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Morningstar | Cheniere Boosts Guidance; Moves Forward With Corpus Christi Stage 3 and New Apache Contract. See Updated Analyst Note from 03 Jun 2019

Cheniere unveiled a number of positive updates across its business, and we are increasing our Cheniere fair value estimate to $79 from $75 to account for the expected final investment decision on Corpus Christi Stage 3 in 2020 and completion in 2025, while leaving our fair value estimate for Cheniere Partners unchanged at $40.50. The most significant updates were around capital allocation as Cheniere should have over $9 billion in available cash in the next five years.

Our major incremental takeaways and related model updates from these series of announcements are threefold: 1) the addition of the 9.5 million tons per year of Corpus Christi Stage 3 will add $1 billion in EBITDA and $700 million in distributable cash flow per year, 2) the use of $1 billion in capital to buy back shares below our fair value estimate, and 3) the addition of an integrated project management contract to Cheniere's stable of contracts, providing it with another opportunity to earn contracted fees while providing substantial flexibility to customers. The new contract type should prove particularly attractive to independent U.S. gas producers with limited marketing operations and thus limited to no access to global LNG prices for their gas, expanding Cheniere's customer base from utilities and national gas firms.

First, on the capital allocation front, Cheniere plans to fund the Sabine Pass 6 as well as the Corpus Christi Stage 3 trains with at least 50% equity. The Corpus Christi Stage 3 trains will leverage infrastructure from the existing Corpus Christi liquefaction project (three trains with 4.7 to 5 million tons per year each) and will be made up of seven 1.4 mtpa trains (9.5 mtpa in total) with a final investment decision targeted in 2020 and are expected to be completed by 2025. The cash flows will accrue to Cheniere Energy, versus Cheniere Partners. We will update our model to reflect the additional trains, which should contribute around $1 billion in EBITDA annually and $700 million in distributable cash flow. The equity support for the trains and planned de-bottlenecking spending will consume about $5 billion in capital over the next five years with the remainder debt.

Next, Cheniere updated its debt and stock allocation plans. Cheniere plans to reduce debt about $3 billion to $4 billion to eventually reach a debt/EBITDA ratio in the mid- to high-4s. We had already assumed this was achievable, as Cheniere had previously highlighted its desire to move leverage down to the 4s over time. Cheniere also announced a $1 billion share buyback to be completed over three years. Given the current discount to our fair value estimate, we see this as a wise use of capital. A dividend at Cheniere Energy will be considered on an annual basis, but we don't expect to see anything on this front until the early 2020s. In total, the new capital plan should consume around $8.5 billion in capital out of the over $9 billion expected, allowing for some incremental capital to be prioritized at a later date, including a likely dividend.

From a production perspective, Cheniere is benefiting from having six trains operational and is able to optimize their performance. Now, its production midpoint is 4.85 mtpa, up from a midpoint of 4.75 mpta in November 2018, and 4.45 mpta in April 2017. We think this ongoing improvement speaks the high level of operational execution from Cheniere, as expected from an organization run with a utilities-like mindset focused on high reliability while dealing with regulatory complexity, given CEO Jack Fusco's extensive experience in the utilities industry.

Finally, Cheniere announced a 15-year 0.85 mtpa contract with Apache with a twist. The latest contract will be marketed by Cheniere marketing and results in Apache being paid a LNG price based on international indexes, net of a fixed liquefaction fee and other costs to Cheniere. All three contract types include an element of toll-like payments to Cheniere. Integrated project management (IPM) is the third contract type that Cheniere now offers, in addition to free on board (FOB) and destination ex-shipping (DES), and we think it exemplifies the flexibility and attractiveness that Cheniere offers both producers and end consumers, while extracting value for Cheniere. Cheniere began with FOB contracts where the LNG is sold to customers at Cheniere loading docks and the customer is responsible for shipping, and has signed a number of DES contracts over the past year, which has shifted the responsibility of shipping and delivery to Cheniere. FOB contracts are the safest type, as Cheniere does not take on shipping cost risk, which requires it to procure LNG vessels where the per day cost can be variable over time. DES contracts offer higher returns to Cheniere, as we believe it has the ability to earn higher returns via sourcing LNG from a variety of places (Corpus Christi, Sabine Pass, other third parties), and locking in long-term LNG shipping charter contracts, earning the incremental return from the higher level of risk. In both FOB and DES contracts, the end price (in this case LNG prices) are not specified, as the focus is on providing certainty around the cost of gas acquisition, with the customer benefiting from any spread between current LNG prices and the cost of acquiring the molecules including Cheniere fees.

IPM contracts essentially hand off everything to Cheniere, as it sources the gas, in this case from Apache, and then is responsible for obtaining the best LNG price for its molecules via its marketing operations, while being responsible to deliver Apache a price based on an international LNG index. In this case, Cheniere has the opportunity to capture its standard tollhouse fees for liquification and gas procurement, as well as incremental profits from any spread between its long-term LNG shipping vessel contracts and the market, and the price spread between the ultimate destination for its LNG molecules and the indexed price paid to Apache. The benefit for Apache is that it obtains higher LNG prices for its molecules than it would be able to obtain by itself given the global nature of Cheniere's marketing operations. These types of contracts ensure some level of contracted fees for Cheniere versus pure marketing contracts where it performs similar functions (currently expected to be around 10%-15% of total Cheniere capacity) on an opportunistic basis without any level of contracted fee embedded.

Cheniere is taking a portfolio approach to managing its use of FOB, DES, IPM, and marketing capacity, allowing it to manage downside risk. The downside risk with FOB contracts is fairly minimal, mostly relating to the cost of Henry Hub gas versus global alternatives. The risk with DES contracts is that vessel shipping prices could fall below contracted prices for Cheniere, hurting profits, with IPM and marketing contracts more exposed to narrower LNG differentials between the U.S. and other global LNG market hubs.

For more on our LNG forecast for China, please see our Energy Observer published in November 2018, "China Oil & Gas Demand: Above-Consensus Forecasts for Medium-Term Growth, but Electric Vehicles Loom Large for Oil."