Aug 13 Sep 13 Oct 13 Nov 13 Dec 13 Jan 14 Feb 14 Apr 14 May 14 Jun 14 Jul 14 Aug 14 EQUITY RESEARCH Energy 28 August 2014 Liquefied Natural Gas (LNG.ASX) Bear Head provides Magnolia Plug n Play for Export LNG Event: Acquisition of Bear Head LNG, Nova Scotia, Canada Investment Highlights: Bear Head LNG acquisition demonstrates competitive advantage. LNG has completed the acquisition of a previously proposed LNG import terminal in Nova Scotia to establish a second export LNG project in North America. The 100% owned Bear Head LNG proposal is for a 4mtpa export terminal (with potential for 8mtpa) that will utilize the development, technical and engineering work already completed by the Magnolia LNG project team. Guidance for pre-development capital is circa $40 million to reach FID in 2016 (including $11m for acquisition of the site) with the economic returns for shareholders likely replicate our valuation and financial assumptions the Magnolia LNG project. Located on the east coast, the Bear Head project opens up access the European markets and provides diversification to markets accessed from the US Gulf Coast. Valuation and economics for Bear Head LNG similar to our Magnolia LNG base case: Initial discussions with management indicate Bear Head will utilise a tolling model with capital costs and economic returns similar to those of the Magnolia base case of 4mtpa. We believe the retained equity interest is likely to be greater given LNG s improved financial position and options for development funding vs 18mths ago with Magnolia. FSB initial estimates indicate Bear Head could deliver unrisked equity value of circa US$2.5 billion or +$5/sh with ownership at 80% or better. Magnolia Plug n Play for US export LNG. We view the near term Magnolia LNG milestones for bankable documents across Permitting, FEED/EPC, Tolling and Project Finance will support the company s vision for multiple export LNG projects in North America and validate a Magnolia plug n play replicated across sites. We highlight our valuation has yet to price in a value on the OSMR technology. A portfolio in the US alone could be >20mt with 100% ownership rights to OSMR for other markets. Cheniere Energy s proposed 40mt capacity across two projects has an EV of circa US$30b. No impact to Magnolia schedule with FID <12mths away. Magnolia FEED, Permitting and FID documentation is moving into a critical 3-4 months with bankable Tolling, EPC and Project Finance milestones to be reached by 30 November. We also anticipate FERC s draft EIS report and Scheduling Notice in late September. High probability of all four milestones being reached positions the stock for a further re-rating and de-risking towards our Magnolia 8mtpa expansion case valuation (unrisked US$4.3b). Upgrade in our risked equity valuation to $5.18/sh. We have upgraded our risked equity valuation to $2.4b or $5.18/sh (previously $3.44/sh). Key change is the inclusion of our risked valuation for Bear Head at $819m or $1.77/sh and an increase in cash to $80m post the recent $38.6m equity raise. Recommendation: We maintain our BUY rating and upgrade our 12mth PT to $5.20/share. Rating BUY Previous BUY Price Target (A$) 5.20 Previous (A$) 3.44 Share Price (A$) 3.68 52 week low - high (A$) Valuation (A$/share) - Un -risked 0.18-4.00 5.18 Methodology EV/EBITDA Risk High Capital Structure Shares on Issue (m) 461.4 Options/restricted on issue (m) 4.4 Market Cap (A$m) 1,698.0 Market Cap- Fully Diluted (A$m) 1,714.0 Net Debt/(Cash) (A$m) -80.0 EV (A$m) 1,634.0 12mth Av Daily Volume ('000) 3,349 Board and Management Richard Beresford Maurice Brand Yao Guihua Leanne Bond Chairman Managing Director Non-Executive Director Non-Executive Director Major shareholders Baupost Group 8.8% Valinor Management 7.0% Claren Road 6.2% Top 20 73.0% Catalysts Magnolia FERC Scheduling Notice Q3CY14 Magnolia FERC draft EIS Q4CY14 Magnolia EPC Contract & Capital Cost Q4CY14 Magnolia Binding Tolling Agreements Q4CY14 Magnolia Project Finance Term Sheet Q4CY14 Magnolia FERC Final EIS Q1CY15 Magnolia FERC NTP & FID Q2CY15 Magnolia First LNG Q2CY18 Bear Head FEED Q2CY15 Bear Head FID Q1CY16 Bear Head First LNG Q2CY19 Share Price Graph Share Price $5.00 $4.00 $3.00 $2.00 $1.00 $0.00 Analyst Martin Carolan martin.carolan@fostock.com.au +61 2 9993 8168 Volume (000) 30,000 25,000 20,000 15,000 10,000 5,000 Foster Stockbroking Pty Ltd was the Lead Manager to the Placement of 14.8 million shares at $2.60 per share to raise $38.6 million and received a fee for this service. 0 DISCLAIMER: Foster Stockbroking Pty Ltd does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Refer full disclosures at the end of this report.
ACQUISITION OF BEAR HEAD LNG PROJECT IN CANADA FOR US$11M US$11m acquisition of Bear Head LNG for 100% ownership of a 4mtpa site scalable to 8mtpa. Bear Head LNG will replicate the development, technical and engineering work already completed by the Magnolia LNG project team In late July LNG announced the acquisition of the Bear Head LNG project and site from Anadarko Petroleum Corporation ( Anadarko ) for US$11 million. Concurrently, the company also completed a $38.6 million capital raising at $2.60/sh to fully fund all acquisition, FEED and permitting activities through to Financial Close estimated for early 2016. LNG s proposal is to transform the site into a 4mtpa export facility that has future expansion capacity to 8mtpa. Similar to Magnolia, the project and site will be designed to scale up incrementally with market demand and gas supply and production in the area. Bear Head provides a site on the east coast with the shortest shipping distance to European LNG markets vs other proposed North American projects. The Bear Head acquisition is not a surprise to us given the company s ambition of developing a 20mt capacity portfolio across North American sites which it can replicate its development, technical and engineering work already completed by the Magnolia LNG project team. Utiliising the company s proprietary OSMR technology and the LNG development team s expertise provides the company with a key competitive advantage in moving quickly on other sites. This deal highlights the opportunity presented to LNG to capitalise on the abundance of cheap North American gas and implement its low-capital intensive OSMR technology to quickly build a portfolio of North American projects and leverage the credibility being attained in the market through the completion of FEED and permitting on the Magnolia project. We view the purchase price of $11 million to be an exceptional use of capital together with $38 million of new funds that could deliver over $2b in shareholder value should the team derisk the project through completing FID (including permitting, tolling agreements, gas supply and transportation) in the first half of 2016 and construction through to 2019. Figure 1: Bear Head LNG export site location Source: LNGLtd The site located in Nova Scotia, Canada, was previously proposed by Anadarko for an 11.3mtpa LNG import terminal. The project comes with all rights and approvals and it also has the benefit of LNG tank foundations and significant civil works across the site. Our research from historical filings by Anadarko indicate upwards of $100 million has been spent on the project. 28 August 2014 Level 25, 52 Martin Place, Sydney, NSW 2000 +61 2 9993 8100 www.fostock.com.au 2
Figure 2 below highlights the significant civil works already undertaken at the site in 2005/6 by Anadarko which include the foundations for two tanks. The site has already been levelled for final construction with an estimated US$50m in capital works that can be utilised in the design for an export terminal. Bear Head site underwent significant civil works in 2005/6 by Anadarko which include the foundations for two tanks and a fully permitted import terminal for 11.3mtpa Figure 2: Bear Head LNG site works completed by Anadarko in 2005-2006 Source: LNG Ltd Other cost savings and benefits will flow to the project through the utilisation of work already completed by the Magnolia LNG team, including: FEED engineering and technical completed for the EPC; commercial agreements for tolling and pipeline capacity; and equity and debt structure agreements. Management have informed the market $38.6 million capital will fully fund the acquisitions and work program through to a target FID in 2016. This estimate is approximately 50-60% of the pre-development capital for Magnolia. Figure 3 outlines the high level project timeline with the project expected to have a fast approvals schedule due to permitting work already completed. $38.6 million capital will fully fund the work program through to a target FID in 2016. This estimate is approximately 50-60% of the pre-development capital for Magnolia, with the project expected to have a fast approvals schedule due to permitting work Figure 3: Bear Head LNG site works completed by Anadarko in 2005-2006 Source: LNG Ltd 28 August 2014 Level 25, 52 Martin Place, Sydney, NSW 2000 +61 2 9993 8100 www.fostock.com.au 3
Our understanding of the approvals process for permitting is similar to that of the US FERC body, with the National Energy Board (NEB) being the authorising body in Canada. NEB s role is to regulate pipelines, energy development and trade in the Canadian public interest. To date there have been 11 projects approved for export LNG that include projects within the country or those seeking to transport Canadian gas for liquefaction and export from the US (i.e. Oregon LNG). It appears the government continue to show support for export LNG approvals and with Bear Head LNG on the East Coast, the company has received indicative support from the federal government ministers along with local governments endorsing this site location. Bear Head site is within 36 miles of existing pipeline infrastructure, with LNG to provide updates on gas supply and transport in the coming months. Pipeline expansion plans are underway for the transportation of gas to align with growth in market demand from the Marcellus Shale. Gas Transportation and Supply LNG s initial comments indicate the Bear Head LNG Project plans to be viable at relatively low gas supply volumes, ~300 mmcf/d for 2 mtpa which allows the project to start and then grow with further gas supply. We await the company to make further updates to the market in due course relating to gas transport and supply options under consideration. We note the project site is within 36 miles of existing pipeline at Point Tupper. Our initial research into gas supply options from the prolific Marcellus Shale area indicates that Anadarko have existing gas producing operations in the Marcellus, sitting on 260,000 net acres, +1 BBOE of risked gas resources and a growing production base of 100 MBOE/d. This seems to be an ideal candidate for tolling of gas along with others in the area seeking growth in production to align with pipeline transportation upgrades. Kinder Morgan Energy Partners (KMP) subsidiary the Tennessee Gas Pipeline Company (TGP) has announced the Northeast Energy Direct Project to upgrade its existing pipeline system in the region for sufficient scale to address the long-term energy needs of New England and Atlantic Canada by providing access to abundant new supplies from the Marcellus, Utica and other supply areas where TGP has connectivity through to the Dracut Hub near Boston. KMP have advised the Northeast Energy Direct Project has capacity scalable from approximately 800,000 Dth/d to 1.2 Bcf/d, or ultimately up to 2.2 Bcf/d, depending on final customer commitments. Subject to receiving sufficient commitments for capacity as well as regulatory approval, the project is expected to begin service in November 2018. Given LNG s existing relationship with Kinder Morgan for the Magnolia LNG project, we assume discussions will take place for a capacity agreement to bring gas from the Marcellus. Figure 4: Bear Head LNG proximity to US gas transport infrastructure Source: LNG Ltd 28 August 2014 Level 25, 52 Martin Place, Sydney, NSW 2000 +61 2 9993 8100 www.fostock.com.au 4
What we are yet to understand is the reverse flow requirements from the Dracut Hub to Goldboro in Nova Scotia. The existing pipeline operators are PNGTS Pipeline and Maritimes & Northeast Pipeline who transport gas from offshore Nova Scotia into the US market. Figure 4 above provides an outline of the Bear Head project located in relation to existing gas transmission infrastructure in Canada and its connection to the US supply market. RISKED VALUATION FOR BEAR HEAD DELIVERS ~$800M SHARE PRICE UPSIDE While we recognise it is early days in the development of the Bear Head project, we have ascribed a risked valuation of US$761 million or US$1.65/sh. While we recognise it is early days in the development of the Bear Head project, we have ascribed a 12mth risked valuation of US$761 million or US$1.65/sh. Figure 5 below outlines the key assumptions which align with our base case valuation assumptions for the 4mtpa case for Magnolia LNG given we understand the project will be a replication of the technical and engineering design. We highlight there still remains upside to our Magnolia LNG assumptions given potential for: 1) reduced capex; 2) lower interest costs; and 3) increase in tolling capacity fees. We note the key changes are the equity ownership which we estimate at 80% and we apply a higher discount rate of 25% to account for the early stage of discussions on gas supply and transportation to the site along with FEED activity and capital cost estimates will be finalised over the next 12mths. We do not foresee LNG selling down equity before FID in early 2016 where it will still retain 100%. We have used a nominal 20% sell-down to cover the equity requirement of the project either to an infrastructure fund or an LNG industry partner. We do not foresee LNG raising material equity from the market with the upside case being no sell-down at all given 100% project finance scenario could be supported by Magnolia LNG cash flows underwritten by binding tolling agreements at this time. We will look to unwind our risked equity valuation in line with key milestones on gas supply, transport, tolling, permitting and FEED. Figure 5: Bear Head LNG valuation FSB key assumptions which align with our base case valuation assumptions for the 4mtpa case for Magnolia LNG given we understand the project will be a replication of the technical and engineering design. Assumption Bear Head (4mtpa) Magnolia (4mtpa) Magnolia (8mtpa) Trains 2 2 4 Year of Production (FY) 2020 2019 2021 Tolling Capacity Fee (US$/mmBTU) 2.30 2.30 2.40 Capital Cost (US$m) 2,200 2,200 3,500 Project Debt (US$m) 1,600 1,600 2,800 EBITDA (US$m) 100% basis 404 404 844 LNG Equity Interest 80% 60% 60% EV/EBITDA multiple 12 12 12 EV (US$m) 4,848 4,848 10,128 Equity (US$m) 3,248 3,248 7,328 LNG Equity (US$m) 2,598 1,949 4,397 LNG Equity Unrisked (US$/sh) 5.63 4.22 9.53 LNG Equity Risked to Production (US$/sh) 1.65 2.25 3.84 Notes: Magnolia discount rate 15%; Bear Head discount rate 25% Source: FSB 28 August 2014 Level 25, 52 Martin Place, Sydney, NSW 2000 +61 2 9993 8100 www.fostock.com.au 5
ASX200 INDEX INCLUSION IN SPETEMBER ADDS A LIQUIDITY KICKER LNG s inclusion in the September ASX200 index rebalance will leave the domestic index funds underweight the stock. Given the growth in market capitalisation to $1.8b and average daily liquidity now +3m, we expect the stock will enter the S&P ASX200 index in the September quarterly rebalance. We understand the announcement will be made on September 5 and lead to an uplift in market liquidity (and share price) on or before the rebalancing date approximately 22 September. Given the LNG register is now approaching 50% held by US long funds, another 10% by HNWs and another 10-15% by domestic institutions, we can foresee a scramble by index funds to address the underweight position in the third week of September. VALUATION & PRICE TARGET Risked Valuation & 12 month Price Target - $2,390m $5.18/share We continue our valuation for Magnolia LNG using an EV/EBITDA approach to align with the comparable stock valuations of US infrastructure and utility stocks. We have also applied this methodology to Bear Head LNG; however we highlight the higher discount rate given the early stage. Our 12mth price target which is set at $5.20/sh on a fully diluted basis of 461.4m shares on issue and includes the recent placement shares and update cash balance of $80 million. We continue to highlight our model assumptions still use conservative assumptions for capital costs, interest costs and tolling fees for magnolia LNG. We note a multiple of 12x has been applied to derive an un-risked equity value of US$2b (US$4.22/sh) on the 4mtpa case and US$4b (US$9.53/sh) on 8mtpa. We discount this future value by 15% per annum to derive our risked value for 4mtpa of US$2.25/sh (FV assumed FY19) and 8mtpa of $3.84/sh (FV assumed FY21) Our risked valuation for Magnolia LNG of A$3.28/sh is based on a blended valuation of our discounted 4mtpa and 8mtpa case and adjusted for AUD:USD $0.93. Our risked valuation for Bear Head LNG of A$1.77/sh is based on a discounted 4mtpa case and adjusted for AUD:USD $0.93. Our 12mth price target which is set at $5.20/sh on a fully diluted basis of 461.4m shares on issue and includes the recent placement shares and update cash balance of $80 million. We highlight the upside risk to our valuation of Magnolia LNG from the finalisation of Tolling Agreements, EPC capital costs and Project Finance terms. Figure 6: Equity Valuation Summary Risked Equity valuation $Am $Am A$/sh Magnolia LNG $1,512 $3.28 Bear Head LNG $819 $1.77 Cash $80 $0.17 Corporate -$20-0.04 Equity Valuation $2,390 $5.18 Source: FSB Research RECOMMENDATION We reiterate our BUY recommendation and upgrade our 12mth PT to $5.20/sh. 28 August 2014 Level 25, 52 Martin Place, Sydney, NSW 2000 +61 2 9993 8100 www.fostock.com.au 6
FOSTER STOCKBROKING DIRECTORY Liquefied Natural Gas Ltd (LNG.ASX) Name Role Phone Email Stuart Foster Chief Executive Officer +61 2 9993 8131 stuart.foster@fostock.com.au Chris Francis Executive Director +61 2 9998 8167 chris.francis@fostock.com.au Haris Khaliqi Executive Director +61 2 9993 8152 haris.khaliqi@fostock.com.au Martin Carolan Executive Director +61 2 9993 8168 martin.carolan@fostock.com.au Mark Fichera Executive Director +61 2 9993 8162 mark.fichera@fostock.com.au Mark Hinsley Executive Director +61 2 9993 8166 mark.hinsley@fostock.com.au Kevin Massey Senior Equities Dealer +61 2 9993 8130 kevin.massey@fostock.com.au Tolga Dokumcu Execution & Dealing +61 2 9993 8144 tolga.dokumcu@fostock.com.au George Mourtzouhos Execution & Dealing +61 2 9993 8136 george.mourtzouhos@fostock.com.au Foster Stockbroking Pty Ltd A.B.N. 15 088 747 148 AFSL No. 223687 Level 25, 52 Martin Place, Sydney, NSW 2000 Australia General: +612 9993 8111 Equities: +612 9993 8100 Fax: +612 9993 8181 Email: contact@fostock.com.au PARTICIPANT OF ASX GROUP Foster Stockbroking recommendation ratings: Buy = return >10%; Hold = return between 10% and 10%; Sell = return <-10%. Spec Buy = return > 20% for stock with very high risk. All other ratings are for stocks with low-to-high risk. Returns quoted are annual. Disclaimer & Disclosure of Interests. Foster Stockbroking Pty Limited (Foster Stockbroking) has prepared this report by way of general information. This document contains only general securities information. The information contained in this report has been obtained from sources that were accurate at the time of issue. The information has not been independently verified. Foster Stockbroking does not warrant the accuracy or reliability of the information in this report. In preparing the report, Foster Stockbroking did not take into account the specific investment objectives, financial situation or particular needs of any specific recipient. The report is published only for informational purposes and is not intended to be advice. This report is not a solicitation or an offer to buy or sell any financial product. 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Diligent care has been taken by the analyst to maintain an honest and fair objectivity in writing the report and making the recommendation. Specific disclosure: Foster Stockbroking was appointed as Lead Manager to the Placements in August 2013, December 2013, March 2014, May 2014 and July 2014 for LNG and received fees for this service. 28 August 2014 Level 25, 52 Martin Place, Sydney, NSW 2000 +61 2 9993 8100 www.fostock.com.au 7