Sempra Energy (NYSE:SRE) was among the first wave of US companies that applied to federal regulators to build projects that liquefy and export natural gas following the shale gas boom of the 2000s. Its Cameron LNG project in Louisiana has encountered some problems since then, but are they serious enough for investors to consider steering clear of Sempra as an investment?
Cameron LNG is a massive project in terms of both size and cost. The first phase of three phases of Cameron, known as Train One, started operating in August and cost roughly $10 billion to construct. But even with that type of capital expended, the project represents only a small fraction of what Sempra does. San Diego-based Sempra is a utility holding company with more than US$60 billion in assets, including electric and gas distribution in the US and South America, and it’s the 10th largest utility stock in the US. The company has a market capitalization over US$41 billion and posted more than $11 billion in revenue for 2018.
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What’s gone wrong with Cameron?
The project has faced extensive delays and cost overruns based on flooding and other weather-related events. In addition, one of the project’s main contractors is McDermott (MDR), whose financial condition has been badly hurt by delays at Cameron and other projects. Cameron is more than a year behind schedule and roughly 97% complete, according to the credit rating agency Moody’s. Trains 2 and 3 of the project are expected to start commercial operations Q1 and Q3 2020, respectively.
Cameron LNG was also flagged by the US Pipeline and Hazardous Materials Safety Administration for failing to report the “unintentional release of LNG” on January 9 and May 15 as it was getting ready to launch operations. In September the project declared force majeure, meaning an unforeseen issue kept the project from fulfilling its contractual obligations. Details on the incident were scarce, but a spokesperson from Cameron LNG later attributed it to an “electrical issue,” and said the issue has since been resolved.
The case for “make”
Sempra has not yet relied on Cameron as a profit center and the company has fared pretty well with its other businesses. In Q3, for example, the company posted adjusted earnings of $1.50 per share, ahead of the analyst projection of $1.23 per share. And Sempra has partners on Cameron LNG, so it does not have to handle all the risk alone. The project’s co-owners include France’s Total (NYSE:TOT), and Japan’s Mitsubishi Corporation and Mitsui. All three co-owners also have 20-year contracts in place to buy LNG from Cameron, each for one-third of the project’s total production. The contract counterparties are obligated under “use or pay” agreements, meaning they must pay for the LNG produced by the project whether they need it or not. This is good news for Sempra because it means the project is insulated from commodity price exposure.
Once all three phases of the project are in place, Sempra projects its share of full run-rate earnings from the three trains at Cameron LNG between $400 million and $450 million annually. Train One of the project didn’t have much time to contribute to Sempra’s Q3 earnings, but management said its operation did help offset a loss in the LNG division.
The case for “break”
If delays on Cameron LNG continue, the negative impact could impact the company as a whole. A delay in the expected 2020 completion of Cameron could impair Sempra’s ability to report credit metrics adequate for its credit profile as soon as next year, according to a report from Moody’s. “These credit metrics include cash flow from operations pre-working capital to debt well in excess of 16%,” Moody’s said. There is also a risk that debtholders on the project could call on completion guarantees from the project sponsors as early as Sept. 30, 2021, if the project is not complete. The guarantees total more than $7 billion based on the project’s large size and complexity. However, the risk of the banks calling on the sponsors’ guarantees remains “modest,” Moody’s said, based on the project’s advanced stage of construction.
The verdict
Sempra’s Cameron LNG project has encountered some bumps in its road to starting production, and the risk remains that additional phases of the project will not meet targets for completion. A bankruptcy from the project’s contractor McDermott could further complicate things if it does not find a way to reach an agreement with lenders. But based on Sempra’s strong utility base, its move into US LNG export should represent an opportunity for improved earnings for the long-term investor rather than a cause for alarm. Once near-term uncertainty and start-up kinks subside, Cameron LNG has the potential to “make” Sempra into a viable option for investors looking to add a utility stock with some diversity in the assets it holds.
