The world is currently scrambling to find gas supplies to replace Russia’s previous output. One of the markets that has benefited from this mad dash for new resources is the global liquefied natural gas market.
A booming industry
LNG is an interesting fuel. It is essentially super cooled natural gas, which can be transported around the world in greater volumes as a liquid. Compressing gas to this form and then transporting it around the world is not easy, nor is it cheap.
The world's largest LNG facilities cost over $50 billion to build and require huge amounts of experience and engineering know-how just to put together.
Transporting the fuel also requires specialist equipment, and turning it back into gas, which is usable with existing facilities at the other end of the shipment, is just as complex and expensive.
The demand for vessels that can deal with LNG fuel has skyrocketed as the world has rushed to find new gas reserves, generating a windfall for companies in the sector. Against this backdrop, in theory, no company should be trading at a discount to the value of its assets.
But that’s not the case.
Dynagas LNG Partners LP(DLNG, Financial) trades at just 40% of book value.
The company operates as a limited partnership, which focuses on owning and operating LNG carriers.
The business owns six carriers, and they are all on long-term charters with international gas producers with an average remaining contract term of 6.6 years.
At the end of June, its contracted revenue backlog was just under $1 billion. Considering the current market capitalization of the business is just under $150 million, that is a significant figure.
As such, on the face of it, this company looks to be a rare opportunity in the world of value investing.
It is a business that is both trading at a significant discount to the book value of its assets, and with a contracted revenue stream, making it easy to assess future cash flows and intrinsic value.
So then, why does the stock look so cheap? Well, on the face of it, one thing that immediately stands out is the volume of debt.
High debt levels are concerning
Gross gearing was near 150% at the end of the 2021 financial year. That is quite a lot of borrowing to have in a rising interest rate environment.
Indeed, rising interest rates on its debt hit the company's operating income in the first part of the year. Even though it managed to reduce the total outstanding amount of debt, the reduction was outweighed by higher rates.
However, this debt is balanced against company assets, which were valued at $914 million at the end of 2021.
The value of these vessels has declined over the past six years, but considering the current demand for LNG, one could quite easily argue that this figure undervalues these assets. They might be worth significantly more in the open market, easily outweighing the company’s indebtedness.
Another reason for concern is the company's long-term charter agreements. These agreements bring revenue stability, but they are limiting the amount of cash the group is able to generate in the current environment.
And I think investors also need to take into account the company’s preferred shares, which are currently consuming the majority of free cash flow from operations. As a partnership, the business should be able to distribute large amounts of free cash flow to its partners, but it has not paid any distribution on the partnership units since 2019. Virtually all of its cash has been distributed to preferred stockholders.
The bottom line
Dynagas does look cheap and has plenty of attractive qualities, but the business is not perfect.
Still, as a way to invest in the current global rush for LNG, it might be a good opportunity.
If the stock remains cheap, there is no denying its appeal as an acquisition for a larger company that wants to buy six vessels at a discounted price will only increase.
