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SLB, AES and new natural gas picks ?3

02:25 01-Dec-17


Natural gas had been rising this week, but it fell back on Thursday after the EIA inventory numbers, even as OPEC and company agreed to extended cuts.  The modest rebound in oil prices is of no surprise to me, but it's good for Schlumberger, which just got DoJ clearance.  SLB also has a an ex-dividend date coming up next week.  I'm more interested in two longer term factors, though:

  1. What happens with oil once Aramco finally manages its IPO next year?
  2. Will natural gas pricing will continue its divergence from oil?

I suspect that there could be trouble in 2019, following #1, but even if oil prices relapse, I'm doubtful about the impact to natural gas.  It has been an oversupplied market for years, and if oil production in the U.S. were to decrease sharply, I could imagine natural gas prices going up even as oil prices fell, due to globalization of the market via LNG (liquefied natural gas) in combination with increasing demand.

With that context in place, I'd like to introduce two very different natural gas infrastructure picks that are based (loosely in one case) on subscriber ideas.  Though they have very different risk profiles, I think each could do quite well over the next year or two:

Cheniere Energy Partners Holding

Cheniere Energy Partners Holding trades under the ticker CQH.  The company mainly holds CQP shares, which is a Master Limited Partnership, and thus has distributions, rather than dividends, that can make for some onerous tax reporting.  CQH effectively converts the distributions back to dividends, and is thus easier to own, particularly in retirement accounts.  However, CQH just started paying the full dividend for the first time this month, and it sports a higher yield.  The holding company also has some exposure to the parent of both companies in the form of $1b 11% 2025 notes convertible to LNG shares on March 1, 2020.  In the somewhat unlikely scenario that I described above, that could be a bonus.  Either way, the only rationale I could see for owning CQP over CQH at current prices would be if one had carry-forward loss or some other reason for preferring capital gains to dividend taxation.  The market may also still be in the process of rebalancing between the two.

At any rate, the underlying gas liquification business has long-term take or pay contracts indexed to Henry Hub pricing, so margins are stable.  It also achieved investment grade credit ratings from all three agencies this past year.  Shipments are made from operations on the Texas/Louisiana border to 24 countries, with almost half going to Latin America.  Revenue has increased 7-fold YoY as 4 gas-powered trains that deliver from pipelines have been completed.  3 more trains are set to come online in about 18 months, and construction for more is permitted.  Even so, I'm not inclined to go overboard on the growth prospects here.  Cheniere had about a 2 year head start on the rest of the industry with this project, and the new contract rate has already declined from 1H16.  New competition will come online and regional efficiencies in combination with bizarre and nepotistic U.S energy policy could create challenges.  What I'm looking at instead is the increase in distribution/dividends projected in the most recent report from $1.73 in 2017 to $2.00-220 in 2018, equating to about an 8% yield at current prices.

CUI Global

If you're looking for growth on the order of what we've seen in Energy Recovery, that might come from new natural gas infrastructure on the distribution and consumption side.  I'll be looking at CUI Global's next report for signs of progress in that area, as well as in innovative data center power products.  Sticking with the former, Snam Rete has resumed installing the company's disruptive gas testing solution.  According to the last conference call, it should be installing units at the rate of roughly 100 per month.  If the margins remain the same, that should barely get CUI to positive EPS going forward.  I'm not generally willing to bank on progress in Italy going as planned, but the GasPT product recently got a second validation for biomethane, in France and it is in the midst of a 45 to 60 day evaluation period in Canada.

The immediate opportunity on the datacenter side should also start to become more clear with the next call.  Nearly 1000 ICE Switches are set to be delivered in January and they price between $700 and $1000 each.  I've seen no estimates on the margins, but that first order can't be expected to move the needle much.  They will be followed by an ICE Block product which uses batteries to implement power-shifting from peak to non-peak in much the same way as is sometimes done on the grid.  These should work on a 1 to 1 basis with the switches and sell for $4500-5500, with a gross margin in the mid-thirties.  I'm not completely sure that power-shifting isn't better left to the utilities, but they are generally slow moving and over-regulated.  So, there could be real opportunity here.

CUI has seen many OMIBs over the past year, with the most recent being 2500 shares bought by the CFO at $2.80 on November 13, right after the earnings report where management said that Hurricane Harvey created 1 month of delays, impacting revenue by $.5-1M.  Repairs should increase the business going forward, but Q4 & Q1 are seasonally low.  On the other hand, the rebate rate has been hovering around 8%, and spiked briefly to 140% in mid-November.  That shows short squeeze potential, but there's no denying that this is a GRoDT stock.  To go back to the Energy Recovery analogy, break through sales could send the stock soaring, but that only happened with ER after years of development, management change and focused sales efforts.

Concluding Thoughts

CQH, CQP and CUI are all very thinly traded, which brings its own risks though also potentially greater reward.  For those seeking liquidity and long-term safety, I still like the flexibility, global reach and innovation embodied by AES Corp.  As expected, the bounce off recent lows has been somewhat anemic.  Though December could easily bring a return to those lows, AES is another case where shares can currently be bought for a little less than what insiders most recently paid on the open market.  AES is a much longer-term opportunity than the new picks presented here.  It should eventually benefit from the need for change in energy supply and distribution, but not be as much affected by the tides of fossil vs renewable sourcing.  That could wind up being relatively better or worse, but I wanted to provide a window into all the possibilities I'm looking at.