Wagon Wheels

The wagon wheel effect — it’s the thing that happens when you watch a covered wagon race across the plains and it looks like the wheels are moving backwards. If all you could see was the wheel, you'd think it was moving in the wrong direction. When you look at the whole wagon, it's clearly moving the other way. You don't think about it too much when you can see the whole wagon other than maybe "huh, that's interesting," or "why are people still driving wagons across the plains?"

Depending on what you pay attention to, your eyes can play tricks.‍ ‍

Earnings in reverse‍ ‍

Of the 22 quarters it’s reported since 2021, Cheniere has printed losses in six of them. It's lost money close to a third of the time. That's a backwards move for a business. Add in its enormous debt, about $26 billion, and you might think the company was racing towards a cliff.‍ ‍

Lots of investors require their investments to make money. Obvious, right? They do this for good reason: putting money into things that consistently lose it is just some weird form of charity.‍ ‍

On top of discerning investors making sound decisions about individual companies, many indices require their constituents make money. So, the investors holding index funds of those indices also require them to make money. A big group of investors just won't consider companies that make losses.‍ ‍

So, Cheniere losing money is bad? Negative profits cut out a huge section of potential investors in Cheniere. That’s bad for shares. If it truly operated at a loss, that would be bad for business, but…‍ ‍

The accountants said Cheniere lost money. Its cash balance says different. Cheniere's operation brought cash into the business in every quarter. It set up its business to knock down as much risk as possible. Those maneuvers, though, caused it to print negative profit.‍ ‍

Circle the Wagons‍ ‍

Cheniere agreed to long-term deals with customers. Some signed up for 20-years or more. The customers get locked-in volumes of liquid natural gas. At the other end of its operation, Cheniere signed long-term deals with natural gas suppliers to keep its economics fixed. It would profit from the difference between what it sold under the long-term customer arrangements and what it purchased under the long-term supply deals – basically a fee. It was mostly locked in.‍ ‍

If it’s taken out all that risk, why do its earnings look like a rattle snake chasing a jackrabbit?‍ ‍

The accountants saw something different. They saw those transaction tracks leading in different directions. They said the gas Cheniere agreed to purchase was a derivative. Any gains and losses would be marked to the current market price and run through the P&L. Big spikes in the price of natural gas? Big paper losses. Big dips in the price of natural gas? Big paper gains.‍ ‍

The company made steady cash and wild EPS. It grew the whole time. It now supplies 9% of the global LNG market. In part due to its success, the LNG market has become a global one. That globalization meant it could change its accounting. It meant that in Q2, Cheniere could move from this weird derivative accounting that doesn't really describe what's going on with the business to a more intuitive one where purchases of gas are booked at the same time as sales of the liquid product. The company booked 75% of its sales this way during the quarter. ‍ ‍

Lamplighter’s talked about how investors can take advantage of accounting changes a few times. ‍ ‍

Westward Ho‍ ‍

The new accounting treatment will stabilize the company's earnings from here on out. Investors love stable earnings. The accounting change should make that more obvious. Investors also love obvious things. The new situation ought to appeal to those stuffy investors demanding that their holdings make money. A bigger audience for a company that's been consistently delivering quarter after quarter of attractive, growing cash returns ought to help the shares forward.

Disclaimer: None of this is investment advice. It's meant to illustrate ways LCM thinks about investing. Things that LCM decides are good investments for LCM and its clients are based on many criteria, not all of which are covered here. Some or all of LCM's ideas may not be suitable for other investors. LCM does not recommend investing either long or short any position mentioned. LCM may own positions in some of the companies mentioned. Some of its ideas will lose money — investing entails risk. See full disclaimer here.