What’s that Floating Pipeline? (and check-ins on a couple stocks, including one buy)

by Travis Johnson, Stock Gumshoe | October 25, 2013 4:18 pm

Updates on Xerox and TGS Nopec and some teaser solving for the Friday File

Today I thought I’d finally get around to sniffing out the answers to the Australian Edge teaser from David Dittman about liquefied natural gas (LNG) — we’ve had a lot of questions, and I also personally have a small investment in an LNG stock (that’s Golar LNG, GLNG, which we’ve covered many times in the past), so we’ll look into that in a moment.

But first, we had earnings releases this week on a couple past “idea of the month” stocks that I should at least mention — and one of them led to a small personal buy today for me.

TGS Nopec (TGS in Oslo, TGSGY on the pink sheets) I already mentioned for you, but that was yesterday in a side note and you might have missed it[1] — I suggested it as one of our “Idea of the Month” candidates for it’s large and valuable seismic library and great cash flow (and a beaten down price after they cut guidance a couple times this year), and they released earnings on Wednesday. Short answer: steady as she goes, the quarter was no worse than we had been led to expect, they have some visibility into several large projects to increase the library (and revenues) next year, and I think it’s still worth buying under $27 (under 160 Kroner if you’re able to buy in Oslo, where it’s much more liquid). It’s not likely to become a growth darling immediately again, but should have excellent cash flow and not be in critical condition if oil prices collapse (thanks to their asset-light model, and lack of debt). I still own it, I’m not buying more but I like the stock as a long term cash flow compounder — if the model is really changing and the prefunding paid by explorers starts to drop on a more consistent basis (as opposed to just a bad year), I’ll have to reconsider, but I’ll give this some leeway while I wait unless we get a substantial drop in the price that forces me to re-evaluate.

And Xerox (XRX) released earnings yesterday (you can see the conference call transcript here[2]) that you would have thought were the end of the world — the stock crashed by 10%. Now, that’s probably really just because everyone had started to fall in love with the turnaround plan (“become the next IBM in services”) and was disappointed that the switch wasn’t turned a little more aggressively this past quarter, but I still like the stock and the plan and, more importantly, the valuation.

XRX should still see more than $1.7 billion in free cash flow this year they way they define it, and they’re continuing to throw that cash into repurchases (probably at least $600 million in stock repurchases this year) and dividends and paying off debt. That’s a lot for an $11 billion company. Their debt levels have come down a bit, but don’t be too worried about the large-looking debt balance — it’s quite manageable, and only about $3 billion of it is really core corporate debt — a large portion of the overall $8 billion in debt is financing debt that Xerox handles for customers who are buying their equipment on credit.

The fourth quarter is not going to be a good one, but there are substantial growth opportunities as they invest in health care and other growth areas on the services side and look for bolt-on acquisitions in the business services business, and they are, though it is a struggle, continuing to try to improve margins and acquire companies to help boost the returns from the services business as they transition their focus away from commoditized photocopying machines.

So they’re not going to shoot out the lights in earnings per share, but even with an expected weak fourth quarter that is causing this stock selloff they’ll still earn more than a dollar per share this year, with more buybacks to shrink the share count and an almost guaranteed dividend raise next year, and the stock is profitable and trading at book value. It’s hard to see any kind of huge downside here under $10, it’s stable and has good renewal rates and cash flow.

I don’t know if the next stop will be $8 or $12 after this, that will depend a lot on sentiment and on how worked up investors get over what will probably be a very weak fourth quarter, but I think their business shift is still moving in the right direction, they have a strong customer base and exposure to growing needs like health care management and exchanges, and they’re shareholder-friendly in their capital allocation, so I think this will work out very well over the next several years.

Which is why today I increased my personal XRX holdings by about 25% — it’s still not a huge position, but it’s moving up to mid-size in my personal holdings now, closing in on 2% of my equity portfolio. There may well be opportunities to buy more opportunistically in the next few months, because the next quarter might be really lousy (they have a big student loan processing business that they’re losing this quarter, for example), so I’ll continue to keep an eye on them and see how they’re doing.

And now, some teaser action!

David Dittman has taken over the Roger Conrad mantle over at Investing Daily, which means he’s now head honcho at Australian Edge (as well as Canadian Edge and some other services), but he was working on these letters with Conrad for quite a while before the shift so I doubt things are changing much in terms of their portfolios or strategies.

Australia is, like Canada, a market dominated by commodities producers and the related service companies — Australia is a huge supplier of copper and iron ore and all that other good stuff China (and other growing economies) need to build stuff, so most of the teasing of Aussie stocks focuses on companies in the commodities businesses … and this time it’s no different, with the pitch being that some Australian stocks will profit from building the “floating pipeline” that supplies Japan, in particular, with natural gas.

It’s not really a pipeline, of course, they can’t (yet) build an economic subsea pipeline that travels thousands of miles, but what they’re really talking about is the emerging LNG trade between Australia and Asia, particularly the gas-thirsty economies of South Korea and Japan.

LNG is liquefied natural gas, the super-chilled and pressurized natural gas that is transported via LNG Tanker and has been, until the last decade or so, a very sleepy business with just a few major suppliers (Trinidad, Qatar) and customers (Japan, South Korea, the US). The big shift in the US from planning for needed LNG imports a decade ago to now planning LNG exports has shaken up the markets some and caused a big wave of investing in LNG tankers and liquefaction and gasification plants (those are the export and import facilities, respectively), but it’s not just the US that’s shifting the market — Australia has been developing LNG capacity for quite a while, and they’re a much smaller consumer of natural gas domestically, so they have been, from the beginning of their discoveries of large gas deposits, very export-focused (unlike the US).

And they are, of course, a lot closer to most of the big customers — there is demand for LNG shipments all around the world to some degree, but the real price-setters who demand the largest amount of LNG are Japan, South Korea and Taiwan (European imports have generally been falling, though that could change if Russia turns the screws and slows their pipelines again or if Southern Europe picks up … Spain, Italy and France have historically been the biggest LNG importers in Europe and the biggest outside of Asia, though some of that also comes on much shorter trips from North Africa).

So Dittman is teasing two LNG opportunties in Australia — what are they? Well, it turns out that he’s not really teasing the direct plays on the “pipeline” business (the tanker owners), but instead the owners of the big natural gas projects that are ramping up for LNG export.

Let’s start with the hints for number one:

“Australian LNG Opportunity #1:

“Your first Australian opportunity is a gas and oil explorer that operates five major natural gas sites across the country.

“Their projects include an offshore site they created with Kansai Electric and Tokyo Gas.

“Remember, Japan has virtually no gas or oil of their own. (They account for just 1/10th of 1% of world production.) So a reliable supply of energy is a national security issue for them. It’s so critical that when the United States shut Japan out of the oil market in July 1941, they bombed Pearl Harbor five months later….

“When this project is done it will nearly double the amount of LNG this company can export – a true game changer.

“I expect the share price to double. And as a kicker, it yields 3.2%.”

This one, sez the Thinkolator, in all likelihood is Woodside Petroleum (WPL in Australia, WOPEY for the pink sheets ADR). That’s a match on their LNG partners (Kansai Electric and Tokyo Gas) and the five gas sites, and it’s a major and profitable Australian company (second largest oil and gas company in Australia, I think), but it’s not a perfect match — that’s because the yield is substantially higher than 3.2%.

3.2% would actually be a below-average dividend in Australia, which is a fairly “high yield” country (as we talked about when Steve Sjuggerud was teasing the appeal of Australian a few weeks back[3]), Woodside has a yield closer to 6%. I’m not sure what dividend taxation is like for Aussie stocks held by US investors, so that might account for some of the difference.

The project being teased is, I think, the Pluto offshore LNG project, which shipped its first LNG to Japan last year, and Woodside has also seen the troubled side of the LNG business, with an unexpected shutdown of Pluto production for a while earlier this year that substantially cut into earnings for a brief while. But it is a LNG export site, with high production expected for many years, and it’s built to export to Japan where the customers are hungry to pay a premium price — I haven’t owned this one, but I’d be more comfortable with Woodside as an integrated producer/exporter than with the very expensive and still-building-their-facility Cheniere LNG (LNG) here in the US. They’re far from being in perfect shape, and LNG projects aren’t easy to plan, finance and build even in commodity-friendly Australia (Woodside canceled a massive $40 billion LNG project back in April called Browse, for example), but the company is pretty reasonably priced (PE of 10 or so, good dividend, excellent balance sheet) and they are more nimble and growth-oriented than a lot of the US energy majors.

If you do decide to buy WOPEY on the pink sheets, which actually has decent volume sometimes, do use the WPL.AX price as your guide and use limit orders only, don’t forget to do the currency translation (I use xe.com to check currencies — at A$38.50, for example, the US ADR shares ought to trade at about $36.90, it’s not unusual to have a to pay a small premium if your’e anxious to buy a stock, but you might also be able to get it at a discount). That’s not to say I’m suggesting you buy the stock, of course, I don’t own it and won’t be buying it personally, and I have not dug into their books or looked at their other projects — just trying to help if you do decide you like Dittman’s pick here. Always remember to check home exchange pricing and convert the currency before buying a foreign stock on the pink sheets, there’s no guarantee that the pink sheets price is current or fair at any given moment.

And what’s Dittman’s second idea?

“Australian LNG Opportunity #2:

“Your second opportunity is another exploration company whose business with Asia is exploding.

“They recently inked a joint venture with Chinese oil giant Sinopec for the largest LNG supply deal in Australia. It comes in at a staggering 7.6 million metric tons per year.

“This is one more bit of evidence that Asian companies are determined to lock up supplies of LNG – even if it means buying the producers themselves.

“As soon as it was signed, the deal cemented this company’s status as a force in the LNG business. The best news is you can sit back and watch it yield 4.1% as its share price doubles.”

Pretty much every LNG project has either Chinese or Japanese investors heavily involved in Australia (and, indeed, in many other exporting or potential exporting countries), but this one is, in all likelihood, the big coal seam gas (CSG) project that’s aiming to export gas as LNG.

The partners in that project are Sinopec, Origin Energy, and ConocoPhillips, and since I can’t imagine Dittman can justify flying to Australia to recommend ConocoPhillips (COP), I expect this is a tease of Origin Energy (ORG in Australia, OGFGY or OGFGF on the pink sheets, both are very low volume). Origin currently pays a 50 cent annual dividend, which actually puts the yield closer to 3% than 4% at current prices, but the stock was down around $12 just a couple months ago (it’s closing in on A$15 now), so the tease could certainly still fit fine.

Origin is a more expensive and somewhat utility-like stock compared to Woodside, they are a fully integrated energy company from exploration and development to transport and consumer delivery. This big export project (called the Australia Pacific LNG Project) is not due to have the first export from its first train (not a choo choo train, they call each production line for LNG a “train”) in about two years, so there’s a lot of investing and potential hassle between now and then, but they do have a pretty steady business in other areas and they’re not a “pure play” on exporting LNG (Woodside isn’t either, but they’re closer).

I don’t know Origin’s business all that well, they’re a large company and they’ve come up in teaser pitches from time to time but I’ve never owned the stock — they have also just done a big international roadshow, so you can see more about them in that presentation here[4] if you’re curious. They’re also active in the energy infrastructure in New Zealand, in case you’re curious. (As long as we’re talking international, by the way, Woodside is also involved in the Leviathan field offshore Israel[5].

And we get one more quick hint for which I can share a solution with you:

“LNG Opportunity #4 is an infrastructure play, too. That’s the company whose chart I showed you earlier. Remember, this company shot up 42% in the past year alone… while yielding 5.3%.”

That’s almost certainly Envestra (ENV in Australia, EVSRF on the pink sheets), a pipeline company that’s subject to a not-entirely-friendly but will-probably-succeed (from what I can tell) takeover offer from APA Group (APA in Australia, APAJF), a large energy infrastructure company that trades as a stapled security (debt tied to equity) and has a decent yield — we covered that as one of the teasers from Australian Edge when they first launched that newsletter about two years ago and it has done quite well over that time period but is no longer as dramatic a dividend payer (they’re mostly a pipeline company, and the pretax yields are similar to some US pipeline firms at around 6%). Envestra’s yield is lower, in part because the stock recovered a bit after a court fight regarding the takeover bid in July, but it still yields around 4%.

So there you have it — a few “floating pipeline” stocks from Australia, I’m still satisfied with my Golar shares as my exposure to LNG at the moment but it is a growing industry that I should probably research more. There’s likely to be a LNG tanker glut for a brief while over the next few years as the tanker building is happening faster than the LNG project development, but it will normalize over time and I expect we’ll see a far more vibrant market in spot shipments of natural gas on the oceans in a decade than we do today. I wrote in more detail about re-assessing Golar a little while back right here[6], by the way, if you’re thinking about the LNG business more broadly — my opinion hasn’t changed since then, and nor has the situation at Golar in any significant way.

Endnotes:
  1. yesterday in a side note and you might have missed it: http://stockgumshoe.com/2013/10/tgs-quarter-update/
  2. see the conference call transcript here: http://seekingalpha.com/article/1769372-xerox-management-discusses-q3-2013-results-earnings-call-transcript?part=single
  3. Steve Sjuggerud was teasing the appeal of Australian a few weeks back: http://stockgumshoe.com/reviews/true-wealth/rich-bullion-secret-currency-and-some-thoughts-on-personal-holdings-and-watchlist-picks/
  4. international roadshow, so you can see more about them in that presentation here: http://www.originenergy.com.au/files/20131010_International_roadshow_presentation_Oct13_FINAL.pdf
  5. Woodside is also involved in the Leviathan field offshore Israel: http://www.globes.co.il/serveen/globes/docview.asp?did=1000887696
  6. wrote in more detail about re-assessing Golar a little while back right here: http://stockgumshoe.com/2013/08/lng-shipping-and-seed-streaming/

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