Operating Room

When the US Will Press the Gas Pedal The crisis surrounding the annexation of Crimea is pushing Europe to look for an alternative natural gas supplier to Russia, and in the US, public pressure is building to increase natural gas exports to Asia and Europe ■ What developments are expected in this area, in what time frame, and who can benefit from them April 3, 2014 by Kobi Feller March has ended, with stock indices traded amid growing volatility, due to rising uncertainty. The latter is mainly attributed to the tension between the US and Europe and Russia, but also to a slowdown in China and the upcoming annual report season, which will reveal the harsh winter's impact on last year's results and earning forecasts for the entire year. In any economic or other event which takes place in the world, there are winners and losers. The latest tensions surrounding the annexation of the Crimean peninsula has underscored European countries' need to find an alternative energy provider to Russia, which currently provides, on average, approximately 30% of the continent's energy needs. Russia is also the world's second largest exporter of oil, and its conduct poses a political and economic challenge to many other countries. The talks between the US and Europe, which begin today, and the debate among European countries regarding their need for energy independence, are expressed in a letter presented by the leaders of Poland, Hungary, the Czech Republic and Slovakia to the speaker of the US House of Representatives, John Boehner, in which they describe the adverse effects of the 2006 and 2009 natural gas crises on their countries. They are pressuring the US to reach a decision about increasing its LNG exports, saying that natural gas can be supplied to Ukraine via their countries, at rates even lower than those which Russia charges Ukraine. In the US, which is at the height of an energy revolution to increase its use of fossil natural gas available for production, there is a growing call to amend the legislation so as to increase overall natural gas export quotas, and also to include in them countries with which the US has no free trade agreements. European countries have not, of course, made a strategic decision to decrease their dependence on Russia, and it is difficult to assess whether such a decision will be made in the near future due to the need for massive infrastructure adjustments, which take a long time. However, the very future potential inherent in such a decision has sent us to examine what companies

in the gas production and transportation business, as well as in adjacent fields, can benefit from a future US policy change. Sail Away The increase in demand for natural gas is significant, and comes mainly from the US and Asia, especially China, where the demand for LNG is growing at a rate which is expected to reach 15% this year. According to estimates, China will become the world's largest importer of LNG by 2020. Following the harsh winter, the US's natural gas reserves are at an 11-year low, and are expected to support current prices. Canada, the US and Australia have approved - and are expected to approve - large investments in LNG projects, but the latter will only mature in 2016-2017. On the other hand, the increase in the US's LPG exports, which is expected in the next two years, already creates opportunities for companies specializing in shipbuilding and freight in the short term. According to estimates, by 2016, LPG exports - mainly to Asia - are expected to double in relation to 2013. After this year, the demand and supply equation for freight ships is expected to balance out and, in addition, the expansion of the Panama Canal is expected to shorten the supply route to Asia, which may, in turn, reduce freight charges. The impact of a possible increase in the US's energy exports may be reflected in a significant number of fields, such as the building of freight vessels, production and exports of natural gas from the US, exports of distillates, LPG and LNG, etc. The natural gas production field in the US looks promising regardless of the talks, due to the increased consumption of natural gas in the US. However, the increase of exports from the US is a long process and has long term consequences. This fact makes the investment in various companies in this field suitable for investors with a long investment time horizon, who have patience to follow the numerous changes which are expected in this area in the months and years to come. LNG and LPG. There are two types of natural gas which are transported using vessels, and they are markedly different from one another. LNG (Liquified Natural Gas) is natural gas which has undergone liquification for transportation purposes. It is extracted from either land-based or offshore wells, such as those found near Israel's coastline. LPG (Liquified Petroleum Gas), a by-product of the oil distillation process, is more readily available and requires smaller capital investments. LPG is mainly intended for home use, such as cooking or heating, while LNG has numerous uses which include production plants and heavy machinery.

Which stocks will take off once the US increases its energy exports to Asia? SAMSUNG HEAVY [KS.010140] This is the world's third largest shipbuilding company, half of whose revenues are derived from building vessels carrying LNG and the remainder from constructing offshore natural gas rigs. The decrease in the company's stock price brought it to a historical low in relation to its 2014 order backlog, which was up 10%, reaching $14.6 billion. According to our estimate, the company's earnings', which slumped in 2013, are expected to grow by 25%.   

Target price: 43 thousand won P/E ratio for 2014: 9.8 Dividend for 2014: 1.5%

MEMORIAL PRODUCTION [MEMP] This company represents the MLP71 field (an association similar to an exploration partnership, which enjoys tax benefits), specializing in natural gas production in the US, and has proven 16-year gas reserves. It is exploring for natural gas mainly in Louisiana, Texas, and California, and is also extending its natural gas reserves through M&As. According to our estimate, gas prices are expected to remain stable, with possible increases in case of an expansion in the US's natural gas exports. Thus, an upside should be expected in relation to the stock's current price.   

Target price: $25 P/E ratio 2014: 10.8 Dividend for 2014: 9.6%

STEALTHGAS [GASS] This Greek sea freight company has 40 ships - the world's largest fleet for LPG freight - in addition to a small number of vessels for transporting distillates. The company is aiming to increase the size of its fleet and upgrade it. Thus, if the US will increase its LPG exports to Europe, the company is well positioned to take part in this process. The company's downside is its small market cap, which increases the risk embodied in this investment. The company is traded at an EV/EBITDA ratio of only 4.6 in relation to its expected 2014 results.

  

Target price: $14 P/E ratio 2014: 9 Dividend for 2014: not expected

SCORPIO TANKERS [STNG] This is a shipping company which specializes in transporting petroleum distillates. Fifty seven ships are currently being built for the company, and when they are completed, by the first quarter of 2016, it will have the world's largest fleet for transporting petroleum and its distillates. In addition, the company has holdings in vessels specializing in transporting LPG. This year, the company expects to post a $67 million profit, which is expected to rise to $190 million when the new fleet is ready in 2016. Its EV/EBITIDA ratio will reach 16 this year, and is expected to go down to 6.7 in 2016. Target price: $13 P/E ratio for 2014: 28.6 Dividend for 2014: 3.3% * The author is Chief Investments Officer for UBS Wealth Management Israel Ltd. The author of the article and/or the company may have a personal interest in the subject. The above does not constitute investment marketing and/or consulting, which take into account each person's own situation and needs.