Cheniere Energy Partners: Sustainable Distributions With A +5% Yield

Navigating through these tumultuous times feels like riding a roller coaster, where even good news can unexpectedly become a harbinger of uncertainty. Despite the economy flexing its muscles and showcasing remarkable resilience amidst relentless interest rate hikes, we find ourselves on the brink of a potentially higher-for-longer interest rate era, possibly paving the way for an economic deceleration. In such a whirlwind of unpredictability, dividend investors are on a relentless quest for stability and assurance. This brings us to the doorstep of Cheniere Energy Partners (NYSE:CQP), a beacon of dependability in these uncertain times.

In my previous article written almost three years ago, I highlighted Cheniere Energy Partners' potential to capitalize on the surging demand for LNG—a potential that the company has since realized through expanded production capacity. Now, as the company transitions into a new development phase, there is a fresh and potentially rewarding opportunity for shareholders to consider.

Boasting a robust 5.6% yield, Cheniere Energy Partners stands out as a compelling option for investors seeking a rare blend of reliability and attractive returns, making it a contender worth closer examination.

Introduction

Cheniere Energy Inc. (LNG) is a familiar for many energy investors, and it’s easy to see why. They were the pioneers, the first ones to start exporting LNG from the U.S., making the most of our abundant, inexpensive shale gas and the strong demand from overseas. It all kicked off in 2016 when they sent the first shipment from their Sabine Pass LNG Terminal in Cameron Parish, Louisiana. That facility is one of the biggest and the most advanced LNG production plants in the world. Owned and operated by Cheniere Energy Partners, an MLP established by Cheniere in 2006, the terminal set a high bar in the industry.

The Sabine Pass facility includes six LNG trains, the last of which came online in early 2022. Together, they can produce around 30 mtpa of LNG. The LNG terminal is also equipped with three marine berths and regasification facilities including storage tanks and vaporizers. Cheniere Energy Partners also owns interest in a 94-mile pipeline that links Sabine Pass with other interstate and intrastate pipelines.

But I believe the real beauty of Cheniere Energy Partners’ business is its ability to generate reliable levels of cash flows, year in and year out, due to the fact that it sells LNG primarily through long-term sale and purchase agreements [SPA]. I think this is a great thing that looks even better under the current uncertain economic environment.

Uncertain Environment

The U.S. economy is standing tall, showing impressive resilience even as the Federal Reserve has substantially increased interest rates. Initially, these hikes were aimed at taming inflation, and there was a real concern that they might slam the brakes on the U.S. economy’s growth, possibly even pushing the country into a recession. Yet, here we are, with the US defying expectations. Despite these concerns, the economy expanded by 2.2% in the first quarter and 2.1% in the second quarter of 2023. However, while inflation has indeed cooled off, dropping from 6.5% last year to 3.7% in September, it’s still sitting above the Fed’s 2% target.

Looking ahead, I believe the third quarter might bring more good news, as recent data points like increasing factory production—even in the face of United Auto Workers [UAW] union strikes—and a surprisingly strong growth in retail sales in September suggests. Retail sales rose by 0.7% in September, surpassing the 0.3% increase that many were anticipating. Similarly, factory output rose by 0.4% in the same period, outpacing the expected 0.1% increase.

However, I believe that with the economy continuing to flex its muscles and inflation remaining stubbornly high, it’s becoming increasingly likely that we’ll see interest rates staying elevated for an extended period. This, in turn, could set the stage for an economic slowdown further down the line as the impact of these high interest rates starts to make itself felt, potentially eating into corporate profits and affecting dividends and the broader stock market.

Reliable Cash Flows

Navigating these unpredictable times, Cheniere Energy Partners stands out for two main reasons. Firstly, as previously highlighted, the company predominantly earns its revenue through long-term SPAs. A substantial 90% of its total LNG production capacity, which stands at 30 million tonnes annually, is secured by long-term SPAs set to last until 2025. These agreements ensure that Cheniere Energy Partners receives fixed capacity charges, regardless of whether its clients purchase any LNG cargoes. In cases where they do make purchases, Cheniere Energy Partners profits from a price generally around 115% of the current Henry Hub natural gas price. This model ensures a steady stream of cash flow each quarter, comfortably surpassing its distribution needs.

In the MLP space, a firm's ability to maintain healthy cash flow for distributions is often gauged using the distribution coverage ratio. This ratio is usually deemed healthy when it falls between 1.2x and 1.5x, or higher. It's important to note that Cheniere Energy Partners doesn't disclose its distributable cash flow numbers. As a result, I’ve used free cash flows as a substitute, calculated as cash flow from operations before changes in working capital, minus capital expenditures.

In the first half of this year, Cheniere Energy Partners generated $2.62 per share in free cash flows, outpacing the $2.06 per share in distributions. This results in a coverage ratio of 1.27x, a solid indication that the company is generating healthy levels of cash flows. I anticipate even better results in the future.

My future expectation is rooted in the recent completion of planned maintenance on two trains at the Sabine Pass facility in the second quarter—the largest maintenance project the company has ever undertaken. While this temporarily impacted Cheniere Energy Partners’ LNG production, the company still met all its long-term contract obligations. However, it was less active in the short-term market than usual. In the second quarter, both the number of LNG cargoes and volumes fell by around 5% compared to the previous year, and operational costs increased. Despite these challenges, the company maintained a commendable level of cash flow, underscoring its capacity for generating reliable revenues—even amidst downtime.

With the maintenance work now behind them, the two trains at Sabine Pass are gearing up to return to full capacity. This will not only boost the company’s LNG production but also enable it to sell its output not covered by long-term SPAs on the spot market. I expect this to enhance both earnings and cash flows, likely resulting in an improved coverage ratio.

Healthy LNG Demand

Secondly, despite the unpredictable economic landscape, the strong demand for LNG appears to be a consistent trend. Currently, the prices of this commodity are at strong levels, with the European Dutch Title Transfer Facility [TTF] and the Asia-focused Japan Korea Marker [JKM] benchmarks floating around $15 and $18 per MMBtu respectively. Although there’s been a drop of over 30% in prices this year, they are still nearly double their five-year averages.

The increase in LNG demand since 2022 has largely been driven by Europe, as it seeks to diminish its dependency on Russian gas. This has led to an influx of deals with suppliers from various nations and a heightened presence in the spot market. Even in light of reduced gas consumption in Europe in recent weeks due to diminished industrial demand, the appetite for LNG remains robust. In the second quarter, Cheniere Energy Partners reported a 9% increase in LNG flows to Europe compared to the previous year, and I see no signs of this trend reversing in the near future.

In the longer term, European demand for LNG may decrease as new plants start operating, consumption drops, and the region diversifies its energy sources. However, by that time, I anticipate a stronger demand emerging from Asia.

Japan, traditionally one of the major LNG consumers, has seen a decrease in demand this year due to rising electricity prices and a shift towards nuclear power, with LNG imports in May hitting their lowest point in over two decades. Conversely, Southeast Asia is quickly becoming a hotspot for LNG, with substantial growth in Thailand, the Philippines making its entry into the global LNG trade, and Vietnam initiating work on its first regasification terminal. Demand from this region surged by 31% YoY in the last quarter, indicating a promising start. Additionally, China’s LNG imports have grown by a substantial 20% in the second quarter, even with its economy growing slower than expected.

What excites me about Cheniere Energy Partners is its strategic positioning to leverage this burgeoning demand. The company is planning to expand its capacity with the development of up to three new trains adjacent to the existing Sabine Pass facility. The “SPL Expansion Project” is poised to enhance its LNG production by 20 mtpa, marking a 67% increase from current levels. Cheniere Energy Partners is actively engaging with regulators, has commissioned Bechtel to conduct a Front End Engineering Design [FEED] study, and has secured multiple long-term SPAs with global giants including Korea’s KOSPO, Norway’s Equinor (EQNR), China’s ENN (OTCPK:XNGSY), and Germany’s BASF (OTCQX:BASFY).

It is important to note that the development of LNG projects entails a complex undertaking, necessitating regulatory approvals, construction processes, among other critical steps, which could extend the completion timeline to several years. The SPL Expansion project may require several years to come online. However, the positive aspect is that Cheniere Energy Partners boasts an exemplary track record of delivering projects punctually and within budget. Upon commencement, this project is poised to significantly bolster the MLP’s earnings and cash flows.

Takeaway & Risks

To wrap things up concisely, in these times of economic uncertainty, Cheniere Energy Partners stands out as a beacon of stability, primarily thanks to its long-term sale-and-purchase agreements that ensure a consistent stream of cash flows. The LNG market itself is demonstrating remarkable resilience and strength, and this bodes well for Cheniere Energy Partners. The firm is not just passively benefiting from the market conditions; it is actively expanding its capabilities and preparing for the future with the development of new trains.

In my view, Cheniere Energy Partners stands as a compelling investment opportunity within the MLP space. With an attractive distribution yield of 5.6%, it’s an enticing option for investors seeking steady income. This yield is underpinned by the robust and reliable cash flows that the company generates, giving confidence in the sustainability of the distributions. When you put its 5.6% yield against the S&P 500’s average of 1.6% and the energy sector’s median of 3.46%, it looks great. However, it’s worth noting that this yield is slightly lower than the 6% Cheniere Energy Partners has typically delivered over the past five years, as data from Seeking Alpha shows.

In terms of valuation, the units of Cheniere Energy Partners are currently trading at an EV/EBITDA [forward] multiple of 11.24x. This positions the company at a higher price point compared to some of the leading energy infrastructure MLPs, such as Enterprise Products Partners (EPD), Energy Transfer (ET), and MPLX (MPLX), all of which trade below a 10.5x EV/EBITDA [forward] multiple. For investors considering adding Cheniere Energy Partners to their portfolio, it might be prudent to wait for a more favorable entry point when the market offers a dip in prices, ensuring a better valuation and potential for higher returns.

While Cheniere Energy Partners exhibits strong fundamentals, it is critical to weigh in on the potential risks as well. Cheniere Energy Partners is not immune to the complexities of the global economic landscape. The looming threats of a global economic slowdown pose a significant risk, potentially impacting the demand for LNG, even from regions that have historically shown robust demand, such as Asia. If the global LNG trade experiences turbulence, Cheniere Energy Partners could find its prospects and financial performance adversely affected. The prevalent high interest rate environment adds another layer of complexity to the mix. Cheniere Energy Partners’ need to refinance existing debt and secure additional funding for growth initiatives could become more expensive endeavours, as rising interest rates drive up borrowing costs. This scenario could lead to a strain on cash flows, leaving less room for distribution growth and potentially impacting the overall financial health of the MLP.

Additionally, the challenges brought about by high inflation cannot be overlooked. Across various sectors, businesses are grappling with increased operational and capital expenditures, and Cheniere Energy Partners is no exception. The construction of new LNG plants, a crucial aspect of the company's growth strategy, could become substantially more expensive. Operational costs are also likely to escalate, and the company might face higher maintenance expenses. These factors collectively have the potential to put a damper on the company’s future cash flows, thereby potentially impacting its ability to grow distributions over time.

Investors need to carefully evaluate these risks and consider their tolerance for such uncertainties before deciding to invest in Cheniere Energy Partners.