Flex LNG Ltd. Q2 FY2020 Earnings Call

Ladies and gentlemen, thank you all for standing by, and welcome to the Flex LNG Quarter 2 2020 Earnings Presentation. I must advise all that this conference is being recorded today, Wednesday, 19th of August 2020. And without any further delay, I would like to hand the conference over to the first speaker of the day, Mr. Øystein Kalleklev, CEO. Please go ahead, sir.

Thank you, Gino, and good day and welcome, everyone, to the second quarter 2020 presentation for Flex LNG. My name is Øystein Kalleklev, and I'm the CEO of Flex LNG Management, and I will be joined today by our CFO, Harald Gurvin, and we will guide you through today's presentation. A replay of this presentation will also be available at our website, flexlng.com. So first, a disclaimer with regards, among others, forward-looking statements and completeness of detail. The full disclaimer is available in the presentation, and we recommend that the presentation is read together with the interim financial report as well as our 20-F annual report. So the highlights. The spot market for LNG shipping has stayed weak over the spring and summer due to the fallout from the COVID-19 pandemic. A general weak spot market over the summer is not really surprising and something which we also highlighted in our Q1 presentation in May as well as in our market webinar in early July. When we presented our numbers in May, we disclosed the fact that we have booked 97% of Q2 days at time charter equivalent earnings, or TCE, of close to $50,000 per day. Earnings on the remaining 3% have been on the soft side. So we are, therefore, delivering a TC of $47,000 per day, which is, however, in line with our current cash breakeven levels. Our cash breakeven level is, however, expected to be reduced a bit when we are scaling our business with the remaining newbuildings, which, on average, also has slightly lower financing costs. In Q1, we achieved a TCE of $68,000 per day for our fleets. So the average TCE for the first half of the year was $57,000. This is a trading result which we are reasonably satisfied with, given the very challenging market environment. Notwithstanding the obstacles posed by the novel coronavirus outbreak, we have managed to operate our ships with 100% uptime and availability. We are pleased that cargoes have been delivered without disruptions or delays to our customers. Furthermore, we have mobilized our newbuildings for delivery as planned. Flex Aurora was delivered end of July while Flex Artemis was delivered on Monday, actually 2 weeks ahead of our contractual schedule. Crew rotations have been made particularly difficult for the shipping industry, resulting in a lot of seafarers being effectively stranded on ships. We are, however, pleased that we, on average, have been able to carry out 2 crew changes per ship in this difficult period, thus minimizing extended stay for our seafarers. So again, we would like to convey our gratitude to our seafarers and onshore personnel for delivering first-class operational performance also in trying times for everyone involved. In terms of financials, we delivered a slight adjusted loss of $700,000 for the quarter or an adjusted loss of about $0.01 per share. This compares to an adjusted net income of $9.3 million in the first quarter or $0.17 per share. Thus, during first half of the year, we delivered adjusted net income of $8.6 million translating into $0.16 per share. When it comes to financing, we are pleased that we have put in place $920 million of attractive long-term financing for our 7 newbuildings for delivery in second half of 2020 and first half of 2021. Five ships, including Flex Aurora and Flex Artemis, just recently delivered will be financed under the $629 million ECA facility, which we recently increased to a $639 million facility as we were able to add the $10 million accordion pass for the Flex Artemis as she is employed under a long-term charter with a subsidiary of Gunvor. For the remaining 2 newbuildings, Flex Amber and Flex Volunteer, we announced $281 million of financing through our sale-leaseback and a bank loan, respectively, in our May presentation. This financing was subject to final documentation and this financing have now been signed and executed in June according to plan. Hence, 98% of our remaining CapEx is covered by long-term debt. The remaining $17 million of CapEx, we can easily finance by our cash at hand, which stood at $116 million at quarter end. We also believe we will be starting to generate positive cash flow again in the fourth quarter, which we could utilize for this purpose. Having all ships financed long-term with no maturities before second half of 2024 as well as having a very comfortable cash position puts us in a very strong financial position. As we have previously announced, we have been active securing contract coverage for our 2020 newbuilds in order to not be too overly exposed to fluctuations and gyrations in the spot market. Hence, Flex Aurora, Flex Amber and Flex Resolute have all been fixed out on TCPs with periods ranging from 8 up to 12 months. Flex Artemis is already committed on a long-term charter with Gunvor, as explained earlier. With more ships on the water in the third quarter, we expect our revenues to continue to grow. Although freight rates are now finally improving ahead of autumn, these rates are typically for voyages in September or October. Hence, we are guiding similar TCE numbers for the third quarter as numbers are also being slightly dragged down by the fact that we have certain positioning and mobilization costs for the 3 or possibly 4 ships for delivery in the third quarter. When it comes to dividend, which we all like, we have to ask for some patience from our shareholders. Right now, the world is facing its sharpest decline in economic activity and energy demand since the Great Depression. In this period of time and given the state of the LNG shipping market during the second and third quarter, we think it's rather in the best interest of our shareholders that we continue to preserve cash for the time being. That said, we will continue to be a very shareholder-oriented company as our affiliated companies, Frontline, Golden Ocean and FL, have evidenced both in the past as well as yesterday with the 66th consecutive quarterly dividend paid by SFL. So before handing over to Harald for financial review, I will just summarize our fleet composition. As of today, we have 3 ships on fixed TCs. This is Flex Ranger, which commenced on new TC with Spanish utility, Endesa, at end of May. During July, ship management for Flex Ranger was transferred to Flex LNG fleet management, and we thus have all our ships under in-house management. In addition, Flex Aurora and Flex Resolute have been fixed on shorter-term TCs of 8 and 11 months, respectively. These TCs also have a fixed rate higher structure, and these TCPs commenced subsequent to deliveries from Yamal. We have, in total, 4 ships currently operating under variable higher TCs. This provides us with what could be described as utilization insurance while we keep exposure to the overall freight market. The ships serving these types of contracts are Flex Enterprise, Flex Rainbow and Flex Artemis, which was recently delivered under long-term variable TC to Gunvor. Flex Amber will also be operating under a variable TC once she is delivered either at end of September or October. Three of our ships are operating in the spot market, Flex Endeavor, Flex Constellation and Flex Courageous. So with these ships, we are fully exposed to the ups and downs in the spot market for good or bad. With our contract portfolio, our industry low cash breakeven levels, our very strong financial position and the fact that our fleet consists entirely of planned new efficient LNG carriers, which are generally sought after by charters, this isn't certainly a risk we can't manage. Lastly, we have three remaining unfixed newbuildings being Flex Freedom, Flex Volunteer and Flex Vigilance, which we market towards potential clients now. All in all, we think this gives us a balanced contract mix where we are keeping exposure to the overall freight market while also allowing an adequate level of utilization and fixed earnings for our fleet. For Q3, we are now 94% fully booked and we also have a fairly high level of income secured for Q4, also with 7 ships serving fixed or variable TCs in this quarter.

Thank you, Øystein. Looking at the income statement. Revenues for the quarter came in at $25.8 million, down from $38.2 million in the previous quarter. Revenues in the quarter were affected by the fallout caused by the COVID-19 pandemic, which has resulted in lower gas demand and thus impacting freight demand. Adjusted EBITDA for the quarter was $17.4 million, down from $27.8 million in the previous quarter. The result for the quarter includes a noncash unrealized loss on interest rates of approximately $6.2 million. At quarter end, we had entered into interest rate swaps totaling $610 million at an average interest rate of approximately 1.3%, and the noncash mark-to-market loss was the result of the continued fall in long-term interest rates during the quarter. All our interest rate swap-related financing agreements are not required to post any cash collateral under agreements when the mark-to-market is negative. We also recorded a noncash foreign exchange gain on cash deposits held in Norwegian kroner of $700,000 in the quarter due to strengthening of the Norwegian kroner against the U.S. dollar in the quarter. Net loss for the quarter was $6.7 million. And adjusted for the above items, the adjusted net loss was $700,000 or $0.01 per share. Then moving on to our balance sheet as of June 30. We had solid liquidity of $116 million per quarter end, down from $120.8 million in the previous quarter. The time charter equivalent rate achieved for the quarter is around our cash breakeven rate, and the reduction in cash is primarily due to an increase in working capital of $4.3 million in the quarter. As mentioned, we do not have any restricted cash relating to our interest rate swaps, and a very limited restricted cash of $70,000 relates to mandatory deposits required by tax authorities. Our assets at quarter end consisted of 6 vessels on the water with an aggregate book value of $1.1 billion. In addition, we have booked vessel purchase prepayments of $349 million relating to the 7 newbuildings still to be delivered at quarter end, which represents the advanced payment on these. Total debt at quarter end was $762 million, of which approximately $36 million is due over the next 12 months and thus classified as current liabilities. Total equity as per quarter end was $812 million giving a strong equity ratio of 50%. As Øystein mentioned, we have now secured attractive financing for all our vessels, including the 7 newbuildings still to be delivered at quarter end. In June, we signed 2 financing agreements announced in the previous quarter. The first is a $156 million, 10-year sale and leaseback transaction with an Asia-based leasing house for the newbuilding, Flex Amber, which is scheduled for delivery in September or October this year. The transaction is priced at LIBOR plus a margin of 3.2% per annum and has an 18-year payment profile with 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. The second facility is a $125 million term loan and revolving credit facility for the financing of Flex Volunteer, which is scheduled for delivery in the first quarter of 2021. The 5-year facility has a payment profile of 20 years, in line with our other bank facilities and we've 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 that facility, giving attractive oil linked pricing, including margin of 3.3% per annum. In July, we also agreed a $10 million accordion increase for Flex Artemis under the $629 million ECA facility based on the long-term charter for the vessel with Gunvor. The vessel was delivered on Monday this week, whereby the $135.8 million charge was strong. Post quarter end, we also utilized the swap option under the $629 million ECA facility to replace Flex Amber with her sister vessel, Flex Vigilant, which is the final of our newbuildings scheduled for delivery in the second quarter of 2021. With $920 million in debt secured for the newbuildings, the net unfunded CapEx is less than $20 million versus $160 million in cash at quarter end. Following these transactions, we will have a very comfortable debt maturity profile with the first maturity due in July 2024. The staggered debt maturity profile also mitigates refinancing risk.

Thank you, Harald. Let's begin with a brief overview of the LNG shipping spot market. The year 2020 followed the typical seasonal trends. Rates weakened in February due to a warm winter and the COVID-19 outbreak significantly affecting market sentiments. We saw a brief rally in March as China appeared to manage the outbreak quickly. However, as the impact of COVID-19 became clearer with lockdowns worldwide, the market fell again in April and remained weak through spring and summer. The rates for modern 2-stroke tonnage dropped from $55,000 to $60,000 in March to around $35,000 to $40,000 per day in April, where they have remained until early August. The most significant change in Q2 relates to ballast bonus sentiment. In Q1, ballast bonus sentiment varied widely, but in Q2 we experienced below full ballast bonus sentiment, with many voyages operating on one-way economics of fuel back to hub. This has led to achieved TCE being much lower than the headline rates in the spot market. Recently, though, we have seen improved sentiment in the spot market. In August, headline rates rose to the $50,000 level as sentiment turned bullish. The Atlantic is now back to full round-trip economics while the Pacific has recovered to full ballast bonus to hub, indicating a positive shift for owners. Looking ahead, we anticipate that rates will follow the usual seasonal pattern, peaking in winter. However, this year, arbitrage economics are unlikely to support the significant rate spikes we observed in 2019 and 2018. Now, moving on to gas prices, before the COVID-19 pandemic, we were already experiencing very low seasonal gas prices due to two consecutive warm winters and weak Asian demand stemming from economic slowdowns. European buyers played a critical role in 2019, purchasing around 90% of the approximately 35 million tonnes of new supply that came online. However, with another warm winter, the existing supply overhang was exacerbated by lockdowns and diminished economic activity due to the outbreak. Consequently, we witnessed record-low gas prices during the summer, with European gas trading below $1 per million BTU for some time. Asian spot prices briefly fell below $2, and the Henry Hub hit a one-year low in June at $1.40. Recently, though, LNG prices have rallied, with the JKM now exceeding pre-COVID-19 levels, assessed at $4.2 per million BTU, while LNG prices in Northwest Europe have rebounded to $3.8, the highest since early January. The oil market also faced a steep decline in March, with West Texas Intermediate prices briefly dropping below $0 and Brent falling to about $20 per barrel. In contrast to LNG, there have been significant production cuts in oil, leading to expected 2020 output being about 8% lower than in 2019, following a sizable cut by OPEC and reduced U.S. output. This has stabilized oil prices, which quickly rose back to the $40 range. Oil prices influence around 70% of LNG sales through pricing formulas with a typical six-month lag. As a result, we can anticipate significant fluctuations in contract prices, which are currently low but are expected to recover alongside oil prices. Meanwhile, spot LNG prices remain in contango, indicating a strong expectation of recovery leading to more stable prices as the product market tightens in the coming years with the resumption of economic activity. Regarding Europe, despite record low gas prices being observed, this region remains a significant LNG importer, accounting for about 25% of global volumes. The unusual low prices in Europe can be attributed to ample import and storage capacity, allowing it to serve as the buyer of last resort, which benefits European consumers. We observed this trend in 2019 and noted that European buyers have been very active during spring, accumulating LNG for storage. The recovery in carbon prices in Europe has encouraged this accumulation as LNG is more economical than coal. Although energy demand in the EU is expected to decline by about 10% in 2020 due to lockdowns, we see that low gas prices are displacing both pipeline gas imports—significantly reduced in the first half of the year—and even more so, posing a challenge to coal in Europe, especially given the high cost of carbon permits. In June, the U.K. set a record with nearly 68 days without burning any coal power. Despite this, Europe's storage capacity is limited to about 100 million BCM or around 70 million tonnes of LNG equivalent, which still represents approximately 80% of European LNG imports in 2019. This has led to European import costs decreasing during June and July, aligning storage levels with injection figures from 2019, thus avoiding tank tops in summer. However, the reduced demand from European buyers has resulted in significant production cuts of flexible U.S. volumes, helping to rebalance prices from the lows recorded over the summer. Lastly, looking at Asia, the largest import area accounting for approximately 70% of imports, we see the traditional import markets in North Asia as well as the expanding markets in Southeast and Southwest Asia. These regions, together with Europe, account for about 95% of global LNG production, while the Middle East and Latin America represent the remaining import regions.

Yes. Yes.

Yes. The Asian imports have been relatively stable in 2020, increasing by about 3 million tonnes from January to July. At the start of the year, despite a mild winter, there was a notable increase in imports into Asia. However, following the lockdowns, imports, especially in Japan and South Korea, have been lower. On the other hand, demand in China and India has rebounded more quickly as lockdowns have lifted, and these countries benefit from lower costs for LNG due to fewer long-term contracts tied to oil prices. Earlier in the year, there was optimism surrounding the Phase 1 trade agreement between the U.S. and China, and there were hopes for improved relations. U.S. exports to China began again in April with three cargoes, increasing to seven cargoes in May. Nevertheless, due to the repercussions of COVID-19 and rising tensions between Washington and Beijing, U.S. shipments to China declined again, with only three and two cargoes in June and July, respectively. We anticipate only two or three cargoes for August. Currently, it seems that there will be no political developments before the November elections in the U.S., and China is significantly behind its $200 billion commitment made in January, according to Standard & Poor's. We have now examined the dynamics influencing Europe as a swing buyer, so let's delve deeper into the situation regarding U.S. producers as swing producers. As we noted in our July webinar, U.S. producers face greater risk of cargo cancellations due to their cost structures and flexible contracts, allowing customers to cancel cargoes 60 days before loading by paying a fixed tolling fee, typically around $2.50 per million BTU. In contrast, most LNG projects globally are integrated oil and gas operations where the feed gas involved in LNG production is associated gas at very low or negligible costs. Additionally, the capital investments are generally sunk, leading to a very low short-run marginal cost for producing LNG, ranging between $1.5 to $2.5 per million BTU. U.S. projects, which need to purchase feed gas in the market, have a higher but more flexible cost base. Consequently, it is not surprising that U.S. projects on the higher end of the cost curve experience cargo cancellations. The Tango FLNG project in Argentina has the highest short-run marginal cost, and the charter YPF has declared it post-major due to COVID-19 impacts. Despite these cancellations, U.S.-based producers can still perform well as they possess built-in flexibility in their models, with Cheniere announcing a remarkable $708 million in compensation for cargo cancellations in Q2, securing a net income of $197 million for that quarter. That said, companies like Cheniere typically perform better in a strong LNG market where income from trading activities is higher. Thus, increased feed gas deliveries to U.S. export plants recently should bode well for future export volumes. Regarding floating storage, 2020 has seen significant fluctuations, with some periods experiencing unexpected spikes in floating storage, particularly following Chinese lockdowns in February. During the summer, many cargoes have been floating due to low prices and soft demand, with 3.5 million tonnes of floating storage corresponding to around 50 ships, which is unprecedented during summer months and reflects disruptions and weak demand. As prices have improved, floating storage levels have begun to decrease, and we currently see 13 ships marked as floating. As we approach the winter months, we expect a gradual increase in floating storage in line with seasonal patterns. We also anticipate cargo cancellations from the U.S., and it is likely that some of these will enter floating storage, taking advantage of contango time spreads. In our Q1 presentation, we indicated that we expected floating storage levels would be significant, and we maintain that expectation as we near peak consumption months. The final slide before summarizing today's presentation shows an updated graph from the July webinar illustrating monthly and cumulative export growth alongside cargo cancellations. At the start of the year, we anticipated an increase of about 25 million tonnes in exports for 2020, and the trajectory in the first quarter was promising. However, during the second quarter, there was a decline in Asian demand, which Europe initially compensated for by injecting inexpensive gas into storage. Yet, in June, July, and August, low gas prices led to cargo cancellations, causing export volumes to decline. We view July and August as peak cancellation months and anticipate a gradual decrease in cargo cancellations, leading to a recovery in export growth in the fourth quarter, which will support freight demand. As of September, Platts reports that 165 U.S. cargoes have been canceled, and we expect roughly 270 cancellations in total for 2020, with around 200 of those being U.S. cargoes. Egypt is also facing significant cancellations, exporting about 3.7 million tonnes in 2019 but only about 0.5 million tonnes in 2020. We have seen lower export activity from Australia in July and August, while Qatari exports remain stable and are likely to match 2019 levels. Numerous projections about growth following the COVID outbreak were made, and we estimated a 10 million tonne increase in our July webinar. However, due to higher U.S. cargo cancellations and revised past cancellations, we now expect the goal to be approximately 6 million tonnes for 2020, aligning with recent estimates from Energy Aspects. A worst-case scenario, which anticipated a fall of 6 million tonnes in April, has been updated to a decline of around 2 million tonnes. It is crucial to distinguish between import and export figures, as export numbers are a more reliable indicator of shipping demand. Approximately 3% to 4% of exports are used by ships as boil-off gas during transport and cargo operations, depending on voyage lengths and whether they involve floating storage, which also impacts freight demand. Forecasting 2021 exports is challenging, as it will heavily depend on winter weather and the pattern of economic recovery. Regarding winter temperatures, the chances of an El Niño phenomenon are minimal, with a La Niña alert for autumn and winter, indicating a 55% to 60% probability. La Niña typically results in colder winters, which should be favorable for gas demand. Economic recovery is closely linked to the swift availability of a vaccine that allows a return to normalcy in daily life. Should growth and demand recover, there is significant potential for growth in the LNG market, both in the near and long term, which would positively influence freight markets. To summarize, we reiterate the same points from our July 2 webinar, with two updates. First, we have secured $920 million in financing for our newbuildings instead of $910 million, following an additional $10 million financing for Flex Artemis. The second update is that the second wave of COVID-19 has materialized in various regions instead of being a mere possibility. With the recent fixtures, Flex LNG is well-prepared with a diverse portfolio of fixed and variable contracts, as well as ships in the spot market, which we believe will improve in the near term due to a significant reduction in U.S. cargo cancellations and increased floating storage. Our vessels are equipped for optimal service in terms of cargo deliveries, featuring low boil-off rates. The two main factors affecting the shipping market in the near term are winter temperatures and the state of economic recovery, as previously mentioned. While politics, especially surrounding the November election, could play a role, we don't foresee a swift resolution to the tensions between the two superpowers. With only three newbuildings ordered in the first half of 2020, we are returning to a fundamental approach in newbuilding contracting. On a positive note, a softer shipping market combined with cautious investor and bank appetite for capital in the sector typically results in diminished newbuilding orders, a trend we are seeing across most shipping sectors today. Nonetheless, we anticipate project orders moving forward, particularly with some of the significant projects approved last year along with the major expansion by Qatar. Lastly, our strong balance sheet and financial position are noteworthy. We have secured necessary equity and hold a substantial cash reserve of $116 million at the end of the quarter. We also have $920 million in financing for our newbuilds in place. Our financial stability, modern fleet, and exceptional operational performance position us advantageously for continued growth. There are around 160 older steamships and high fuel ships set for redelivery under their existing charters over the next five years. TradeWinds reported today that Nigeria LNG is considering renewing its fleet and retiring older steamships. Approximately 200 steamships still remain in the market, constituting about 40% of the fleet. We believe this situation will present significant opportunities for us to expand our contract portfolio, thereby reinforcing a robust commercial and financial strategy. That concludes today's presentation. Thank you for your attention, and let's open the floor for questions.

Our first question comes from the line of Gregory Lewis from BTIG.

Øystein, my first question is about the dividend. It seems you have the balance sheet where you want it, and financing is mostly secured. As we consider the decision regarding the dividend this quarter, would you say it's more influenced by uncertainties surrounding COVID or related factors? Or is it more about having vessels in the spot market and how that might affect your dividend decision? Additionally, as your fleet gets fully delivered in the first half of next year, does that change your perspective on the dividend?

Yes, good question, Greg, and it's nice to have you on the line again. When we decided to suspend our dividend back in February, there was a lot of uncertainty, which was a key factor. We had significant exposure to the spot market, and we anticipated that Q2 and Q3 would be challenging quarters, as we mentioned back in February. In March, the financial and credit markets were in turmoil. Interestingly, now in August, the S&P 500 has regained its levels from before the COVID situation. Considering the uncertainty in the financial market, our stock's poor performance, and the limited capital available, we felt it was unwise to distribute dividends. Preserving cash was more beneficial at that time. Although uncertainty appears to be lower now, especially in the markets, we will reassess the situation eventually. Our affiliated shipping companies have a strong history of being shareholder-friendly and distributing excess cash when feasible. Our aim isn't to expand unnecessarily; instead, we plan to return free cash flow to shareholders when possible. We've just wrapped up Q2, and it's unlikely that Q3 will be much better. Once we start generating profits again, we will have an open discussion about dividends with the Board, but it's too early to predict the outcome. What I can assure you is that we will pay a dividend once we are profitable.

Europe has been a key destination for LNG, mainly because there are limited alternatives for its storage. As we progress through the winter, what are your thoughts on the impact of LNG storage in Europe on the market? You mentioned the possibility of rising JKM prices; could some of that LNG come back to the market if opportunities arise in Asia? Or does it typically remain in the system once it’s there? I'm just curious about this aspect.

I think if you look at the current market, we have seen another decrease in floating storage. The floating storage over the summer has not been due to people engaging in time spreads, but rather due to disruptions or the need to find alternative locations for storage, as you've noted, like a dumping ground. We've returned to a more normalized level, and we expect this to increase again since now it’s possible to engage in time spreads—buying September cargoes, for example, selling and potentially floating a month, and then selling into a notably higher November price. The recent low LNG prices have made such time arbitrage difficult, but this is becoming viable again. We anticipate a gradual increase in floating storage. Over the past two years, we have observed around 35 ships in floating storage, and we believe this number will likely be higher this year. Regarding reloads, this is another significant factor that typically boosts shipping markets. If spreads between Europe and Asia begin to develop, we could see cargoes moving from Europe to Asia for reloads. With Northwest European prices rising to $3.8 and JKM at $4.2, the spread remains too narrow for that trade to take place. However, it will depend on winter conditions. A colder winter will increase demand, and the economic recovery is also influencing this situation. Overall, markets are becoming more normalized, and we are witnessing a substantial increase in gas prices, which is also contributing to the rise in freight rates lately.

Thank you, everyone, for participating in the presentation. We'll return in November with the Q3 numbers. I hope the COVID focus will gradually diminish, allowing us to return to more normal conditions. With any luck, we'll have a strong winter market. I'll see you all then. Thanks again. Thank you. That does conclude our conference for today. Thank you all for participating. You may all disconnect. Have a good day, everyone, and stay safe. Thank you.