Flex LNG Ltd. Q1 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by, and welcome to the Flex LNG Q1 2020 earnings presentation and investor day conference call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. I must advise you that this conference is being recorded today, Thursday, 28th of May 2020. I'd now like to hand the conference over to your first speaker today, Oystein Kalleklev. Thank you. Please go ahead.

Thank you, Marian. Welcome to the 2020 first-quarter results presentation for Flex LNG. My name is Oystein Kalleklev, and I'm the CEO of Flex LNG management. Together with our CFO, Harald Gurvin, I will guide you through today's presentation. A replay of the webcast will be available at flexlng.com. Flex LNG is a shipping company focused on the growing market for seaborne transportation of liquefied natural gas, LNG, and we are listed both on the Oslo and New York Stock Exchanges under the ticker FLNG. First, a disclaimer regarding, among other matters, forward-looking statements and completeness of details. The full disclosure is available in the presentation, and we recommend that the presentation be read together with the interim financial report and our annual report, all available on our website. Let's summarize the highlights today. First of all, I am pleased to say that we delivered time charter equivalent or TCE earnings for our ships at approximately $68,000 per day, which aligns with our guidance of close to $70,000 per day. Given the seasonal softening of the market in the first quarter and the outbreak of the novel coronavirus, we are satisfied with the trading results for the quarter. TCE of $68,000 per day translates into revenues and adjusted EBITDA of 38.2 and 27.8 million for the quarter. During the first quarter, interest rate levels around the world plummeted due to the adverse economic consequences of the COVID-19 pandemic. This resulted in us booking a noncash unrealized mark-to-market loss of approximately 22 million for our portfolio of interest rate swaps. Our portfolio of swaps at the end of the quarter consisted of $485 million hedged for around five years at about 1.5% fixed interest rate. We have hedged the interest rate risk for about 50% of our bank loans, so keep in mind that lower interest rates mean our financial expenses will be lower going forward as the other half of the loans have floating interest rates, which today are close to zero. Hence, adjusted for noncash unrealized items, our adjusted net income was 9.3 million for the quarter, representing clean earnings of about $0.17 per share compared to $0.41 in adjusted profit per share in the fourth quarter of 2019 when we made $94,000 per day in TCE. Market conditions have, so far in 2020, been challenging. We have seen the warmest winter on record in the Northern Hemisphere where most gas is consumed. Coupled with the coronavirus outbreak, this has depressed the price of natural gas worldwide. The pandemic also adversely affected our ability to carry out crew changes, meaning many seafarers have remained on ships away from their families for a prolonged period. We would like to extend a special thank you to our crew, who have done a fantastic job ensuring that our ships have been able to trade without interruptions and serious incidents during this difficult period. Given the fallout from COVID-19, we expect lower trading results in the second quarter. We have so far booked about 97% of our second quarter and expect a TCE of close to $50,000, which is in line with our current cash breakeven levels. Given the uncertainty regarding COVID-19 and low gas prices resulting in shut-ins of cargoes, we expect the market in the third quarter will also be challenging. Given the high inventory levels in Europe and the contango in gas prices, we believe it is probable that the freight market will firm up again as we approach autumn. Consequently, the board has decided to suspend the dividend and instead focus on preserving cash. Suspending the dividend has not been an easy decision, but given our lackluster stock price, we believe it is advisable to maintain our substantial cash position to ensure that investors and financiers have full confidence in our ability to perform, even in tough market conditions like this. We are pleased to announce that we have agreed to a new bank loan of $125 million for Flex Volunteer, as well as a sale-leaseback transaction of $156.4 million for Flex Amber. In total, we have secured $281 million of new financing. We have previously stated that we would fast-track the financing of the last two new buildings given the uncertainty, and now we have delivered on this. With these financings, the $281 million of new loans and the $629 million ECA financing signed in February, we have thus secured about $910 million of financing, which represents an average of $130 million of financing for each of these seven new buildings. The $910 million also matches very well with the $937 million of remaining CapEx for the seven new buildings to be delivered over the next 12 months. This leaves us with a net unfunded CapEx of only $27 million compared to a cash balance of $121 million at quarter-end. With this financing, we are confident that we have a very robust capital structure. We have attractive long-term financing in place for all our line ships and not a single loan maturity prior to July 2024. Long-term financing is also coupled with the newest, most efficient fleet of ships, which presents substantial advantages. Given the significant equity invested in the company, we have an industry-low cash breakeven that will be reduced to around $45,000 per day once all ships are delivered. As mentioned in the highlights, COVID-19 has also affected our business and operations. During this difficult time, we are pleased to say that we have a capable organization that has been able to run our ships with 100% uptime and no delays despite these challenges. To mitigate the situation, we have minimized ship visits, allowing only critical external visits for piloting, vetting, and necessary repairs. We have utilized video conference tools for remote visits, including the first-ever remote management change conducted by classification society ABS for the Flex Courageous on March 27. Five of our ships are now under the in-house ship management company, and we are planning to transfer the last ship, although this has been slightly delayed due to the ongoing situation. Onshore, we have established a COVID task force that meets every morning. This group consists of key personnel who are in constant dialogue with our ships to assess the situation and provide assistance as needed. We have closely monitored our crew for any symptoms and are glad to report we have not had any of our crew or onshore personnel test positive for COVID-19. However, minimizing ship visits has made crew rotation practically impossible for some time. This has resulted in prolonged stays for crew members away from their families, and we have been working closely with relevant authorities to find practical ways to allow for crew rotations. We are pleased to see gradual improvements in crew changes, and we have already managed limited rotations on one ship and are planning for others. We also have new buildings scheduled for delivery in the second half of the year, with sea trials and mobilization for officers who have undergone quarantine in South Korea before conducting such trials. There have also been reported delays of ships in dry dock due to the coronavirus. However, as our fleet consists of brand-new ships, we do not have any dry dockings planned prior to 2023 and cannot be affected by these issues. OK. Harald, will now provide an update on recent financing as well as financial numbers before I return with some market information.

Thank you, Oystein. As mentioned, we are pleased to announce two new financings totaling $281 million post-quarter-end, which adjusts the funding range for all seven new buildings under construction. The first facility is a $125 million term loan and a revolving credit facility for the financing of Flex Volunteer, scheduled for delivery in the first quarter of 2021. The five-year facility has a repayment profile of 20 years, aligning with our other bank facilities and will be split into a $100 million term loan and a $25 million revolving facility. We have already entered into interest rate swaps for the full amount of the facility, providing attractive all-in pricing, including a margin of 3.3% per annum. The second financing is a $156 million, 10-year sale and leaseback transaction with an Asian-based leasing house for the new building Flex Amber, scheduled for delivery in the third quarter of 2020. The transaction will be priced at LIBOR plus a margin of 3.2% per annum and has an 18-year repayment profile. We will have annual repurchase options commencing on the first anniversary, and there is a purchase obligation at the end of the 10-year lease period of $69.5 million. Flex Amber is included under the $629 million ECA facility entered into in February this year. We intend to utilize the swap option under this facility to replace Flex Amber with the sister vessel Flex Vigilant, the final new building scheduled for delivery in the second quarter of 2021. Both financings remain subject to final documentation and customary closing conditions and are expected to be drawn upon delivery of the relevant vessels from the shipyard. We have been active on the financing side over the last two years, arranging a total of $1.7 billion of attractive financing for our fleet of 13 latest-generation LNG carriers. At the same time, we have diversified our funding base with a mix of bank financing, lease financing, and ECA financing, expanding our relationships with several leading international financing providers. Having access to various funding sources is crucial given the current market and demonstrates our ability to raise finance at favorable terms in an environment where many are struggling to do so. Following the execution of the two latest financings, we will have less than $30 million in net remaining CapEx against a cash position of $121 million at quarter-end. The $629 million ECA facility for five of the new buildings also includes an accordion option of up to $10 million per vessel, subject to long-term employment acceptable to the banks. Following these transactions, we will have a comfortable debt maturity profile with the first maturity due in July 2024. The staggered debt maturity profile also mitigates refinancing risk. Moving on to the income statement. Revenues for the quarter came in at $38.2 million, down from $52 million in the previous quarter. The reduction was due to a softer market in line with the seasonal pattern. Adjusted EBITDA for the quarter was $27.8 million, down from $41.6 million in the previous quarter. The result for the first quarter includes a noncash unrealized loss on interest rate swaps of approximately $22 million. At quarter-end, we had interest rate swaps totaling $485 million at an average interest rate of approximately 1.5%, and the noncash mark-to-market loss resulted from the sharp fall in long-term interest rates during the quarter. All our interest rate swaps relate to financing agreements, and we are not required to post any cash collateral under the agreements when the mark-to-market is negative. We also recorded a noncash foreign exchange loss on cash deposits held in Norwegian kroner of $2.3 million in the quarter due to the substantial weakening of the Norwegian kroner against the US dollar. The net loss for the quarter was $14.9 million. Adjusted for the above noncash items, adjusted net income was $9.3 million or $0.17 per share. Moving on to our balance sheet as of March 31, we had a solid liquidity position of $121 million at quarter-end. Our assets consist of six vessels on the water with an aggregate book value of approximately $1.1 billion at the end of the quarter. Additionally, we have booked vessel purchase prepayment of $349 million relating to the seven new buildings under construction, which represents the advanced payments on these. Total debt at quarter-end was $771 million, of which approximately $36 million is due over the next 12 months and is thus classified as current liabilities. Total equity at quarter-end was $819 million, giving a strong equity ratio of 50%. Looking at our cash flow for the quarter, the operational cash flow was $14 million for the first quarter. The operational cash flow for the quarter was negatively impacted by working capital adjustments, mainly due to less prepaid hire following the softer market in the first quarter compared to the fourth quarter. Scheduled loan installments were $8.3 million, and in addition, we had upfront financing costs of $6.5 million in connection with the $629 million ECA facility signed in February. The dividend for the quarter of $5.4 million or $0.10 per share was paid at the end of March. Adjusted for the negative foreign exchange effect on cash deposits held in Norwegian kroner of $2.2 million, the cash at the end of the quarter thus came in at $120.8 million. Now I will hand it back to Oystein, who will give an update on the market.

Thank you very much. Let’s start on Slide 11 with a quick recap and review of the spot market for LNG shipping. In line with the seasonal pattern, the market has softened during the first quarter as we exit the peak winter season. We experienced yet again mild weather with the highest winter temperatures recorded in the Northern Hemisphere, adversely impacting gas this winter as consumption is primarily in that region. We had positive news with the signing of the Phase 1 trade agreement between the US and China, and US LNG shipments to China resumed. However, headlines quickly shifted to the coronavirus outbreak in Wuhan, leading to associated pump shutdowns in China during February. These shutdowns resulted in poor sentiment in both the freight and product markets, with JKM dropping to a low of $2.7 in February. The market turned more positive in March when China began to resume normal import levels, and JKM rebounded 30% to $3.5 by mid-March. For the freight market, this resulted in a shift from one-way economics in February to full round-trip economics in March, allowing shipowners to be compensated for both the laden and ballast legs, yielding TCE in line with headline TC rates. However, as we know, the coronavirus situation escalated into a global pandemic, resulting in unprecedented low gas prices, with European prices dropping to $1 while JKM fell back to $2, creating an historically low spread towards the Henry Hub Index in the US and leading to cargo cancellations. The lack of demand and arbitrage has made sentiment in the freight market very weak in April and May, with headline rates for modern two-stroke tonnage around $40,000 per day under typical one-way economics. This indicates that the ballast leg is for the owner's account, capturing only 50 to 60% of the headline rates. All this uncertainty in the market means that charters prefer fixing single voyages rather than longer periods. Hence, while we see a high level of fixtures, it results mainly from single voyages rather than multi-voyage or period fixtures. It's not surprising that charters, working from home, are focusing on immediate cargo rather than securing shipping for the longer term. Before we continue to the next slide, let's look at importers and trade flows, which have totally changed in 2019 compared to 2018. In 2018, Asia increased its imports by 30 million tonnes due to rapid Chinese growth. In 2019, Asia's demand was muted following a mild winter and nuclear restarts in Japan and South Korea. Due to an economic slowdown following trade disputes with the US, Chinese demand was also soft, growing by only about 7 to 8 million tonnes. Europe stepped in, increasing its imports by 33 million tonnes, showing close to a 70% growth in a mature market due to a well-established LNG infrastructure and underutilized capacity. Coupled with record low gas prices and rising carbon prices, cheap LNG became very competitive in Europe. Similar trends seem to be continuing this year, with most import gains being European. For instance, the UK is continuing its efforts to phase out coal, recently going a month without utilizing any coal, a feat not achieved since the industrial revolution. Portugal has also gone through April without consuming coal, signaling a rapid shift considering that in 2012, coal provided 40% of UK's power generation, while in 2019, that number had reduced to 2%. South Korea has also favored burning gas over coal, having closed a substantial number of coal plants. With COVID-19 being primarily a respiratory illness, switching off coal and cleaning the air seems to be a sensible measure, particularly as it can be done cost-free. Despite the shutdowns in India and China, these countries have continued to grow their LNG imports in 2020, showcasing LNG's increasing market share amidst recent turmoil. Now let's consider the largest market, Asia, with significant import markets being Japan, China, South Korea, and India, along with growth markets in Southeast Asia. Despite COVID-19 lockdowns, China, South Korea, and India have shown growth this year. Chinese growth lagged behind 2019 levels prior to lockdowns due to lower economic growth, but we have seen a strong rebound in growth from March onwards. US exports to China are expected to reach approximately half a million tonnes in May, representing nearly 10% market share and the highest import level of US LNG since January 2018 following trade tensions. While we observed a slowdown in Indian imports in April, there are expectations for them to rebound to 2019 levels come May. The Japanese market appears weak, facing prolonged lockdowns and not adopting the coal replacements policy that South Korea has implemented to some degree through LNG imports. Let's return to discussing Europe's growth market. Even with high inventory levels coming out of winter due to an unseasonably warm season, European buyers have continued aggressively purchasing LNG in 2020. The primary reason for this is the low LNG prices stimulating demand for gas injection into storage, with expectations that European inventory levels may reach tank tops by July or August. Furthermore, reduced French nuclear capacity will also drive additional gas demand. Due to relatively limited onshore storage for gas, while it exists extensively for oil, the bulk of gas storage is concentrated in the US and Europe rather than key import nations in Asia, making Europe the natural swing importer. The oversupply of LNG has resulted in record low gas and electricity prices in Europe. Once European inventories are full, we expect a shift toward storing gas on ships, which coupled with contango in gas prices, could result in more floating storage as we approach autumn. This trend should be supportive for the freight market, particularly for large modern ships known for their low boil-off rates — characteristics exemplified by our fleet. Regarding the product market, low prices have been driven by the surplus of LNG. As illustrated, both Asian LNG and European gas prices have plummeted since the year began, falling from nearly $10 and $8 respectively to historic lows, with JKM at around $2, paralleling Henry Hub prices and the Dutch TTF gas hub trading below $1. Such convergence to these low prices is unprecedented. Furthermore, the recent oil price crash with the WTI crude dropping below zero underscores these trends. LNG is still predominantly traded under long-term oil index-linked contracts, with around 70% of LNG volumes tied to such arrangements, which conventionally see a slight discount compared to oil. Typically, LNG is priced at 17% of a barrel of oil for 1 million BTU, with historical correlations placing the index slightly below 17%. The pricing mechanism commonly employs a three-month average followed by a timely delivery lag, suggesting a long window for price adjustment. Japan and South Korea, being the largest importers, are traditionally well-covered by contracted LNG which often includes destination limitations, thus limiting their reactions to lower prices. However, with current low contract rates, we might see a switch to gas over coal in these nations and potentially an increase in spot cargo procurement. Market participants currently do not anticipate the rock-bottom gas prices to persist, and forward prices are projected to stabilize, a phenomenon called contango, which may benefit the freight market due to floating storage. With LNG once again becoming an efficient, and cheaper, fuel compared to coal, we hope more countries will take cues from South Korea and the UK to replace coal with natural gas. Following the pandemic, we will likely witness delays in sanctioning new projects. Last year's record-setting number of sanctioned projects is now expected to experience reduced volumes coming online due to recent events, with an intent to curb costs. Only Qatar's expansion project is on track to be sanctioned this year. In summary, despite the challenges posed by the current market, we delivered reasonably good trading results with TCE running at approx. $68,000 per day, aligning with guidance, which is substantially above breakeven levels around $50,000. As the remaining seven new buildings come online, breakeven levels will drop closer to $45,000, achieved through outstanding fleet efficiency. We are excited to deliver two new financings, totalling $281 million for the seven remaining new buildings, while our cash position of $121 million ensures we maintain liquidity. Our fleet remains modern, fully equipped with two-stroke propulsion systems, ideal for longer-term charters. With our first-class management portfolio, we stand well-positioned to capitalize once the market has stabilized post-COVID. This concludes my presentation. Thank you for your participation, and I’ll hand it back to Marian for any questions.

Your first question comes from the line of Gregory Lewis from BTIG. Please ask your question.

Yes. Thank you, and good afternoon.

Good afternoon, Greg, and glad to have you coming up with the first question, as we have done in the past.

Thank you for your kind words. Oystein, I wanted to discuss some of your comments regarding the potential for LNG storage in the latter half of this year. We've noticed a decline in spot cargoes coming from the US and I'm curious if you could elaborate on what you think will influence that storage on vessels. It appears that there isn't much, if any, onshore storage available in Asia. However, it seems that some end users are turning away from cargoes or delaying their acceptance of them. I'm wondering if there is an economic arbitrage affecting this situation in the latter half of the year, or if we're just not seeing significant shut-ins at this time, which means it has to be stored somewhere. Any insights on this would be appreciated.

Thanks. I think most people have been focused on the shut-ins of cargoes in the US. The buyers have the option to shut-in and not take delivery of cargoes; it’s mostly a take-or-pay contract. Nevertheless, we have seen some shut-ins in Egypt, and their exports have now been halted due to low prices. Algeria is doing the same, and a super-expensive FLNG unit for Shell has been down since February due to COVID-19 issues. Regarding US cargoes, we see considerable cancellations, potentially 30 to 40 cargoes in July. They typically have two months' notice to do this, and if they cancel, they still must pay their tolling fee. It's more about what price point you have. Currently, with JKM close to Henry Hub, it doesn't make sense to take the cargo, which is why we see those cancellations. Even if you need the cargo, the smarter choice is canceling and buying at market rates. The economy will dictate whether more floating storage will occur, but prices need to increase. We are at unprecedented low levels. However, forward market pricing is starting to bounce back. Historically, once we approach September, it will make less sense to cancel cargoes as filling demand increases again, particularly as we approach winter in Asia. Thus, we anticipate growing requests for shipping as traders search for reliability in winter coverage.

OK. Great. One more for me on the finances. Clearly, you guys had a successful quarter or the last few months in lining up some financings. I guess it's kind of a two-part question. Looking at your new builds financing lined up, it appears the remaining equity contribution for those is minimal, maybe $20 to $30 million, does that provide an opportunity for Flex? Given the difficult outlook for the next couple of years, does this mean another chance for Flex to step on the gas a bit and grow the fleet? We're hearing that some new build vessels might be for sale in the coming quarters. Is there an opportunity for the company to leverage this period to grow its fleet given the financing success you've had?

For those familiar with the John Fredriksen system, it’s understood that we adopt an opportunistic strategy. We are pleased with the financing initiatives we’ve secured. Following our announcement of the ECA financing at the end of November, we fast-tracked our deals when the financing market turned challenging. We have proven our capacity to raise substantial financing, and our banks are supportive. They favor financing good new assets, especially if the management has demonstrated its ability to charter these ships at premium rates. Regarding the amount needed, I’m very comfortable with our current liquidity of $121 million, all of which is unrestricted cash. With $910 million secured against a $937 million remaining CapEx, our liquidity is solid. I understand some analysts question our decision to suspend dividends, but in light of our share price, it’s prudent to ensure we can navigate these troubled waters. This ensures we can re-enter the market competitively when additional opportunities arise. Given the challenging market dynamics where many are struggling for financing, we are strategically positioned.

OK. Perfect take. Thank you very much for the time.

Thanks, Greg.

The next question comes from the line of J. Mintzmyer from Value Investor's Edge. Please ask your question.

Good afternoon, Oystein. Congratulations on a fantastic quarter.

Hey, J. Good to hear from you again. How's Vegas?

Well, we're recovering. Doing what we can. But yes, it’s good to see that you were able to achieve the $68,000 TCE. While reviewing your presentation, I noticed you didn't include the fleet delivery chart. You mentioned last quarter that the fleet might be delivering ahead of schedule. Is that still the case, or are we back to the normal schedule with potential delays?

Most ships are on course. Initially, we had more options to take earlier deliveries, but currently, given the market conditions, we prefer to stick to the scheduled deliveries. Flex Aurora will deliver as planned, and Flex Artemis should also deliver as scheduled in August, embarking on a minimum five-year contract with Gunvor. We do not anticipate major changes to the schedule and therefore have not included the chart this time.

Understood, so we are sticking to the regular schedule. Can you talk about the variable time charter awarded to Gunvor for Flex Artemis? Is there a floor structure involved, and will there be profit sharing? How does that work?

It's a great question. In our press release for that time charter, we agreed not to disclose specific terms since it's crucial for traders to maintain competitive confidentiality regarding their cargo bids. Our summary information from contracts suggests, though, that rates correlate closely to market rates while providing downside protection through utilization and, for some contracts, structures with floors.

That makes sense. Sounds like we can predict that as a normal MEGI market rate with full utilization then, okay. Looking forward to your cash demands; very impressed with your refinancing for 2021. I see no real cash needs until 2024, right? You maintain a clear debt maturity profile with a strong cash balance, while your shares trade at a significant discount to NAV, potentially $12-15 or more, with your shares at around $4. How do you view this? Will you consider share repurchases or a tender offer to help close this gap?

Post our conversation in early March after our investor day, where discussions about the 2021 new buildings closed is appreciated. We managed to secure fast-tracked financing that certainly strengthens our cash position. Even after taking delivery of those ships, we anticipate maintaining over $100 million of cash. Regarding use of funds, we prefer not to raise additional capital, especially given our depressed stock prices. Our focus now lies on ensuring our investments assure our survival through this turbulent period. Should any feasible opportunities arise for resale acquisitions, we remain open to exploring those avenues, bolstered by our robust financial standing.

Yeah. Definitely, I understand it's a complicated balance. I was going to ask about resale opportunities; I've heard 2022 vessels might be available for around $170 million. If that's the case, we hope Flex considers share repurchases ahead of vessel purchases if the shares are trading at such substantial discounts, but we trust you to make the right choices. Thanks again for the inquiries and congratulations on a great quarter.

Thank you, J. Always a pleasure hearing from you.

There are no further questions at this time. Please continue.

That's good. Everything is very clear. I wish you a continued good day. We will reconnect for our second-quarter call sometime in August. Have a pleasant day, and enjoy your weekend.

Thank you. That does conclude the conference for today. Thank you for all participants. You may all disconnect.