Hoegh LNG is the owner and operator of a number of LNG (Liquified Natural Gas) carriers and more recently, regasification units. Most of the units are on long-term contracts and it plans to order further regasification units on the back of robust demand and attractive contracts. It eventually plans to drop a number of these assets into an MLP structure to sweeten the economics further. We feel Hoegh is a very safe and compelling long at current levels, and one of the very few ways to play the booming LNG market.

 

 

Hoegh has been around for over 40 years, and is still majority held by the Hoegh family. Their experience has focused on providing floating LNG services, being a minor player in a very niche market, or rather what was a niche market until the recent LNG boom. My meetings with the management as well as the owners reveal a very conservative streak. They primarily passed on (or missed) the current boom in ordering LNG carriers on speculation and have now found a niche that works well for them, essentially the regasification market. Hoegh has a long history of operational excellence, has long-standing relationships with all major customers and players in this historically very closed segment of shipping, and is inline to benefit from a much ignored category.

 

 

 

Gas demand is increasing for a number of factors. First of all is emissions. Global warming is real, and the governments globally are starting to appreciate the true costs of burning coal, as well as oil (in the few industries still burning furnance oil). The following figures represent the relative emission metrics for coal and oil relative to gas (indexed to 100).

 

	Coal	Oil	Gas
Carbon Dioxide	178	140	100
Carbon Monoxide	520	83	100
Nitrogen Oxides	497	487	100
Sulfur Dioxide	259	112	100

So clearly gas is cleaner. And because it is so abundantly available, and there already exists tried and tested mature technology for electricity generation from gas, it is fast becoming the short-term (next 2 decades) winner to control and reduce emissions. Obviously in the long run (next 100 years), you will clearly need to reduce the reliance on hydrocarbons in general, including gas, to control global warming. Also global proven natural gas reserves have increased from 126 trillion cbm in 1990 to 154 in 2000 to 187 in 2010. There is an abundance of conventional gas reserves, let alone the shale boom which has only exacerbated the trend. I won't delve on this much further, there is a huge demand for additional gas, and new infrastructure is being built to both get the gas out, as well as transport it where it needs to go.

 

 

While the demand for gas is exploding, gas has historically, even today, been transported primarily by pipelines. While the technology to liquify natural gas has been around for a long time, and LNG carriers have existed since the 70s, the costs have been uncompetitive for most areas when compared with pipelines over even very large distances. Hence only those areas that can only export or only import via the use ships have used LNG carriers. In addition the demand for gas used to be much lower than where it is now. Recent increases in efficiency in the liquification process and decreases in cost to build LNG trains (the infrastructure to liquify natural gas) has led to a boom in demand for LNG carriers. Most of the world's LNG carrier fleet has historically operated on the basis of long-term contracts and there has really not been a spot market for these ships. Part of the reason was that the market was too small and both the owner and customer needed the security of a long-term contract. The recent increase in number of LNG carriers worldwide in the early 2000s has led to some enterprising LNG carrier owners to try and trade their ship in a spot market basis. Golar has been at the forefront of this effort, and hence a few ships do trade on short-term contracts (1-3 years) in a LNG carrier spot market. 

 

The orderbook for LNG carriers fell to as low as 5% as almost no new ships were ordered after the 2008 crisis despite the strong demand fundamentals. Because of this rates for LNG carriers bottomed out in June 2010 at around $30k per day and have risen steadily since then all across last year to reach about 150k per day now (also reflected in Golar's share price). Considering it costs about 18k per day to run one of these ships, it'd be fair to say these are super profits. And it could go higher still. As is wont with the shipowners, there has been a huge surge in orders placed in the LNG carrier market with a total of 60 new LNG carriers that are being built and will be delivered between 2013-2015. Therefore the spot LNG carrier rates will climb back down over the next few years but unclear by how much.

 

Unlike the LNG Carrier market, the FSRU market is likely a much safer way to play the LNG trade from this point on. FSRUs are Floating Storage and Regassification Units. They look like LNG Carriers with some additional equipment on top. Their task is to unload the liquified gas from the carriers onto their own tanks and then gassify it and feed to the pipeline onshore for eventual destination. The demand for FSRUs is coming from two factors. Firstly, a scarcity of available land in most of the ports and terminals in the world to allow an onshore regassification facility to be built to allow the carriers to unload. And secondly the decrease in costs and hassles. To clear land next to the terminal you have to get permission, licensing, deal with environmental lobby, deal with likely delays as happens with onshore projects, and in the end would pay a lot more than you would from just getting a FSRU built by a Korean shipyard that is delivered on time and sails straight outside the terminal. Because FSRUs would sit in one place (outside a terminal) where these is gas demand, for a long time, they still only operate on long term contracts. Additionally the FSRUs can re-deploy elsewhere if gas demands change (e.g. local shale production or discovery), while onshore gassification facilities will sit vacant in that scenario, like at Cheniere.

 

This has led to some LNG Carrier providers to try and convert their LNG carriers into FSRUs. Such conversions were more economic when LNG Carrier rates were low, but don't make much sense now as there has been an incredible tightening in the LNG carrier market with dayrates reaching all-time high. Also there are additional efficiencies from ordering brand new FSRUs. Not only are newer ships cheaper to run, but also newer bigger FSRUs can take the complete load of a LNG carrier that rolls up in one fell swoop and then regassify at a leisurely pace and letting the carrier head back for next voyage. Older LNG carriers were smaller and if they are converted to FSRUs they will not be able to take the full load of a modern LNG carrier, and this will cause a significant delay as the carrier has to wait for the FSRU to gassify some of the load to offload the rest, causing uneconomic downtime. 

 

All this has led to a robust demand for FSRUs (especially new purpose built FSRUs) amongst most of the countries and terminals that have a need for gas

 

Name	Ownership	Capacity (cubic m)	Built	Type	Timecharter ($/d)	Contract/Comments
Normal Lady	50%	87,600	1973	LNG Carrier	34,500	Contract expires in 2012 but there's an 8 year option which most likely will be exercised as option timecharter rate is less than current market rates
Matthew	0%	126,538	1979	LNG Carrier	0	Ship management agreement with GDF Suez
Arctic Lady	50%	147,208	2006	LNG Carrier	70,000	Contract with Total till 2026 with 2 options of 5 years each
Arctic Princess	34%	147,208	2006	LNG Carrier	70,000	Contract with Statoil till 2026 with 2 options of 5 years each
STX Frontier	0%	163,600	2010	LNG Carrier	2,000	Management contract only. Carrier has contract with Repsol till 2013. Hoegh has purchase option for the carrier at either $226m (on 100% basis) or $194m (on 50% basis).
LNG Libra	100%	126,400	1979	LNG Carrier	80,000	Bought from Mitsui OSK in Aug 2011. Being delivered in July 2012 from yard upgrade. Short-term 6m contract till end 2012 for now.
GDF Suez Neptune	50%	145,130	2009	FSRU	110,000	Contract with GDF Suez till 2030 with 2 options of 5 year each
GDT Suez Cape Ann	50%	145,130	2010	FSRU	110,000	Contract with GDF Suez till 2030 with 2 options of 5 year each
New FSRU 1	100%	170,000	2013	FSRU	125,000	Under construction. To be delivered in 2013. Contract with Perushuan Gas Negara for 20 years til 2033 with 2 options of 5 years each
New FSRU 2	100%	170,000	2014	FSRU	155,000	Under construction. To be delivered in 2013. Contract with Klaipedos Nafta for 10 years

 

Hoegh has a number of LNG Carriers and more recently FSRUs. It has had a lot of success with its FSRU discussions with the various majors over the last few years, and has positioned itself to become a dominant FSRU provider. It currently has 2 options for FSRUs to be delivered in Q2 and Q4 2014 at the same price as the first two FSRUs that it ordered last year. Now that it has firmed up the contract on the first two, Hoegh will move towards ordering the next two FSRUs. Hoegh has had discussions about 20+ such FSRU projects globally with various customers and it is in very advanced negotioations and has very firm visibility on atleast 5 such projects in the short term. The LNG market is a very relationship oriented industry and Hoegh, having been a long standing market player of excellent repute on delivering, is finding a lot of traction as demand for these assets increases. Given the current economics of ordering an FSRU (which I will go over below), Hoegh will most likely keep on ordering these while it can continue to make oversized profits.

 

Hoegh's management has traditionally been fairly conservative and hence they have said they don't want to have more than 2 FSRUs at a time on speculation (without contract). So as they keep securing contracts, they'll keep ordering more. In addition the longer game is to drop all these FSRUs (as well as the few LNG carriers) into an MLP structure to gain additional economic benefit. For the structure to work they need to gain a certain minimum size and contract duration (lets say 6-7 assets minimum of on average 10+ year contract duration).

 

 

The FSRUs that Hoegh ordered (and the price on the options they have) cost a total of $253m. The payment structure is 5-5-10-10-10-60 (with 60% coming the final payment on delivery of FSRU. To-date Hoegh has only paid the first two installments on both FSRUs, with is 10% on each and hence about 50m total. Hoegh, being conservative, doesn't want too much leverage on its assets and wants to fund 40-50% with equity. To get to the 40% equity funding method (all payments besides final 60% payment) would require 100m on each FSRU and hence left a hole of 150m for them still. In addition if they wanted to order more FSRUs they'd require additional funding. Hence the company recently did a $200m equity issue. This came in at a discount of 10-12% on the market price which is common for an illiquid Norwegian stock. The new issue should create more liquidity. But I have done the valuation on a pre-money basis. 

 

Dayrates can be looked at in the timecharter rate, opex on these vessels are 18k-20k with older vessels at 20k and newer ones at 18k. Getting the SGA guidance from both historical as well as management guidance which is in line. Assuming the remaining capex is all debt funded, you get the following cash flow results.

 

 

Gross Profit				2011	2012	2013	2014	2015	2016
LNG Carriers
Norman Lady				4.7	4.7	4.7	4.7	4.7	4.7
Arctic Lady				13.5	13.5	13.5	13.5	13.5	13.5
Arctic Princess				17.3	17.3	17.3	17.3	17.3	17.3
LNG Libra				0.0	11.3	22.6	22.6	22.6	22.6
SRV - shuttle
GDF Suez Neptune				18.3	18.3	18.3	18.3	18.3	18.3
GDF Suez Cape Ann				18.3	18.3	18.3	18.3	18.3	18.3
Ship Management - LNG
STX Frontier				0.7	0.7	0.7	0.7	0.7	0.7
Ship Management - Other segments
Matthew				0.7	0.7	0.7	0.7	0.7	0.7
FSRU
Newbuild 1				0.0	0.0	9.8	39.1	39.1	39.1
Newbuild 2				0.0	0.0	0.0	50.0	50.0	50.0
Gross Profit				73.4	84.8	105.8	185.1	185.1	185.1
SGA				-18	-18	-18	-18	-18	-18
EBITDA				55.4	66.8	87.8	167.1	167.1	167.1
Interest				26.5	26.5	26.5	62.5	62.5	62.5
EBT				28.9	40.2	61.3	104.6	104.6	104.6
Taxes				0.0	0.0	0.0	0.0	0.0	0.0
Net Income				28.9	40.2	61.3	104.6	104.6	104.6
Maint Capex				-8.0	-8.0	-8.0	-8.0	-8.0	-8.0
FCF				20.9	32.2	53.3	96.6	96.6	96.6
FCF Yield				4.8%	7.4%	12.2%	22.1%	22.1%	22.1%

 

Hence these assets will start generating significant FCF yield by 2014/2015. And as they order more FSRUs and keep adding, the yield will improve since the FCF yield of an FSRU is so high. And this is before an MLP structure. So lets look at the economics of ordering an FSRU.

 

Now the company received a 20 yr contract at 125k and a 10 yr contract at 155k. They plan to do more of the higher dayrates than longer durations since the tight market allows them to. Also these durations of 10 yr contracts are more than sufficient to drop into the MLP. In addition, the cost of the FSRU which has a yard cost of 250m, has an additional financing cost associated of about 15-20m but this is uncertain, and depends on financing structure. In addition on both these contracts for first two FSRUs, they were asked to do additional yard upgrades that would end up costing about 30-40m each. Considering all this, it would be prudent to consider the all-in cost at 310m for future contracts as well to take a conservative view (that future contracts also require additional capex). Using the second contract as example:

 

Economics of  FSRU
Cost		310
Dayrate		155
Opex		18
Contract duration		10
Equity		100
Debt		210
Interest		12.6
Gross Profits		50.0
SGA		3
EBITDA		47.0
Interest		12.6
EBT		34.4
Maint Capex		1
FCF		33.4
FCF Yield (3yrs from now)		33%
Multiple for MLP sale		8.4		Golar's sell price to Golar Partners
Sale price to MLP		394.8
MLP Debt gearing		0.7		Assumption based on industry knowledge
MLP equity requirement		118.5
Debt level at MLP		276.4
EBITDA		47.0
Interest and Ammort		24.1		Assuming 6% interest, 20 yr ammortization, 0 residual value……… all conservative.
Maint Capex		1.0
FCF		21.9
Trading yield		7%		Golar Partners currently trades at 5.6% so 7% is conservative
MLP equity valuation		313.0		=21.9/.07
Ownership in MLP		50%		Assumption based on industry knowledge
Equity injection to MLP		-59.2		Half of the MLP equity requirement
Uplift from sale to MLP		84.8		Sale price to MLP minus cost of asset
Equity value of stake in MLP		156.5
Net value increase		182.1

 

So they get significant immediate uplift from dropping these assets into an MLP structure. And this is without getting into how the IDRs will scale up as they get to drop down more and more assets to increase distribution levels. Hoegh plans to do an MLP in 2014 ish once it has these assets and they get delivered. General industry insight indicates you need atleast 6-7 assets to start an MLP and have a pipeline of assets or growth strategy available to scale up. To speed up the process Hoegh might also declare on the buy option for STX frontier which at $226m strike would be fully valued and won't generate significant additional economics on its own. But as a way of accelerating the move to an MLP structure (with additional assets) it would be helpful. 

 

I guess my thesis shows there is a clear path to much higher/firmer valuation than at current levels. The business will start generating significant cash flows a few years from now. So I am not giving a number for how high this can and will go. It's more a step-like process and as we keep checking additional FSRU's ordered, contracted, funded etc, the valuation will keep moving up, with a potential MLP announcement casuing a huge uptick. 

 

 

Hoegh is a small company that is growing rapidly in a niche market where it is very well respected and has a clear pipeline to growth. It is operating in a sector and industry with signifcant headwinds in its favour and there are very few risks to these projects being realized. The most significant risk would be yard delays/cost overruns (which are mitigated since these are turnkey contracts and the Korean yards are very proficient with delivering on time) as well as executing on the contracts when the vessels get delivered in 2014-2015. 

- New FSRUs ordered

- New contracts announced for LNG carriers and FSRUs

- Funding secured

- MLP structure announced