional attention to the value of GLOG’s very attractive IDR.

4. Continued dropdown announcements – these will be leading indicators of increased GLOP dividends and therefore of GLOP IDRs.

5. Additional asset purchases from BG/others – while GLOG has purchased 6 of BG’s legacy LNG vessels, they continue to manage an additional 5 vessels which could conceivably also be brought in-house. The prior transactions came with attractive long-term contracts attached, making them accretive to GLOG, and we believe any future transactions would be of a similar structure. During the recent analyst day, management and board members appeared to be supremely confident that additional revenue-generating assets could be purchased in the near future, possibly by the end of 2014.

6. Continued recovery in LNG vessel spot dayrates – while only one of GLOG’s vessels is directly tied to spot rates, a continued recovery (expected through 2015-16) in this market will focus attention on the looming LNG vessel shortage and buoy contracting activity.

Risks

There are a number of risks associated with an investment in GLOG, although we believe that most of them can be quantified and assessed. Two of the more quantifiable risks to our “base case” are the pace of new vessel acquisitions and the level of long-term contract rates. We have sensitized our base case model under a variety of scenarios ranging from long-term day rates of $65-90k and annual vessel acquisitions ranging from zero to four per year. It is important to note that in very few of these scenarios would our estimate of fair value be lower than the current trading price (see table below).

In addition to these more directly quantifiable risks, there are a few other relevant risks to consider:

1. Controlling shareholders – GLOG is effectively controlled by Peter Livanos who has a beneficial interest in GLOG of 31.5M shares, or 39% of diluted shares outstanding. Additionally, the Onassis Foundation owns 8% of GLOG’s shares and has a representative on the board. While historically there have been no instances of odious related party or any other transactions which would imply a material risk here, the effective control by these two shareholders is nonetheless worth noting.

2. Risk from delayed/cancelled LNG liquefaction projects – LNG vessel demand is entirely driven by the liquefaction and regasification capacity installed globally. There are multi-year lead times for both these projects as well as LNG vessel construction meaning that over periods of a couple of years there can be materially over or undersupply of vessels. While we believe the vast majority of liquefaction projects have solid project economics, this remains a point of risk, particularly for longer-dated projects that have not yet sunk substantial capex.

3. Risk from overbuilding of vessels – We believe that while it is possible for there to be an overbuild in LNG vessels, given shipyard constraints this will only be possible in the next ~5 years if there is substantial slippage in LNG liquefaction projects (see #2 above).

4. Concentration/relationship risk – GLOG is currently very dependent on BG Group, with whom the vast majority of its customer contracts lie. This risk is mitigated somewhat by our belief that BG Group is a very solid counterparty, and by GLOG’s recent ability to expand their relationships beyond BG Group to Shell.

5. Global Oil/LNG prices – Globally, LNG prices are strongly-linked to the oil price. If the long-term expectations for oil prices were to continue to decline considerably, it is possible that the large arbitrage between cheap natural gas in the U.S. and elsewhere and high oil-linked LNG prices could contract. In such a scenario, the incentive to trade LNG globally could decline, hurting vessel utilization. However, we think GLOG is less exposed to this risk factor given their low exposure to spot contracts. Furthermore, in a base case we believe that current liquefaction projects will require vessels even at Brent prices in the 40s, and that incremental liquefaction projects in the U.S. are profitable with long-term Brent prices at ~$60/bbl.

Upside Options

As mentioned, we believe there is additional upside optionality (not explicitly valued in our base or upside case) from the following:

• A dayrate surge driven by a structural undersupply of LNG vessels (driven by bottlenecks at shipyards)

• Additional vessel management opportunities beyond the 5 BG Group ships and 25% JV in managing a ship for Egypt LNG

• Expansion into related vessel management opportunities throughout the LNG value chain, including the production of LNG from stranded offshore fields through FLNGs (GLNG is currently undertaking an ambitious project here – solid economics could open up the market for these types of vessels), as well as the regasification of LNG for importers without fixed infrastructure through FSRUs

Catalyst

1. Flow through of existing strategic actions into cash flow – as indicated in our base case projections, under the current vessel acquisition schedule, GLOG should start generating “distributable cash” in the $1.10-1.30/sh range for the next couple of years. As this earnings power becomes apparent over the next couple of quarters, we believe this will provide a cash flow “anchor” for valuation.

2. Increased GLOG dividend payout – GLOG announced and paid its first dividend of $0.12/sh in late August 2014. We believe that this represents a relatively small payout ratio (43% on 2015 distributable cash) and could potentially be increased over time.

3. Increased GLOP dividend payout – GLOP currently pays a dividend of $1.50/sh, a dividend level at which no value accrues to the IDR. As a result, we believe investors are heavily discounting the value of this fee stream for GLOG. Concurrent with the first post-IPO dropdown of vessels in September 2014, management recommended that the board increase the annual dividend by 15-17% to $1.725 – 1.75/sh due to the accretion generated by the two vessels dropped down. At this dividend level, GLOG’s IDRs have reached the 15/85 split, and will be only 9% away from the 25/75 split and 30% away from the top split of 50/50. Given the likely dropdown schedule over the next couple of years, we believe top splits could be hit as early as 2016, drawing additional attention to the value of GLOG’s very attractive IDR.

4. Continued dropdown announcements – these will be leading indicators of increased GLOP dividends and therefore of GLOP IDRs.

5. Additional asset purchases from BG/others – while GLOG has purchased 6 of BG’s legacy LNG vessels, they continue to manage an additional 5 vessels which could conceivably also be brought in-house. The prior transactions came with attractive long-term contracts attached, making them accretive to GLOG, and we believe any future transactions would be of a similar structure. During the recent analyst day, management and board members appeared to be supremely confident that additional revenue-generating assets could be purchased in the near future, possibly by the end of 2014.

6. Continued recovery in LNG vessel spot dayrates – while only one of GLOG’s vessels is directly tied to spot rates, a continued recovery (expected through 2015-16) in this market will focus attention on the looming LNG vessel shortage and buoy contracting activity.