A Good Bet for Natural Gas Exposure

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser.

With the interest in commodities rising, we thought we'd take a look at a liquified natural gas firm with great growth potential. I'm here today with Allen Good. He's a stock analyst, and we're going to talk about BG Group.

Allen, thanks for talking with me today.

Allen Good: Thanks for having me.

Glaser: So, let's just start from the beginning. Can you give us a little bit of background on BG Group, such as what its business is, and why you think its growth could expand in the future?

Good: Absolutely. BG is what we like to call an integrated gas major with a very unique business model. So, in contrast to Exxon or Chevron, who focuses on oil refining and selling, BG focuses on natural gas, and it does this through LNG. The firm is very early in capturing low-cost stranded resources in countries with typically low domestic demand for natural gas. BG takes this natural gas, super-cools it, and transports it to very high-value markets in Asia, the United States, or Europe. So, as opposed to oil, the firm focuses on natural gas.

However, going out further, BG really has some great growth opportunities, not only here in the U.S. through shale gas, but also in Australia through a coal-seam methane gas that it could also convert into LNG and sell into Asia. And then most prominently, the firm is positioned in presalt offshore Brazil, which offers BG the opportunity to increase production almost by 500,000 barrels during the next decade, which all should be primarily oil.

Glaser: So that seems like it could be lot of growth, but what are some of the things that could go wrong with the story? What are some of the potential headwinds that BG could run into?

Good: Right now, BG has locked in its LNG profits for the next couple of years in anticipation of a tighter LNG market post-2013, which should lead to higher profits. If for some reason that market doesn't develop, then our profit forecast wouldn't necessarily come to fruition. Also in Brazil, BG is relying on Petrobras, the Brazilian state-owned government oil company, to develop those fields. So, if for some reason, Petrobras becomes overburdened with the amount of responsibility it currently has or it is unable to develop these fields on time, those growth projections could be moved further out into the future.

Also with Australia, there is a risk that Asian markets will be oversupplied with LNG, creating lower prices for this Australia LNG. There is also the potential for LNG prices to be delinked from oil like they are currently priced, which would ultimately result in lower profits, as well.

Glaser: Let's talk about valuation. Usually when there is big growth story often you have to pay a lot for it. Is that the case here?

Good: Well, right now actually BG had a recent runup but has pulled back recently. It had some sort of disappointing first-quarter earnings. We think the earnings reflected just some short-term factors that shouldn't play out in the long term. We still like the growth story. Right now, they trade at about 7 times our 2011 EBITDA estimate, which we think is rather reasonable given the growth story. Our valuation of about $155 per share is about 9.5 times 2011 EBITDA and about 8 times our 2012 EBITDA.

So, we still think that's reasonable, given the premium that you should often pay for this growth. Also given this growth, BG is a very solid company nonetheless. A lot of its profits, like I mentioned, are locked in for the next couple of years. So, we think there is little risk to our EBITDA estimates for the next couple of years. And though the growth is maybe five years out, we like the prospects nonetheless, so we think the premium multiple is still worthwhile.

Glaser: So, for people who are looking to get into LNG space, it seems like a good place to do it.

Good: Absolutely.

Glaser: Allen, thanks so much talking with me today.

Good: Thanks for having me.

Glaser: For Morningstar, I am Jeremy Glaser.