New Fortress Energy Inc. Q2 FY2021 Earnings Call

Good day, and thank you for standing by. Welcome to the New Fortress Energy Second Quarter 2021 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Josh Kane. Please go ahead. Thank you. I would like to welcome you to the New Fortress Energy Second Quarter 2021 Earnings Call. Joining me here today are Wes Edens, our CEO and Chairman of the Board; Chris Guinta, our Chief Financial Officer; and Andrew Dete, Managing Director, leading our Brazil efforts. Throughout the call, we are going to reference the earnings supplement that was posted to the New Fortress Energy website. If you've not already done so, I'd suggest that you download it now. In addition, we'll be discussing some non-GAAP financial measures during the call today. The reconciliations of those measures to the most directly comparable GAAP measures can be found in the earnings supplement. Before I turn the call over to Wes, I would like to point out that certain statements made today will be forward-looking statements including regarding future earnings. These statements, by their nature, are uncertain and may differ materially from actual results. We encourage you to review the disclaimers in our press release and investor presentation regarding non-GAAP financial measures and forward-looking statements and review the risk factors contained in our quarterly report filed with the SEC. Now I'd like to turn the call over to Wes.

Great. Thanks very much, Josh, and welcome everyone. As always, we'll refer to the investor presentation, which we posted to the website, as Josh said. But before we get into that, I have just a couple of thoughts. It's been an extraordinary quarter for us and a remarkable six months thus far this year. Our company is in the energy transition business. No surprise, the world needs to decarbonize and do so quickly, and our business is to do so while addressing both energy poverty and energy inequality while also making significant returns for shareholders as we do so. My goal is to be the world's leading company in the energy transition space, and we're making pretty good progress on it thus far this year. What we have today, just to level set, is the constellation of terminals and operations in countries around the world: Jamaica, Puerto Rico, Mexico, Nicaragua, Brazil, Ireland, Sri Lanka. It's a geography test that spans the world that has established all these assets and terminals. Now that we've made the investments and done much of the hard work, I expect that each of these markets will show incremental and substantial organic growth from this point forward. We should expect to see, one, more power plants switching to gas in places like Puerto Rico and Mexico; two, new power plants being built in places like Brazil; and three, soon, you'll see bunkering using LNG as marine fuel in places like Jamaica as a hub. We've already paid for the operations, we've already paid for the infrastructure, we have a massive competitive advantage that is both financial and temporal, and I believe we're going to show tremendous organic growth across the portfolio in the months to come. Second of all, earlier this year, we made the decision to introduce FLNG into our portfolio and go FID on our first project earlier back in March. I believe that the path we're following in FLNG will change the liquefaction of LNG around the world, and it is already doing so. Faster and cheaper liquefier construction combined with access to stranded gas is a powerful combination. The technical solution we have is on time and on budget. Cheaper feedstock represents a big cost advantage to our business but also provides the host countries a path to develop homegrown power and economic activity they desperately need. It's a big win for both sides. It's a huge step for us as a company. Lastly, true energy transition long-term means clean fuels. Natural gas is much better than oil and diesel; it's cheaper, it's much cleaner, but the real goal is clean hydrogen-based fuels like hydrogen, ammonia, methanol, etc. The first part of that journey for us is to identify the problem, which we have, and then come up with a plan to solve it. It's crystal clear to me what the problem is and what the solution needs to be, and now it's simply a matter of executing. The first industry you're likely to see be decarbonized in a material way is the shipping industry, and it's already happening. Alternative fuels make up just 3% of the fleet in the water today, yet make up over 30% of the ships being built in shipyards. The first deal will be LNG, soon to be followed by hydrogen-based fuels. This represents a gigantic opportunity, and our goal is to be a big part of the solution and we have the terminals and infrastructure to be a part of that. So it's been a very good start to the year. With that, now let's turn to the quarter itself and start with Page number 4. We have several significant highlights to report this quarter, but it all starts with earnings. Significant increases in Q2 2021 operating segment operating margins with further increases expected in Q3. If you look at Page number 5, not to skip around too much, we lay out by quarters over the last year and then what we expect this year to happen, and you can see that we are making material strides now in actually transforming from a development company into an operating company. Q2 last year had $15 million in operating margin, Q2 this year we recorded $130 million. Our expectation is approximately $210 million for Q3 and $170 million in Q4. Those are expectations based on what we see right now. Given that we're roughly halfway through Q3, I feel very good about the forecast we have there. We'll talk about this more in detail, but you can see clearly the benefits of not only the terminals themselves coming online but also the diversification of income sources to go from terminal operations to ships, third-party contracts, gas sales, merchant power operations, etc. Our business is diversifying by the day and is growing materially. My expectation for next year is that we'll be over $1 billion in operating margin. In 2023, $1.25 billion, and this is all without any incremental benefit from FLNG or any incremental benefit from Ireland, and no material economic benefit from the organic growth that I expect to see across the portfolio. So we really are at an inflection point as a company from an earnings perspective, and I think there's much more to come. The big story for the quarter and for the year thus far is really gas, and I'll talk about that in some detail. But our gas position today is essentially flat after the portfolio purchases we've made this year. I say we make a lot of bad decisions around here, but we do make a few good ones, and the decision to take the volatility out of our business has been a very good one. At a time when market prices have increased by roughly 50% in the last few months, we have essentially very little to no volatility in our business. In fact, that volatility now creates gas and merchant power opportunities, and Andrew will talk about some of the developments we've seen in Brazil in just a second. Three is liquidity. We expect our projects to be self-funded between financing and asset sales. Chris will detail that in his section, but the bottom line is everything we've committed to can be paid for ourselves. We recently committed on the first leg of our Jamalco sale leaseback, which funded in the last couple of days. We expect the ship financing to fund later this quarter, but we're very much on track from a liquidity standpoint to pay for everything we've done and to be internally financed, which is my goal. Last, what I already mentioned, the fast LNG; we're making significant progress with the technical work. We're on time and on budget, and we have a lot to discuss there. The gas sourcing has been very productive, and we expect to announce our gas source in the next 60 to 90 days. With that, let's flip to Page number 6 and just by way of recap. Over the last six years, we've been largely focused on development, and today, many of the projects are either completed or are nearing completion. As I said, we're very focused on operations and organic growth. 2016, almost to the day, was the first contract we signed with JPS, the utility in Jamaica. In 2016, we had one LNG import facility, operating margins of negative $7 million. Today, this year, we expect six terminals up and operating by the end of the year for a total margin of $550 million; by 2022, we expect 11 terminals for $1 billion. We've invested over $7 billion in these projects over the years. We made enormous investments in both time and money and are now seeing the economic benefit of all those assets. If we look at Page number 7, you can see this is the map that illustrates our assets. We have a significant presence in the Caribbean, Mexico, Central America, and South America. Our first investment in Asia is in Colombo, Sri Lanka, with more exploratory projects on the horizon. However, the focus of our organization has shifted from new markets—though we still have a few material opportunities—to optimizing our current operations and existing terminals around the globe. The path ahead is clear. Energy poverty is a very real issue. The chart on the left side shows this very graphically. Electricity consumption in the United States is 11,500 kilowatts per person, while Nicaragua is at the bottom of the scale with 552. The gap creates tremendous disparities concerning both health and economics and is one that our activities can address. Sustainability and the energy transition are a must. 51 billion tons of greenhouse gases are emitted annually, and enormous adverse weather events are occurring daily. It is no surprise that the entire world is awakening to this as an issue of our generation that needs immediate addressing. Just this morning, Exxon announced that they intend to be carbon-free by 2050. They are among many companies undertaking decarbonization initiatives, which we believe will only accelerate. This creates not just massive problems, but also vast opportunities for companies like ours. If we look at the gas component, you can see that since last quarter, we procured about 50 cargoes and are now fully committed for the demand that we have booked for the next six years. The chart on the left side shows by year the cargo requirements we expect to meet customer needs. The average cost of our LNG portfolio right now is Henry Hub, times 115, plus 256. This is a material discount to current market prices. We do not intend for the LNG book to be a trading book, and we are pleased to have reduced our volatility in this aspect while effectively matching our demand and obtaining this at a price that is below the market rate, allowing us to avoid LNG price volatility in the future. Briefly, let's discuss the FLNG before I turn it over to Andrew to talk about Brazil. This is the graphic we presented before showing how the system works. The point of it is twofold. One, is to modify existing marine infrastructure to serve as a liquefier. We acquired jack-up rigs, and we are currently prepping them to our specifications. They will be deployed offshore. This allows us to liquefy stranded offshore gas and provide a technical solution that's faster and cheaper. The opportunity is substantial. Stranded gas exists worldwide in different geographies, and to date, there are only 7 FLNGs operational or in development, which represents less than 3% of our assessment of the total market. Thus, significant access to solutions for these stranded fields is imperative, and we believe we have the right tools for the job. Reflecting on past experiences, I recall investing in a modular housing company years ago. I found that building a home in a factory is quicker and more cost-effective than traditional building methods. Modular housing offered a 20% cost reduction, with savings in time greater at around 40-50%. We see parallels here with our business because we are constructing a factory for liquefiers, employing equipment designed for efficiency rather than assembling them at the project site. Traditional liquefaction is costly, up to $600 million to $700 million a ton, and it's a lengthy process often requiring professionals from around the globe to oversee production. Building in a shipyard gives us access to qualified personnel, allowing for a quicker, less expensive process. We anticipate 30%-40% savings, with even further reductions in time at around 75%. Thus, we're confident we are progressing as originally planned and see the potential for greater reliability, cost savings, and efficiency. We acquired two jack-up rigs for slightly over $31 million, effectively purchased at scrap prices. They are now in a shipyard for refurbishment. The goal is to prepare them for installation in the second half of next year. I'll turn it over to Andrew Dete to discuss results.

Thanks, Wes. Hey, everyone. Great to talk with you again and excited to share more on our business in Brazil with you. Our two goals today are to provide insights into our macro views on Brazil and discuss the commercial momentum we're experiencing. Let's start with Page 18, which simplifies our message regarding Brazil's current situation on both power and gas. In Brazil today, hydro shortages are leading to power shortages since the electric grid relies approximately 65%-75% on hydroelectric power. We have about 200 hydro stations in the country, but we've seen sustained hydrological shortages over the past seven years. This year, we could see acute hydro shortages resulting in nationwide power shortages. To compensate, we rely on thermal dispatchable power, activating all the natural gas plants and some oil-fired plants. Consequently, this creates gas shortages, and that's where we see a significant opportunity for New Fortress Energy. Page 19 provides insights into what we're experiencing. In 2021, we're 50% below the 20-year average for water inflows into Brazilian reservoirs, and more importantly, we've seen a sustained downward trend. Typically, we'd expect some reservoir management to address this. However, the ongoing downward trend means higher reliance on thermal generation, which is not built to sustain the system. The result? Recently, spot power prices are 10 times above the 20-year average. This spike arose from the need to power gas-fired plants and older, inefficient diesel-fired plants as well. Regarding gas, on Page 20, we illustrate the domestic gas demand dynamics without thermal power demand (the blue box) alongside domestic gas supply (the gold bar). Meeting thermal demand increases gas requirements by over 65%. With declining Bolivian gas supply, inflated LNG prices, and limited LNG terminals available, the situation creates challenges for our competitors. Fortunately, as an LNG provider not reliant on domestic gas, we hold significant value in the current landscape where massive shortages exist. The right side of Page 20 follows the narrative we discussed; high spot prices, illustrating that the Brazilian system isn't equipped for the current crisis, were reiterated by Petrobras's recent announcement regarding gas supply agreements in the Northeast, where our Suape terminal is located. How do we translate this into opportunity for NFE? We're operating our 1.5 GW GP power plant and dispatching 100% of availability, receiving capacity payments. The Suape plant, with 288 MW, is the next thermal power plant in Brazil that can be turned on fastest this Q4. By our analysis, this is of strategic national interest, as reflected in our relationships with regulators. The Barcarena Power Plant, expected in Q1 2025, will be a key player. We have contracts signed for our Barcarena LNG terminal and our Santa Catarina LNG terminal is on track for Q1. We're negotiating an MoU with Norsk Hydro for 1 million gallons a day at our Barcarena terminal and just signed an agreement for 1.4 million gallons a day at the Suape terminal. These agreements demonstrate the value of our terminals amid current supply shortages. Our off-grade business is gaining momentum with three exciting agreements: Two with SCGas in Santa Catarina (66,000 gallons a day) and one with a pulp and paper customer (50,000 gallons a day). Additionally, we've partnered with Gastro Perra at our Barcarena terminal (88,000 gallons a day) with considerable growth potential. We see a total opportunity of $750 million in Brazil, and we're raising our base case from $410 million to $525 million due to the impressive momentum in power, gas sales, and off-grid development. We're particularly enthusiastic about the terminal side, including building new power and expanding emergency power facilities, as well as off-grid opportunities to supply municipalities and industrial customers. As we consolidate from the Hygo acquisition, we reflect on three key takeaways: First, Brazil presents a high-volume gas supply opportunity with over 200 million people and limited infrastructure. With the new gas law accelerating the reduction of Petrobras' monopoly, we see strong margins in this business. Second, acquiring Hygo provides us strategic terminals in advanced stages of development, enabling us to leverage permitting work completed by the Hygo team for efficient terminal activation in Q1 2022. Lastly, we continue to pursue off-grid partnerships, driven by high diesel prices in Brazil creating strong value propositions across our terminals.

Thanks, Andrew, and good morning, everybody. A couple of important points to mention. Please turn to Page 24 in the presentation. With the Hygo and GMLP transactions closing on April 15th, this is the first quarter where our consolidated financial statements reflect the performance of those newly acquired assets and subsidiaries. Therefore, I wanted to clarify the cash flow changes displayed throughout the financials, footnotes, and the MD&A included in the 10-Q. This quarter, we're breaking out results into two operating segments called the Terminals & Infrastructure segment and our Ships segment. Previously, volumes indicated revenues, but we now have a more diversified collection of cash flow. Our Terminals and Infrastructure segment profits via gas sales at regasification terminals, power sales (including capacity payments, long-term PPA sales, and merchant revenues), direct-to-consumer small-scale gas and power sales, and LNG cargo trading activities. Our Ship segment earns from long-term charters to third parties and spot market trading. The nuance here is that as vessels go off hire to third parties to be utilized in our downstream gas sales, costs will flow through the operating expense in the terminals and infrastructure segment. A key note is regarding the accounting treatment for entities not fully controlled, such as the Sergipe power plant, co-owned with our Brazilian partner, and the Hilli, co-owned with Golar. Our share of the operating income from Sergipe and Hilli will appear in the income from equity method investments but will contribute to segments as outlined in the MD&A. As for financial performance in Q2, we sold an average of just under 1.5 million gallons per day earning $224 million in revenue. The Terminals & Infrastructure segment had an operating margin of $55 million, an increase of $12 million from the prior quarter, while the Ship segment had a $76 million operating margin, slightly above initial expectations when we made the acquisition. We added around $2.3 billion in debt, made up of $1.7 billion raised at the NFE corporate level and approximately $660 million assumed from the transactions. Most of this is from sale leasebacks, detailed in the notes of the financial statements. As shown on Slide 25, I would like to communicate the SG&A costs incurred running our business, broken down into core operations and growth. The total SG&A has been affected by elevated costs during Q2 due to merger costs. Core SG&A involves unavoidable expenses necessary for day-to-day operations. Growth SG&A covers costs attributable to our expansion efforts. Ultimately, optimizing core business operations can be done for around $40 million annually, but our gross SG&A reflects our commitment to invest in opportunities that will generate increased cash flows over time. Turning to the next slide, we can see that our projects under construction will be self-funded through a combination of cash flows from operations, ship financing, and asset sales. The left side uses total $1.6 billion, covering the construction costs for all our terminals, including those in Brazil, Ireland, and Sri Lanka. Recently, we established a $75 million letter of credit facility to facilitate working capital regarding LNG cargo purchases and initial asset-level financing. Our Jamalco power plant sale-leaseback transaction is progressing well, with approximately $100 million funded to date. Our ship financing facility is currently in the market, with $300 million committed and robust interest surrounding the remaining balance. This facility, backed by nine vessels, has a three-year term, priced at L-plus 300. We're confident that our portfolio of stable cash flow assets can be utilized for asset-level financing or sale leasebacks. We believe there's over $2 billion of potential proceeds against these assets. With that, I’ll turn it back to Wes.

Great, thanks. So, I included a section on valuation in this discussion. Reflecting on the year, it’s worth noting that the decisions made to acquire the two large corporate assets were pivotal. In considering the total $7 billion investment to date, projecting $1 billion in expected margins, it yields about a 15% return. Comparatively, $1.25 billion in margins will bring this to 18% and $2 billion yields 28%. Such attractive yield rates are significantly advantageous in the global infrastructure investment landscape, where rare yields exist. More importantly, the investments made today are already generating revenue and we expect increased returns as economic activities related to the energy transition rise. Energy transition is one of the strongest movements globally. The drive for decarbonization and associated investment opportunities position our company favorably for the future. We’re at a point where tangible economic results are starting to emerge, and this year has been pivotal for growth. We hope to engage further with all parties to present the value and opportunity our company embodies. Thus, I encourage continued dialogue and look forward to addressing any further questions. Thank you to everyone for participating today.

Your first question comes from Spiro Dounis, Credit Suisse.

Hey, good morning. First one for you. The slides pointed to a transition in the current year, going from a development company to an operating company. I feel like this is probably the first quarter where we haven't really seen a sort of new big initiative announced. So curious, is this kind of the pivot now towards full-bore execution on the products in front of you and what you see is what you get?

No. We actually have made announcements this quarter, including an agreement in Sri Lanka, home to 20 million people without a natural gas line. We view this is a huge opportunity. A variety of new opportunities are ahead, but what's evident is that with our current business list, we can generate billions in repeatable income using existing assets. The company is progressing through three phases: development, commercialization—where we are currently in Brazil—and operations. We’ve passed the development stage. The assets now in place change everything. Onsite infrastructure is impressive. Efficient operations are achievable as we have extensive operating experience across numerous businesses. Our focus is to operate efficiently and safely while exploiting the tremendous value these assets hold.

Got it. Understood. That's helpful. Just curious if you could clarify whether you think at least one of those new opportunities could be in Asia?

Asia and Africa are significant markets for us. Central and South America still hold great promise. It is crucial to note that our priorities revolve around the assets themselves, and their potential for increased usage leads to tremendous opportunities. You're right; the infrastructure we provide creates significant opportunities for gas power and cleaner fuels. Much of our existing work over the years is peaking, culminating in increasing demand on these resources. We anticipate the execution of these projects will present benefits both economically and environmentally.

Got it. Understood. Thanks.

Hey Spiro, it's Chris. Just to clarify about the timing of our capital expenditures and cash flows. When we take FID on a new terminal or power plant, the development cycle generally lasts between 9 to 18 months, depending on various factors. Initially, costs represent around 10% of total capex in the early stages, ramping up to 50% in the second half of the timeline. This allows for cash flow opportunities to match our expenditures, notably with 30% of costs bearing post-COD, providing an internal warranty against equipment metrics.

Got it, that's helpful. Thanks, Chris. Thank you, Wes.

Thanks, hey guys, good morning. I'm focusing on Brazil, Wes. You mentioned earlier about your competitive position. Obviously, the opening of the gas market is allowing new entrants. From your slides, it seems you are participating in public tenders for Suape, Santa Catarina. Can you talk about your competitive advantages in these markets?

The competitive landscape in Brazil is evolving, shifting away from the historical Petrobras monopoly. The country is vast and primarily reliant on hydro; we're now amid a serious drought affecting electric generation. In these dynamics, gas shortages arise, creating substantial demand, and we are capitalizing on these needs with our terminals strategically placed to mitigate costs and logistical challenges significantly. Our infrastructure, established ahead of the competition, creates a unique offering that other developers find hard to match.

There’s sizable competition in Brazil, given the volume of opportunities available. However, our position is primarily defined by our early stage advantages, strategic terminal locations, our existing relationship with regulators, and the commercial stability we offer through our LNG contracts versus Petrobras. This, combined with our flexibility, creates a strong competitive advantage.

Great. No, that's really helpful. And this one might also be for you. You highlighted $1.50 to $2.50 per MBtu margins for Brazil some months back. Do you anticipate higher margins in the future? Can you elaborate?

The margin estimates we’ve provided blend across various contexts, anticipating some fluctuations. The degree of off-grid business yields higher margins compared to pipeline-related volumes. However, overall pricing guidance remains in line with our previous estimations, while we're starting to see increased demand, inferring the possibility that our volume expectations may be underestimated.

Got it, great, and I appreciate it.

Thanks. Hey Wes, I know you guys are looking to accelerate FLNG development compared to previous projects. Understanding the earlier challenges with Golar’s partners over E&P development pace, how will you balance tolling agreements versus control of E&P to manage development pace more effectively?

The Hilli experience has been invaluable in understanding project challenges. Our focus is on working with current producers of oil fields that flare or reinject gas, where we aim to become an ofer for their surging energy needs. Our goal involves partnerships that foster long-term gas stability while also aiding in onshore power development in host countries.

Okay. Thanks for that. It's good to see former GMLP assets contributing. Have you identified new ways to utilize them internally since acquiring them?

We recognize the benefits of our integrated gas and shipping business model, which allows us to engage in various transactions effectively. High gas prices globally have created lucrative opportunities, particularly when we possess both gas and shipping infrastructures. The ongoing market conditions are proving this integration vital for enhanced performance.

Hey, great. Good morning. I want to focus on Brazil once more. I appreciate the update on the power challenges and how it accelerates NFE's opportunities. I'm curious about the contracts duration you're signing and the additional infrastructure being brought online by NFE and others, particularly if it serves as a bridge or long-term opportunity.

Our contracts represent both short- and long-term objectives. The Barcarena facility will likely lead conversations towards longer contract lengths due to consumer demand for pricing stability. Meanwhile, contracts on pipelines rest around five-year terms, establishing a balance relative to what customers are accustomed to under Petrobras' current agreements.

Okay, that's great color. I appreciate it. How do you view incremental margin potential as the company scales, potentially accelerating operating leverage as you build this unique logistics chain?

From a valuation perspective, the capital invested yields substantial returns. The expected margin for next year will enable us to display significant growth potential as we generate new income. If we achieve our organic growth target, the return multiplied can be quite significant given we have established assets with tangible revenue generation. The energy transition presents massive opportunity, and we will continue addressing the ever-increasing energy demand as we scale effectively. Thanks, everyone, for dialing in during the summer. I hope everyone has a great rest of August. Back in summer has arrived quickly. We're aiming for an investor hosted trip in September following COVID safety protocols. Thank you all.

This concludes today's conference call. You may now disconnect.