Perfect storms…. Cheniere Energy, Inc. (LNG)

With a falling stock market, a number of stocks have began to look attractive again. I have recently written posts about the fallen stocks of Sun Hung Kai Properties Limited (read here) and Chipotle Mexican Grill (read here).

Sun Hung Kai Properties Limited

With the plunging China Stock Market, dropping property prices in China / Hong Kong, China’s economic slow down, devaluation of the Yuan, etc. Property stock prices have been dropping faster than the drop in property prices.

Chipotle Mexican Grill

In the U.S, for Chipotle Mexican Grill (CMG), the market drop together with the food safety scares, which started in October last year, has caused the stock price of the company to plunge. Although prices have rebounded slightly in recent times.

Nevertheless, at a PE of 30++, Chipotle Mexican Grill stock is not dirt cheap (read here). It is more than twice the forward P/E of the S&P 500. Nevertheless, CMG prior to the food scare was considered a growth stock with a perennially high valuation.

However, with CMG’s efforts in combating the  E. coli outbreaks which include central processing of ingredients like tomatoes and bell peppers, increase testing of ingredients, discourage sick workers from coming to the restaurant by offering paid sick leave and planning an advertising and social-media campaign in Feb. These together with the decline in quarterly same-store sales caused by a sharp drop in customer visits due to the outbreaks, will dent CMG’s earnings in the future.

 

However, both companies in my opinion are solid, mature and stable companies. The drop in their share prices might present a good opportunity for investors to start picking up bargains. I have picked up some shares of Sun Hung Kai Properties Limited.

 

Oil and Gas

Well, what about Oil and Gas stocks? Aren’t these obvious undervalued stocks? The news have been there for the longest time announcing the deepening price collapse of oil.

Oil could crash to $10 a barrel, warn investment bank bears (read here)

And it is not getting any better…

Oil Prices Tumble as Saudi Oil Minister Says ‘No Chance’ of Production Cuts (read here)

Just over four years ago, the United States and Europe sanctioned the sale of Iranian oil in an effort to curb Tehran’s nuclear program. Oil was trading at $110 per barrel. In recent times, crude dropped below $30 per barrel for the first time in 12 years, thanks largely to a boom in U.S. production.

Truth be told, I have been ignoring O&G stocks for the longest time, despite the ‘cheap’ valuations. I rather add on to my current holdings in my portfolio (non Oil & Gas stocks) eg. Riverstone, Super Group, Colex, etc. There are several reasons for that:

1. The mystery with Commodity Stocks

I have been a long time holder of a “cousin” of the O&G stocks: Palm Oil stock (Golden Agri-Resources Ltd). It occupies a significant portion of my portfolio. I have held on to the shares of the company which I have bought since late Dec 2010, only to watch share prices drop week after week, month after month, year after year (hopefully not decade after decade :p). At one time, the paper loss was almost 50%.

Loss aside, what is difficult about cyclical commodity stocks is that the fundamentals of the company also deteriorated due to the macro economic conditions eg. China Slowdown (global economic slowdown), Environmental groups against the use of palm oil and the impact of palm oil plantation on deforestation, drop in Crude Oil prices (since Palm Oil prices are correlated to Crude Oil as it is use as bio-diesel), tax policies in Indonesia and Malaysia (and import tax from India etc), etc.

For the longest time, I was basically groping in the dark, trying to find some reasons to hold on to the stocks and to maintain my belief that things will turn better. Occasionally coming across news that the Super Cycle of Commodities is over. For years, the media has been continuing bombarding terrible news about the commodity sector (esp. about Palm Oil – and that was even before Oil crashed). Forget about the brain, a very very strong gut is needed.

This is different from holding fundamentally strong companies which has strong balance sheets, high return on equity or return on invested capital, positive free cash flow even when economic conditions are bad or when it has met with a temporary setback. Case in point, I felt that Chipotle Mexican Grill is one such company given the situation it is in (but it’s valuation is still relatively high after the food safety scare).

I do believe that with an improving fundamental, sooner or later, the stock price will reflect the underlying fundamentals. It is not difficult to find the compass leading the way with these stocks.

The rise & fall of Oil & Gas companies, like their other commodity cousins basically depends on the price of the commodity (the Crude Oil Price fluctuations). Timing is important. Unfortunately, I am terrible with timing.

2. Proportion in portfolio

Given that fact that I already have a large percentage of my capital in Palm Oil stocks, I think I already have some exposure to Oil and Gas stocks. After all CPO (Crude Palm Oil) prices are somewhat correlated to the price of Crude Oil.Crude Palm Oil used as bio-diesel.

Incidentally, with the drop in palm oil and crude oil price, the proportion of my Golden Agri holdings in relation to my overall stock portfolio has dropped (a fraction of its former self).

3. Valuations are difficult

The classic metrics of P/E, EV/EBITDA, ROE, ROIC, Intrinsic Values, PEG, etc, which I typically use to value companies are not suitable for cyclical commodity stocks. The historical financial data of these companies are typically erratic and don’t show any consistent long-term trend.

The prime metric I would use is Price to Book, but even that depends largely on the right timing. Another metric I could use would be Net Asset Value (NAV) (or Conservative Net Asset Value (CNAV)), but these are also variable figures that fluctuates accordingly to the valuation of the assets. Well CNAV is less affected.

The other clue I would seek, is profitability and gearing – although in any of these metrics, I would not be looking for great numbers but just reasonably safe numbers.

Talking about timing, the biggest clue I can see so far is insiders buying or huge buying by renown value investors. Of course, this could be wrong, but it does give me a hint as to whether the stock is undervalued or not.

 

The Next Stage

My portfolio has evolved somewhat since 2010. In the past, it consists mainly of blue chips (SIA, CapitaLand, Golden Agri, SMRT, etc) – FYI SMRT was once a blue chip. I have diversified to include lesser known growth / smaller companies. Some have relatively stable business (be it good or bad times, people will need their services & products).

 

In recent times, the call to buy Oil & Gas stocks has been getting ‘louder’ as oil prices keep reaching new lows.

$30 oil unsustainable?

In any commodity, the price is governed by the demand and supply. When there is a falling demand, with constant or increasing supply, prices will drop. However, if supply is decreased (and is decreasing at a faster rate), price will stabilize or increase. With such low prices of oil, for some countries, it just doesn’t make economic sense to extract oil.

Why oil under $30 per barrel is a major problem (read here)

However, as stated in the article above, stopping the extraction of oil for many of these countries is like stopping or reversing an oil tanker— it takes a long time & great effort. With the system and policies in place, it is hard to suddenly put a brake in oil extraction. In some cases, the effort and cost of stopping oil production is just too ‘costly’; not worth the effort.

 

The Vultures are circling

Nevertheless, with the historical low oil prices, it is not surprising to find more and more famed value investors picking up energy stocks. Taking the idea of ‘Cloning” from Mohnish Pabrai – perhaps we can copy their moves. (read here)

First Buffett And Icahn, Now Billionaires Mandel And Klarman, All Bottom Fishing Energy Stocks (read here)

Seth Klarman Bets the Farm on Cheniere Energy (read here)

Carl Icahn faces cash crunch due to bad oil bets (read here)

One particular company (Cheniere Energ, LNG) seems to be very much in the news, in recent times. It is trade on the New York Stock Market and it has got Seth Klarman betting his ‘farm’ on it (18% of his entire portfolio).

For Carl Icahn (another famed activist investor), he owned nearly 14% of Cheniere’s outstanding shares as of the end of 2015.

A little bit about Seth Klarman, he is one of the world’s most successful value investors. Baupost Group (founded by Klarman), the $27 billion Boston-based hedge fund, had its third-losing year ever in its 33-year history in 2015 (read here). That is a very remarkable track record.

Seth Klarman is one of the more low profile & secretive value investor. Not many of his investments are public and not all of his public investments are successes.

Oil is not unique in its problems. Coal and natural gas are also experiencing low prices. Incidentally, Cheniere Energy is the first company to export natural gas from the mainland U.S.

However, Klarman’s recent big bet on Cheniere Energy seems a bit off his usual deep value investment (whereby he adhere to the “cigar butt” approach of deep value investing).

First off, Klarman purchased his stake over the past two years, paying up to $76 a share in 2014. In Feb 2015, Cheniere had around 7.5 bn net debt and 2.3 bn equity. Based on a market cap of around 17 bn USD, this gives a P/B of roughly 7 times. So it was hardly a bargain investment based on this metrics. Eg. not a Net-Net stock then (market capitalization that is less than the company’s current assets minus total liabilities; 17 bn is more than 2.3-7.5bn).

WHY ON EARTH IS SETH KLARMAN INVESTING 1,7 BN USD IN CHENIERE ENERGY (LNG) AT 7X P/B ? (read here)

Second, Cheniere seems to be changing tracks through the years:

“Charif Souki. His great idea was to import natural gas into the US and he raised several billion USD to build a huge gasification plant on the gulf coast. He clearly did not see fracking coming and his investment was worthless. Nevertheless, he was able to raise another few billion bucks and retool the facility in order to export natural gas.”

Well, as for Charif Souki, the former CEO of Cheniere, four months after activist investor Carl Icahn took a big stake in the company and won two board seats, Souki was voted out by the board. Well Souki seems to found other ways to be in the game again (read here).

The company never made a profit in its life as this table with EPS since 2004. In fact it seems to be hanging by a thread. A quick search in Yahoo Finance shows that the company has high valuation, terrible profitability, negligible income and huge debt.

 

The Perfect Storm? And rainbow after the rain?

However that is the whole point of it, when all the risks are accounted for, the only way for a stock is to go up. When all possible negativity is baked in, what comes after can only be positive.

To be frank I know very little about the company, but if you read the investors (and major shareholders) behind the stocks, they might have information (as insiders) which we do not. This is not a quick fast stock, but a long term play. I am not sure if the company will be profitable in the near future, but I do know that with the backing of Seth Klarman & Carl Icahn, the company would not disappear or sink quickly.

“The most beneficial time to be a value investor is when the market is falling. This is when downside risk matters and when investors who worried only about what could go right suffer the consequences of undue optimism. Value investors invest with a margin of safety that protects them from large losses in declining markets.” Seth Klarman

In recent times, the stock price has started to trend upwards, with the first shipment of natural gas is exported by Cheniere. Up approx. 46% from its low of USD 23.65 on 8 Feb 2016. Definitely not a stock for the faint hearted….