Description

Pitch:

Golar (GLNG) could be an attractive long investment because it is a business with a fantastic management team entering a multi-year cycle of over-earning due to significant supply/demand misbalance that the market and street seem to underappreciate in duration.  At the same time GLNG has the opportunity to create significant value for shareholders during this cycle through financial engineering using GMLP by “dropping” down assets into this MLP vehicle at noteworthy multiple premiums and triggering higher splits in the GP they own as a result. 

In a base case GLNG could be worth $60 per share, or ~60% upside from current levels.  LNG import demand appears to be a good LT secular bet and GLNG appears to be the best way to play this multi-year theme via day rates on transport & storage with great leaders at the helm.  

(Please see disclosure at the bottom)

Description:

Golar LNG Limited (GLNG) transports and stores LNG for exporters and importers using its fleet of carriers (transport) and floating storage & regasification units (FSRUs, storage).  For this service it receives short, or long term contracted day rates.  GLNG is parent to GMLP, an MLP subsidiary into which GLNG “drops” its carriers and FSRUs, typically under very long-term 7-8 year contracts such that GMLP can sustain a high degree of certainty into its dividend payout. 

Valuation:

GLNG is currently trading at ~1.5x replication value, but will be receiving a significant number of new transport and storage vessels over the next few years and putting these to work at favorable day rates.  Management intends to drop a significant number of its assets into GMLP over the next few years creating significant value above replication cost.  Historically, GLNG has traded ~1.2x replication value, suggesting investors are not ascribing much value to a potential long-term overearning cycle at the moment. 

In a base case, GLNG could be worth $60 per share using a SOTP valuation, or ~60% upside from current levels.  There are upside levers that could make the reward higher, such as the US becoming a new source of shipping demand via LNG export terminals coming online and further disrupting supply balance. If the market begins to correct in 2014 reverting to normal day rates and GLNG trades slightly below replication value as a result, downside seems limited to ~25%. 

This base case of $60 assumes:

1)    1.1x 2017 GLNG replication value (~$22)

2)    A tight market through 2016. Rates normalize in 17’ (~$15 Net Cash at GLNG in 2017 YE)

3)    NPV of dividend received from GMLP over this time frame (~$7)

4)    A 5.5% yield on the GP stake (~$9)

5)    GLNG’s stake in GMLP (~$7)

(see company structure basics to under the above SOTP figures above)

Variant Perception:

We believe the supply/demand dynamics are setting up such that this cycle could persist through 2016, whereas the street believes economics will begin to normalize in 2013/2014.  The street also does not take into account value created through MLP drop-downs and the higher splits that GLNG’s interest in the GP will earn as a result.  We believe investors want to own GLNG rather than GMLP as a result.  The corporate ownership structure would also suggest this.  Retail investors own GMLP for the dividend.      

Assumptions:

Assuming industry utilizations are able to stay in the low 90s through 2016 with realized day rates between 135-120k GLNG could earn between $8-9 in EPS per year from 2014-2016, which is materially higher than the street.  As supply/demand normalize in 2017 day rates under normalized economics of 60k would imply EPS falls to ~$5.50 in 2017, with FCF using maintenance cap ex being ~$7 per share at this time.  Drop downs as expected by management over the next few years. 

Capital Structure:

Management:

GLNG is run by John Fredriksen and Tor Olav Troim; frequently referred to as the “Buffet & Munger” of Norway.  Over the last 30 years they have built a shipping empire worth 11B.  Their track record of creating value for shareholders is admirable and is worth studying. They are widely considered to be the best managers of shipping assets in the world.  The companies they operate often exhibit the highest margins and returns relative to the peer group.   By betting on GLNG we are betting on the foresight of John & Tor into the next 3-5 year dynamics within the LNG shipping market place, which seems like a decent bet.  

Industry Basics:

3 Korean Ship builders control ~90% of production capacity.  Other yards are not economical (Japan) or do not yet have the skill to build these complicated carriers (China).  Supply is relative well known for the next few years as a result.  It takes 3 years to bring on a new carrier.  It is incredibly capital intensive to build a new carrier with long-term periods required for adequate payback serving as a reasonable barrier to entry.  Access to capital is extremely difficult as the lenders learned the hard way in the last downturn.  The players in the market with access to cheap capital who can compete and add capacity are in the single digits.  European Banks are wary to lend to anyone except the best players.  The Fredriksen Group’s superior long-term track record and reputation has allowed them superior access to low cost financing while other players are effectively locked out of the market. 

Industry Growth:

This market appears to be in LT secular growth.  LNG shipping demand grew at a 9% CAGR from 2007-2011.  Yet, companies are still scared to add significant transport / storage capacity.  Increasing import demand for LNG appears to be a good LT bet. 

Industry Downturn:

From 2004-2006 a huge number of carriers were ordered speculatively without guaranteed contracts to meet expected demand from imported nat gas to the US.  Shale Gas revolution crushed nat gas prices and imports no longer made economic sense, which paralyzed shipping demand.  Utilizations fell from 90-100% down to 70% in 2009, which marked the bottom.  Shipping companies suffered severely as a result from 2008-2010.  So, very few new LNG carriers are coming online from 2011-2013.  Meanwhile Japan’s nuclear reactor shut downs along with increasing import demand from India & China has created the potential for a multi-year supply/demand mismatch. 

Management’s performance during the downturn:

As a testament to this management team’s foresight, they weathered the 2008-2010 downturn well enough to order significant capacity during this time (now being delivered) to take advantage of their predicted 2011 + market undersupply.  Primarily, as a prediction of long-term Qatari export capacity + Asian import demand.  The unprecedented disaster in Japan has further tightened the market beyond initial expectations as natural gas is being used to offset the nuclear shut downs.  The next leg of potential supply tightening could be the US becoming an export market as former LNG import facilities are turned into export facilities.  There is a large arbitrage between US Nat Gas prices and Global Nat Gas prices, but this is not factored into our base analysis.  

Company Structure Basics:

GLNG owns ~65% of GMLP.  GLNG sells ships to GMLP at premiums.  GLNG owns 100% of the GP in GMLP.  This GP is at the mid-end of its IDR splits range currently, with dropdowns over the next few years taking this to the high splits.  The Fredriksen Group owns ~46% of GLNG.  Public shareholders own ~54% of GLNG.  Public shareholders own ~35% of GMLP.

GLNG owns 6 LNG carriers currently.  GLNG has shorter term contracts opportunistically deployed to be signed up under longer term contracts as we enter the sweet spot of the cycle.  GLNG is scheduled to add 10 LNG carriers and 3 FSRUs between 2013-2015.  GMLP owns 3 LNG carriers 4 FSRUs, with one FSRU and one carrier purchased from GLNG recently.  GMLP has long term contracts that average ~7-8 years and pays a dividend to investors under an MLP structure. 

LNG Exporter Economics:

Day rates received by GLNG from LNG exporters are tied to the supply of carriers in the market and the economics LNG exporters can make by transporting and storing LNG to various import markets.  For this reason there is correlation to oil prices that should be studied.  It appears that LNG exporters can earn a reasonable return on capital (~10%) even with Day Rates of 185k at $70 Brent Crude & $6 MCF gas prices, which provides reasonable comfort that this LNG Day Rate cycle will be predominantly driven by carrier supply/demand dynamics.

Risks – falling Day Rates from oversupply:

1)    Japan Nuclear Restarts: 

1. a.     Would reduce LNG demand + distance traveled by vessels.  Japan is a long journey from export facilities and would free up carrier capacity.  Restart potential appears low

2)    Asian Demand Growth: 

1. a.     Account for a significant chunk of mid-decade demand growth
2. b.    A large GDP shortfall would impact LNG demand 

3)    Chinese Shipyards: 

1. a.     If Chinese shipyards gain competency in production it could overcrowd the market.
2. b.    There appears to be indication of this happening nor do buyers trust their carriers

4)    Japanese Shipyards:

1. a.     Significant yen devaluation could make Japanese shipyards economically viable again
2. b.    It’s a difficult manufacturing process and would take them a while to regain the skillset 

5)    Interest rates:

1. a.     Lower interest rates are favorable to GLNG/GMLP’s borrowing capacity and yields that can be achieved in the market place

Disclosure:

We and our affiliates are Golar (GLNG) and may long/buy additional shares or sell some or all of our shares, at any time. We have no obligation to inform anybody of any changes in our views of GLNG. This is not a recommendation to buy or sell shares. Our research should not be taken for certainty. Please conduct your own research and reach your own conclusion.

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