Over the past few quarters, global energy demand has rebounded strongly as the global economy recovers from the pandemic. However, supply has remained tight which resulted in a steep surge in fuel prices. We believe Cheniere Energy (NYSE:LNG) will be an ideal company for investors to gain exposure to amidst the global energy supply crunch and here is why.

Ferlyn Tan |  Published on 23 Dec 2021

• Natural gas prices have seen the largest increase against the current backdrop of strong energy demand growth and tighter supply. 

• Given the surge in the spot market prices relative to the US Henry Hub benchmark, we believe this will encourage more countries to sign long-term contracts with the US LNG providers.
• Cheniere Energy will also see an increase in total production capacity which paints a positive for its future revenue and earnings growth outlook.
• At this point, Cheniere energy has reached an inflexion point in its cash flow generation capabilities, which will support both its deleveraging and capital return plans.  
• We arrived at a target price of USD 143.0, which translates to an upside potential of almost 40% in the next two years. 
Over the past few quarters, global energy demand has rebounded strongly as the global economy continued its recovery from the pandemic. Demand was further fueled by the fact that many countries have been shoring up energy supply to prepare for the upcoming winter season. Meanwhile, supply disruptions and increasing pressure on oil majors to phase out hydrocarbons have led to diminished natural gas supply.
Against this backdrop of strong demand and tighter supply, the prices of many fuels have surged. According to the International Energy Agency, natural gas prices have seen the largest increase, with the European and Asian benchmark prices hitting an all-time record in October this year, a level about nine times higher than a year ago.
In this article, we focus on Cheniere Energy (NYSE:LNG), a full-service US LNG provider that is expected to be a major beneficiary of rising natural gas demand.

Natural gas is still needed 

While most countries are focused on ramping up their investments in renewable energy, the usage of fossil fuel is not expected to dissipate anytime soon. The intermittent nature of some renewable energy resources, such as Europe’s exceptionally low wind speeds and Latin America’s severe droughts this year, can lead to periods of shortages. Certain renewable energy sources such as wind and solar also require mass amounts of land, which may not be feasible in densely populated countries.
For the world to achieve its net-zero ambition, not only does spending on renewables need to rise, it also needs to shift its energy mix from coal and oil to natural gas, which is a much cleaner fuel and is usually viewed as a “bridge fuel” towards a low-carbon future. However, Asia Pacific, the largest consumer of energy, remains heavily reliant on coal (Chart 1). In Europe, coal and oil continue to make up the lion’s share of the region’s total energy supply, even though the region has reduced its usage of these two fossil fuels over the last few decades.

Chart 1: Asia Pacific is still heavily reliant on coal as a primary source of energy

 To move towards a zero-carbon future, we believe that many countries, particularly in Asia, will need to shift to natural gas temporarily as they wean themselves off coal and oil, but before renewables have ramped up. Therefore, we believe demand for natural gas will continue to rise.

Severe lack of LNG supply in Europe and Asia will encourage more countries to sign long-term contracts 

Natural gas prices have been rising across the globe, but it is clear that the impact is most severe in Europe and Asia, where demand for natural gas is rising at a much faster pace. Europe is facing the risk of depleting its inventories whereas China is already experiencing power shortages. 
Besides the rising demand, there is also a shortage of natural gas supply in Asia and Europe due to the lack of LNG facilities to liquefy natural gas. To recap, natural gas in its gaseous state is usually transported at high pressures through pipelines. However, in order to transport natural gas across countries, sometimes it is impractical or impossible to build long-distance pipelines. The only solution is to liquefy the gas into liquefied natural gas (LNG) for easier and more economical transportation via shipping. Unfortunately, many liquefaction projects were delayed as a result of the COVID-19 pandemic, and the LNG market is likely to remain tight in the near to medium term before easing around 2025 – 2026. 
The severity of the natural gas shortage is also reflected in the natural gas price benchmarks, with Europe and Asia paying over ten times more compared to the US for natural gas (Chart 2). The surge in US natural gas prices was not as drastic as the other regions as the US is a net exporter of natural gas. Most of its gas exports, however, are transported to Mexico and Canada via pipelines. Its ability to move gas across oceans via LNG to Europe and Asia is more limited due to a lack of liquefaction facilities.

Chart 2: European and Asian LNG prices have increased at a much faster rate than US’s Henry Hub

 In the next few years, the supply of LNG will be dependent on new liquefaction capacity. According to the IGU World LNG Report 2021, most of the proposed new liquefaction capacity that may come online over the next couple of years will be located in the US. It is also worth noting that all of the new global liquefaction capacity in 2020 came from the US.
Therefore, US LNG providers, such as Cheniere Energy, will have the capacity to absorb the increasing demand for LNG. Coupled with the surge in the spot market prices relative to the US Henry Hub benchmark, we believe this will encourage more countries to sign long-term contracts with US LNG providers instead of relying on the spot market and short-term LNG contracts. 
One point worth highlighting is the fact that the majority of Cheniere Energy’s revenue is underpinned by long-term contracts. Based on Cheniere Energy’s 3Q21 results, approximately 83% of its total revenue was derived from its liquefaction projects sold under long-term contracts. 
Therefore, as more countries sign long-term contracts with US LNG providers such as Cheniere Energy, this will further provide strong earnings and cash flow visibility given how these contracts are usually based on a term of at least 20 years.

Cheniere Energy’s increasing production capacity should translate to higher earnings 

For Cheniere Energy, earnings are dependent on how much LNG it exports. This also suggests that its earnings are limited by how much production capacity it has. Over the last two years, Cheniere Energy has added 18mtpa worth of production capacity (Chart 3). 

Chart 3: Illustration of Cheniere Energy’s upcoming projects

Over the next year, we can expect another additional 15mtpa worth of capacity as its SPL6 train and Corpus Christi Stage 3 projects reach completion, translating to an approximate 40% increase from its current production capacity. In its 2Q21 earnings call, it was mentioned that about 90% of Corpus Christi Stage 3 capacity are already sold to customers with long-term contracts of up to 20 years. Therefore, once these projects come into service, we can expect Cheniere Energy’s revenue and earnings to rise considerably.  
Beyond 2022, the CEO of Cheniere Energy has also shared that they have acquired a plot of land adjacent to its existing Corpus Christi site, allowing Cheniere Energy to develop additional infrastructure and further increase its total production capacity. 
With an increase in total production capacity, coupled with the increase in the price of the Henry Hub natural gas benchmark, we believe this paints a positive outlook for Cheniere Energy. 

New capital allocation plan – dividend initiation and debt reduction

Given the successful completion of the eight trains over the years, Cheniere Energy highlighted that it has reached an inflexion point in its cash flow generation capabilities this year. It can now undertake new projects, without having to sacrifice its balance sheet and shareholder capital return goals. Moving forward, Cheniere Energy will be making new capital allocation plans concerning both its balance sheet and shareholders. 
Building a strong balance sheet remains one of its main priorities as Cheniere Energy will continue to undergo debt reduction, with about USD 1 billion of debt repayment per annum, until it reaches investment-grade status by the early-to-mid 2020s. 
At the same time, Cheniere Energy has also made plans to return significant capital to shareholders over time. In fact, it has declared its first-ever quarterly dividend at USD 0.33 per share (to be paid in 3Q21), a decision that should help boost the value of the stock. It has guided for a mid-single-digit dividend growth rate going forward. Share buybacks will also resume in 3Q21. 
As the production capacity of Cheniere Energy continues to increase in the next couple of years, we believe this will further boost its cash flow generating capabilities, which will support both its deleveraging and capital return plans.  

Strong growth going forward 

Against a favourable macro backdrop, we believe Cheniere Energy is in a good position to capture further market share gains in the booming LNG market. It is poised to grow its total production capacity in the next couple of years, supporting its ability to generate strong cash flow.
We believe Cheniere Energy will be an ideal company for investors to gain exposure to amidst the global energy supply crunch. Based on a fair EV/EBITDA multiple that is derived from recent market transactions, we arrived at a target price of USD 143.0. This target price translates to an upside potential of almost 40% in the next two years (Table 1). 

Table 1: Valuation of Cheniere Energy
Cheniere Energy
Fair EV/EBITDA multiple11.0X
2023E EBITDA5,913
Net debt(28,815)
Investment value36,228
Shares outstanding253.5
Target Price end-2023 (USD)143.0
Current share price (USD)103.7
Upside potential37.9%
Source: iFAST estimations, Bloomberg Finance L.P.,Data as of 22 December 2021

(Related article: Cheniere Energy: First-mover advantage in the booming LNG market)
While Cheniere Energy is currently offering a dividend yield of only 1% after dividend withholding tax, we believe what is more important here is what the dividend signifies. It is a sign that it has reached a stage where the management believes the company fundamentals have improved and it is also comfortable enough with its cash flow generating capability to return capital to shareholders. 
Therefore going forward, we believe investors who are patient enough will be able to reap the benefits as Cheniere Energy becomes a cash flow machine. 

Chart 4: Cheniere Energy’s share price vs EPS (USD)