New Fortress Energy

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 2/5

New Fortress Energy Inc. is an energy infrastructure company, involved in the production, transportation, and distribution of LNG, aiming to provide solutions for a global transition towards cleaner energy alternatives.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

New Fortress Energy (NFE) is a global energy infrastructure company that operates across the value chain of the Liquefied Natural Gas (LNG) market.

Business Overview

  • Core Operations: NFE’s operations are primarily focused on:

    • LNG Production: Primarily through modular liquefaction facilities to create LNG from natural gas.
    • LNG Transportation: Through a fleet of vessels to transport LNG to various locations globally.
    • LNG Distribution: Through terminals, pipelines and regasification infrastructure delivering gas to its consumers.

  • Revenue Streams: NFE’s revenue comes from selling LNG and related services under long-term contracts and a portion from selling of energy/electricity. The company has focused on building integrated solutions for customers requiring natural gas and power. The revenue comes primarily from a core set of contracted customers.

While historically reliant on a narrow customer base, NFE is increasingly expanding its services to reach a diversified customer base.

  • Geographical Focus: While primarily operating in US markets, NFE has grown its reach internationally, mainly in Latin America, specifically in Puerto Rico. The company is also focusing on further expansion in Europe, Africa, Asia, and the Middle East.

  • Business Model: NFE’s focus is on integrating LNG production, transport, and regasification to build a seamless value chain. This approach provides stability through long-term contracts and provides NFE more control and flexibility over the LNG supply chain.

A key characteristic of the company’s business model is the ability to integrate and develop a full value chain, from upstream production, processing, transportation, down to distribution and consumption.

  • Competitive Landscape: The LNG market is highly competitive, with numerous established players. There are major LNG producers, transportation companies, and regasification terminal operators. The competition for supply contracts is high. The company faces competition from large, well-established LNG and energy companies, which have far more financial power and more established reputations. Some key competitors include Cheniere Energy, Sempra Energy, and TotalEnergies.

The company’s competitive landscape can make it challenging to grow and compete with established players, as well as new entrants looking to serve existing contracts and customer bases.

  • What makes NFE different: The company tries to differentiate themselves through their integrated offering that allows it to deliver gas/power to their customers faster and more predictably. It can act both as a producer, transporter, and regassification terminal operator giving it more control over the supply and transportation chain. The company has emphasized their approach in “asset-backed” infrastructure development that can support multiple regions and multiple customers simultaneously.

Moat Assessment

Based on the information available, New Fortress Energy has what would be called a narrow moat, and could be categorized as a “developing” moat. Here is the rating and justification:

  • Rating: 2 / 5

  • Justification:

    • Economic Moats: NFE claims that it has a competitive advantage in infrastructure, which could potentially be a source of an economic moat, by using proprietary technology or processes that allow it to deploy assets quickly. Further, it could try to have contractual lock-in with major customers. However, while having infrastructure and contracts with customers create a barrier to competition, such barriers are not very wide. It has more to do with an established customer base than actual barriers to competition. Its business is also too reliant on price/commodity movements to have a robust moat. It’s focus on cost competitiveness and the ability to serve niche markets with a value-added service, may provide an operational advantage, but this does not translate into a sustainable competitive advantage.

    • Intangible Assets: The company may have brand recognition among certain energy partners, but doesn’t have any wide, identifiable brand-based moats.

    • Switching Costs: NFE’s customer relationships may create switching costs over time as customers’ infrastructure becomes reliant on the company, and they don’t want to go to the effort of switching to a new provider.

    • Network Effect: NFE does have some minor network effects as the company expands its geographical reach, it makes it a more attractive partner for companies wanting access to LNG in areas that the company has already entered.

    • Cost Advantages: With its integrated approach, NFE has the ability to control costs to a greater extent that their peers, because they do both production and distribution rather than needing to rely on multiple counterparties. They can also benefit from having large projects due to economies of scale and by being able to leverage the same asset and expertise over many projects. However, whether these cost advantages are sustainable over the long run is not clear, and depend heavily on management’s execution of their operations. Also, cost competitiveness remains a key competitive parameter.

The current competitive landscape can be brutal, where the majority of contracts are often price and volume based (i.e. based on commodity prices and take or pay type of agreements), therefore the underlying economic moat is mainly dependent on the company’s cost structure and the efficiency with which it can carry its projects. In that case, all advantages from branding, or intellectual property, are generally minimized.

Risks to the Moat and Business Resilience

  • Commodity Price Risk: The biggest risk for NFE is commodity pricing and volatility. Fluctuations in natural gas prices and shipping prices may adversely impact their profitability. Also, the price of LNG depends heavily on regional dynamics and demand-supply changes. High price volatility could destabilize many aspects of its revenue models.

Significant price volatility represents the biggest threat, especially with their business model that relies so heavily on price and contractual agreements.

  • Contractual Risks: A lot of NFE’s revenue is concentrated in long-term contracts. However, there is always the possibility of noncompliance, contract cancellation, litigation, changes in counterparties, or changes in governing regulatory conditions which could lower earnings. The company needs to demonstrate their ability to enforce their contracts to ensure a higher level of dependability.

Counterparty risk and dependence on a few specific contracts could pose a risk to consistent revenues.

  • Project Execution Risk: Because the company engages in complex infrastructure projects (such as developing new LNG terminals and conversion infrastructure), they are subject to delays and cost overruns. Failure to efficiently execute projects may decrease earnings and impair its ability to compete effectively.

The company’s major expansion plans are all susceptible to delays and cost overruns that would not only affect their profitability, but also the stock price and valuation.

  • Reliance on Government Regulations: There are constant changes in government policies and regulations, especially as it relates to the energy transition or energy trading, which could be disruptive for their business. The company’s infrastructure is also subject to permitting and licensing issues, which may lead to project delays or even project cancellation.

  • Technological Disruption: While the natural gas industry itself might be stable, there are other technologies that could disrupt the energy sector in the future. Also, many of NFE’s projects involve complex technologies, which may become quickly obsolete or replaced with newer, more cost-effective solutions from its peers.

  • Financial Risk: NFE has high leverage and may rely on debt to fund their business. These may lead to higher expenses, and potentially reduce cash flow or lead to default on their debt obligations.

  • Geopolitical Risk: NFE is vulnerable to geopolitical risks, such as sanctions, regulations, and political instability, especially when doing business outside of its own region. This could cause delays or even cancellation of operations and development projects.

  • Dependence on Key Personnel and Third Parties: There is a reliance on the skills and experience of a few executives and key technical managers that would impact operations in case of their departure. Likewise, its reliance on external vendors and suppliers (such as shipbuilding, project management, etc) could also pose a risk, in the event those third parties no longer can deliver the required products or services.

Financial Analysis

  • Revenues:

    • NFE’s total revenue for the first nine months of 2023 reached over $1.7 billion, a significant increase compared to the same period in 2022. In the three months ended September 30, 2023, NFE recognized a total of $662 million in revenues. The company’s financials are driven by the delivery of gas and electricity and these segments generated over 90% of the company’s revenues for the third quarter of 2023.
    • The growth from year-to-year is primarily attributable to new facilities reaching operational status, implying higher contractual volumes of deliveries to existing customers.

These high revenues are primarily from its existing operations. Its earnings are very dependent on its ability to successfully bring new facilities and contracts online.

  • Operating Margins: The company reported a gross profit of around $500 million in first three months of 2023, and gross profit of $1.2 Billion for first nine months of 2023, compared to $1.19 Billion for the entire year 2022. Operating margins have also increased, and the company reports a consolidated operating margin of around 14% for Q3. However, the company states that the operating margin is very volatile due to changes in market conditions and other factors outside their direct control.

Even though gross and operating margins have improved significantly, the ability to consistently maintain profitability will depend on how well the company manages its cost structure and their existing contractual obligations, as well as the larger macro environment.

  • Profitability: The company has had volatile profits, in addition, the company is rapidly expanding. Given those dynamics, profitability can vary a lot. Net loss attributed to the common shareholders was about $72 million for Q3, 2023 (compared to a profit of $98 million in the last quarter). This represents the company continuing its efforts to expand and make its operations profitable. For first nine months of 2023, net loss was $54 million (compared to $489 million profit in 2022) suggesting, while the revenue is good, profitability continues to remain a major area of focus for management.

While revenues and operating margins look promising, NFE needs to do a lot more work to bring profitability to a more stable place. Investors should consider the volatile earnings and large losses carefully.

  • Cash Flow: The company has positive cash flow, though that depends heavily on expansion and the start of new operations. FCF from operations for first nine months is approximately $450 million for first nine months of 2023.

While cash flows are improving, they remain volatile. Any short-term changes to contracts or prices could immediately affect cash flows. The cash flow generation is not consistent and mainly due to the timing of capital expenditures.

  • Debt & Capital Structure: The company’s capital structure has shifted from majority equity to a large amount of debt over the last few years, owing to its need to fund large scale projects and operations. A large portion of the company’s debt is floating-rate, exposing them to fluctuations in interest rates. The company’s current debt to equity stands at 2.2x. The company’s current liquidity position is also quite weak, with current liabilities exceeding the assets, indicating a negative working capital. The company’s long-term debt is also very substantial. The debt includes both recourse and non-recourse debt, as detailed in their balance sheet.

The high level of debt and the interest expense associated with it means that NFE’s finances can be quickly affected with changes in interest rates or in the company’s cash flows.

*   **Guidance and Future Outlook**: In its third quarter earnings presentation in 2023, NFE stated that it expects the full year EBITDA to be $1.1 to $1.3 billion, showing some optimism in its operations for this year. However, with so much complexity in its growth stage, forecasting becomes difficult, and should be interpreted cautiously.

  • Recent Issues:

    • The company is currently facing issues related to increased cost of the expansion of its Port Arthur project and some uncertainty over timelines of its completion. Further, the credit rating agency Moody’s recently changed its outlook of the company to “negative” from “stable” which reflects some concerns about liquidity and future profitability.
    • The company has announced a deal to acquire a new business (FLNG) to expand its operations. While this seems beneficial on paper, it introduces execution risk and integration risk which would need to be monitored closely.

  • Management’s View: Management reiterated in the earnings calls that the company’s focus is now on execution and profitability. The company believes that it can deliver the value for its shareholders in the long run. Management has been working to diversify the risk of their contracts, and improve their overall risk profile. Management is optimistic in the long run about the growth opportunity for LNG and natural gas and its role in the energy transition.

Understandability Assessment

  • Rating: 3 / 5

  • Justification:

    • NFE’s business can be difficult to understand fully because of the nuances in pricing LNG, the complex processes in building LNG infrastructure, and the technical aspects of their operations, all while operating in many regions across the world.
    • While the basic concepts (production and distribution of LNG) are not difficult, the company’s financial statements can be difficult for many investors to understand due to all the adjustments, especially when it comes to the treatment of debt. The company also reports a lot of its projects using different metrics, making it difficult to reconcile their operations.

Balance Sheet Health Assessment

  • Rating: 2 / 5

  • Justification:

    • The company has a very high debt burden with a debt to equity ratio of more than 2x. While the assets may be there, this high leverage makes it risky. It also makes the earnings very sensitive to interest rate increases. A large percentage of the company’s debt is also in floating-rate instruments that makes the situation even worse. Also, if the company has any downturn in their revenues, they may not be able to service the debt.

    • The company also has a negative working capital due to the current liabilities exceeding its current assets, which is always a risky proposition for any company.

    • The company has substantial intangible assets including goodwill on its balance sheets that are inherently difficult to quantify accurately, creating further ambiguity about the actual quality of the company’s assets.

    • Therefore, the company has a rather weak and unhealthy balance sheet, and needs to bring down debt levels to improve its financial position. The company needs to demonstrate the sustainability of its business before its debt levels improve.