Flex LNG Ltd. Q4 FY2022 Earnings Call

Hi, everybody, and welcome to the fourth quarter results presentation for Flex LNG. It's February 14, Valentine's Day. I'm Oystein Kalleklev, CEO of Flex LNG Management. I'll be joined by our CFO, Knut Traaholt, who will give you some more details on the numbers a bit later in the presentation. The presentation will be concluded with a Q&A session. As you might recall, the best question this round will get an original Flexington bed linen set for two people. I hope you can provide some questions either by sending us an email at [email protected] or just use the Q&A button in the webcast. Before we begin, I want to remind you about our disclaimer related to forward-looking statements. We do provide some non-GAAP measures, and, of course, the detail level we can provide here is limited given the time. With that, let's review the highlights. Revenues for the quarter came in at $98 million, in line with previous revenue guidance of $95 million to $98 million, where our numbers this quarter were boosted by our index ship in a booming spot market. Net income and adjusted net income came in at $41 million and $55 million, respectively, where the main difference is we realized gains of $14 million on derivatives during Q4. Earnings per share and adjusted earnings per share were $780,000 and $1.02, respectively. In November last year, we announced the extension of three ships with Cheniere, where we added a minimum of 14 years of contractual backlog to an already sizable backlog. Knut will tell you today that we have finalized our balance sheet optimization program. He is presenting a refinancing of the last three ships in our fleet. Altogether, the balance sheet optimization program released $387 million of cash. For next quarter, Q1, we expect revenues to be in the region of $90 million to $93 million as we are doing our first scheduled dry-docking of Flex Enterprise at the end of Q1. Altogether, this year we will dry-dock four of our ships. Nevertheless, we do expect revenues to increase regardless of that off-hire. Revenues are expected to be in the region of $370 million for the year, driven by higher time charter equivalent earnings, where we expect average time charter equivalent earnings to be about $80,000 compared to $72,800 for 2022. Our EBITDA numbers are also expected to increase with a similar amount compared to 2022. With a healthy backlog and a very sound financial position, we are declaring our ordinary dividend of $0.75, along with a special dividend of $0.25, bringing the total dividend per share to $1.00. For the full year of 2022, that means a dividend of $3.75, equating to a $200 million dividend. That implies a dividend given the share price level today of around 11% yield, which should provide investors with an attractive yield from an investment in Flex LNG. Let's review our contractual backlog portfolio. As I mentioned, we extended three ships in November with Cheniere. This was Flex Endeavour, which was extended until the end of 2030, adding a total of 5.6 years. Flex Vigilant added 6.4 years, also bringing that to 2030. Those two ships have options to extend to 2033. The last ship we extended with Cheniere was Flex Ranger, which has two optional years, bringing that ship until early 2027, a position we consider very attractive. This is a time where we will have a lot of new LNG coming to the market. We are competing against much more expensive ships, with current yard ticket prices today of around $250 million. By 2027, we also have Flex Constellation fully open. This ship is firm until 2024, but the charters have the option to extend the ship for up to three years, bringing it redelivered to us in Q2 2027 at the latest. These are the two ships we are marketing for longer-term contracts today, and we are optimistic about the prospects given the term rates, which I will explain later in the presentation. Last year, we also extended more ships. We extended Flex Rainbow for 10 years, and she just commenced her new 10-year charter in February. We also extended Enterprise and Amber by seven years, starting in July last year until 2029. We have additional ships in the portfolio; Flex Freedom has an earliest redelivery in 2027, with a two-year option until early 2029. We have two more ships with Cheniere, Flex Aurora and Flex Volunteer, with earliest redelivery in 2026, also having two-year options, potentially bringing them to 2028. Additionally, we have two ships under a three plus two plus two structure, Flex Courageous and Flex Resolute, with earliest redelivery in 2025, but we believe these ships will be extended given their contract structure. Constellation I have already covered. Flex Artemis is the one ship we have on variable hire contract, which boosted revenues in Q4, as I highlighted. Looking at our guidance in more detail, you can see our revenues and EBITDA over the last couple of years as we have taken deliveries of ships in '18, '19, '20, and '21. Of course, our revenues have increased, and the market has improved. For next year, despite the dry-docking of four ships, we expect revenues to grow by about $20 million, similar for adjusted EBITDA. Looking at our dividend, earnings belong to our shareholders, and I think we have demonstrated that today with our $1.00 dividend, bringing it to $3.75 in total for the fiscal year 2022, which compares to earnings per share of $3.54 or has adjusted earnings slightly below that at $2.83 as we had significant unrealized gains on derivatives during the year. When it comes to factors influencing our dividend decision, I've covered this in great detail in the past. Of course, it's linked to our strong earnings. The market outlook, which is also strong, and we have a very sizable backlog, as I just demonstrated, along with our liquidity position. We ended up with a cash position of $332 million, which will be further enhanced by the refinancing that Knut will shortly explain. Covenants show that we are flying with green colors; we don't have any debt maturities before 2028. CapEx liabilities are limited to the dry-docking of our four ships this year, but we expect dry-docking expenses to be around $18 million to $20 million in total. Other considerations make me hesitant to make predictions. I'm keeping it light on expectations for now. Safety and quality performance is something we take very seriously. We have many repeat customers coming back, and they do so because we have reliable uptime. As shown here, our ships maintained uptimes of 99.9%, 99.8%, and 100% despite challenging operations during COVID. Regardless of that, we keep our ships and propellers turning. In terms of safety, the two relevant benchmarks are the lost time injury frequency and the total recoverable case frequency. We are also measuring favorably in comparison to LNG data from INTERTANKO, with an LTIF of 0.33, which is 25% lower than the industry standard and even better when it comes to total recoverable case frequencies despite a slight uptick in that for '22. With that, I hand it over to Knut, who will review the financial overview.

Thank you, Oystein. Let's take a look at the key financial figures for the fourth quarter and the full year 2022. 2022 was the first year where we had the full fleet operating for the entire year, as we had three deliveries of new buildings in 2021. For time charter earnings per day, we achieved $82,000 in Q4 and $73,000 for the full year. OpEx per day showed slight improvement, with Q4 ending up at $13,500 per day and a full-year average of $13,400. Moving on to revenues, the fourth quarter delivered $98 million in revenues, reflecting the higher earnings under the variable time charter for Flex Artemis. For the full year, we ended up at $348 million. Net income for the quarter was $41 million, and adjusted net income was $55 million. The difference here reflects realized gains on termination of derivatives concluded in October 2022. For the full year, net income totaled $188 million, while adjusted net income stood at $151 million. Regarding cash flow, cash increased by $61 million in the quarter, culminating in a record-high cash position of $323 million. This is primarily driven by net proceeds from financing, where we concluded the refinancing of the Flex Resolute in December, along with the realization of derivative swaps, which were terminated. Additionally, we raised $14 million from our ATM program. It's worth noting that amortization in Q4 is slightly lower than in Q1 and Q3 due to the semi-annual repayments under the ECA facility, which will be fully refinanced shortly. Consequently, for the coming quarters, amortization should be more consistent each quarter. As we highlight later, we are also completing our refinancing program, with estimated net proceeds of $204 million for Q1, further strengthening our already solid cash balance. The balance sheet remains robust with a strong cash position of $323 million and book equity of $907 million, leading to a book equity ratio of 34%. It's important to note that book values reflect vessels acquired at historically attractive prices, contrasting sharply with current replacement costs. Our interest rate portfolio has an active hedging strategy, including long-term swaps initiated when the interest rate market was lower. In October, we terminated $100 million in 10-year swaps, yielding a cash gain of $14 million. In the quarter, we also amended a $100 million 10-year swap that had unrealized gains of $15.5 million, allowing us to transition into a new, shorter interest rate swap of two-and-a-half years, increasing the notional value to $181 million, all while locking in an attractive level of 0.9%. Following this, in January, we secured an additional $50 million in 10-year swaps, resulting in a total swap portfolio of $741 million entered at favorable levels, now forecasted with a hedge ratio of about 54% in the upcoming quarters. The hedge ratio has improved with new financing announcements, which enhance the net basis and further bolster our balance sheet optimization program, now finalized. With the remaining financing, we announce our total cash release of $387 million from this program. Last quarter, we announced the financing of the enterprise was completed, with Resolute and Amber transactions wrapped up. Today, we're also pleased to announce a new lease for the Flex Rainbow, arranged with an Asia-based lease provider as a back-to-back financing under a 10-year contract. This refinancing of Flex Rainbow is under the $375 million facility, which we are replacing with Flex Aurora, pulled from the $629 million ECA facility. We're finalizing our balance sheet optimization program with a $290 million bank facility, of which $150 million will be structured as a bullet RCF. Upon completion of this final financing, we will have successfully refinanced the entire $629 million facility. As previously mentioned, the program aimed to strengthen the balance sheet. Our contract backlog ensures stable cash flow. We've now refinanced and have substantial cash available, which we can utilize for cash management via the RCF, with a cost of just 70 basis points. This gives us the commercial flexibility to continue our Flex journey. With that, I hand it back to Oystein.

Now, let's review the LNG product market. Product exports were up 5% last year, driven by the U.S., which saw an increase of 9% despite the Freeport outage that removed about 112 cargos from the market, equivalent to 8 million tonnes. Freeport has resumed exports again this weekend, contributing growth to U.S. volumes. This year, despite sanctions, Russia's LNG exports were up 9% to 3 million tonnes in total. Malaysia is recovering as well, increasing by 11%, and other countries saw a 2% uptick, bringing the total export market for 2022 to 400 million tonnes. On the import side, we experienced major shifts in trade flows due to high LNG prices and the economic downturn in China from its Zero COVID policies, leading to a staggering 20% drop in imports there for 2022, which was a welcome relief for the European market. European buyers have struggled to access natural gas following the curtailment of Russian flows, with European imports increasing by 45 million tonnes or 54% in total. Looking at the leading import nations, all top six gainers last year were from Europe, dominated by France, the U.K., Belgium, Spain, the Netherlands, and Italy. Just as in 2019, when we faced a weak market in China, European buyers were driven to purchase LNG cargoes because of low prices. This time, however, they are acquiring cargoes due to the curtailment of Russian corridor flows. On the other side, we see that developing countries like Pakistan, India, and Bangladesh have struggled to pay excessively high LNG prices. Additionally, Germany is rapidly ramping up LNG import capabilities by enhancing its regasification capacity. Regarding storage levels, they have surprisingly remained at the upper end of the historical average during Europe’s energy crisis. This has been influenced by various factors, including demand subversion and an unusually mild winter, driving LNG inventories which are now decreasing according to seasonal norms. Pipeline flows from Russia are down about 90% compared to 2021 levels. In 2022, we witnessed a development with diminishing pipeline flows from Russia across Q1 and Q2, sharply dropping during the Q3 Nord Stream explosion, and staying steady at these low levels throughout Q4. Consequently, Europe has been tapping into the LNG spot market to compensate for Russian pipeline losses. As previously mentioned, European gas demand has dropped, reflecting a 12% decline last year, primarily driven by extreme price increases. This is not entirely positive news, as high gas prices have led cold consumption to rise; figures increased by 14% in 2021 and by another 6% in 2022. The demand decline stems mostly from industries like ammonia production, but we also see reduced household consumption due to the mild winter. Looking at how Europe is adapting to reduced Russian pipeline flows, increased regasification capacities are a priority. This rapid expansion is notable within countries like Germany, the Netherlands, and Italy, aiming to substitute Russian pipeline flows with LNG imports. There have also been significant arbitrage opportunities with the U.S. Henry Hub market presenting relatively low prices, even as European and Asian market prices experience volatility. We’ve noticed that the price differentials between the pipeline gas in Northwest Europe and LNG prices have significantly decreased from around $30 to about $1 or $2, representing more normalized market conditions. Going forward, we anticipate a tug-of-war for the marginal cargo as we observe shifts of flows into Asia. The pricing dynamics in Europe and Asia will, to some extent, dictate where cargos flow. In a curious trend, we recorded a rapid increase in floating storage during autumn. From August figures showing approximately 16 million tonnes of LNG, we peaked mid-November at 21 million tonnes on ships; an increase equivalent to more than 5 million tonnes tied up in floating storage across 72 ships. This tightens the freight market significantly towards the year-end as various vessels either congested in Europe or resting in the contango gas price scenario experienced delays. With LNG prices now stabilizing, liquidity of the LNG on water has decreased by 4 million tonnes since the peak, translating to about 56 fewer ships engaged in floating storage, which explains the recent softening in the freight market from the mid-November peak. Analyzing the headline MEGI/XDF spot rates, we recorded high levels around $0.5 million per day at the height of the market in October and November, but we observe declines downward to approximately $100,000 per day. Historically, the spot rates usually stabilize between week seven to eleven, followed by tighter market conditions throughout the year. We anticipate that current market analyses suggest forward pricing could push rates beyond $200,000 for Q4 this year. Another point to note is that liquidity in the spot market has fluctuated considerably; previously very liquid conditions in 2020 into 2021 have dwindled, with most spot activity now being managed by charters themselves, letting very few independent owners engage. This reduced liquidity drives up freight rates. However, term rates have maintained their strength driven by increasing building prices. As Knut previously mentioned, we secured ships at the bottom of the market around $180 million to $185 million, while current prices hover around $250 million for 2027 deliveries. Inflation also influences interest rates. To defend social investments, higher term rates are essential. The current five-year term rate has stabilized at approximately $135,000, leading us to have confidence about securing productive contracts for the 2027 ships we are actively marketing. Refocusing on the overall product market: last year, we witnessed a market growth of 5%, however, we expect this year to be slight less around 4% due to the limited new liquefaction capacity coming online. We anticipate about 8 million tonnes from the U.S. mostly due to Freeport's restart, along with close to 2 million tonnes from Trinidad Tobago LNG. Norway is also beginning production and we expect 2 million tonnes this year. By the end of the year, new FLNG in Mauritania will also contribute volumes, along with several others totaling 416 million tonnes for 2023. Looking ahead, many new projects are poised to come online in 2025, 2026, and 2027, and we are pleased to have an encouraging number of them under construction. The projects, notably driven by Qatar projects, alongside initiatives in North America like Golden Pass and Canadian LNG, are convincing indicators of forthcoming positive momentum. The projects in Texas, particularly Rio Grande from NextDecade and Port Arthur are sizable prospects nearing imminent FID, alongside Calcasieu Pass 2 and the Lake Charles projects also nearing finalization. With that, we will conclude today's presentation, just to highlight that our revenues were $98 million per our guidance, with strong earnings of $41 million or $55 million in net income and adjusted net income respectively, yielding earnings per share of $0.78 and adjusted earnings of $1.02. We have continued reinforcing our backlog with contracts announced for Cheniere last November. We remain positive about prospects of adding further backlog for our company. Knut has finalized the balance sheet optimization program, with only some loans to execute during Q1 expected to yield total net proceeds from this refinancing of $387 million contributing to our substantial cash position. For next year, we anticipate an increase of approximately $20 million to $370 million due to heightened time charter equivalents at about $80,000 per day projected for 2023. With strong backlog, our financial standing is solid, and the great outlook, we are today distributing a $1 per share dividend providing a noteworthy yield of around 11%. With that, we conclude today's presentation and may now begin our Q&A session. Just a reminder, you can win the Lexington bed linen kit for the best question. Knut and I will now start the Q&A round. Thank you very much.

Let's go. We're experiencing some technical difficulties similar to last quarter. Omar Nokta and another analyst inquired about the key strategic priorities for management and the main objectives for the future.

Yes, in the near term, our priority is to finalize the current financing during the first quarter, which will release $204 million in cash. For the long term, as mentioned in our chartering strategy, we have two ships available in 2027 that we are actively marketing in a market where term rates have risen. Our main goal is to secure attractive long-term contracts for those ships, which will increase our backlog and potentially improve our earnings profiles in line with higher term rates. Additionally, we have two ships becoming available in early 2028, which we also aim to market this year. Ultimately, the focus is on building our backlog. The financing process is currently concluded. As noted earlier, building prices are relatively high, and we are concentrating on maintaining and growing our existing backlog for our current ships using the same technology. We also have a robust balance sheet, giving us quick access to opportunities, including a $400 million revolving credit line available should any opportunities arise. We believe scaling the company is achievable. We've demonstrated excellent uptime and quality in our service delivery, which means there is no immediate urgency to order more vessels; we will gradually build our business as we have in recent years.

We received a number of questions about fleet expansion, new building prices, and your capacity to go to the yard for new vessels.

Yes, as I already mentioned, in the current environment, when interest rates are at zero, taking on a new building contract, where you have a lead time of roughly four years, locks up capital without providing any return. Additionally, currently projected ticket prices of around $250 million could inflate toward $270 million to $280 million if we account for the alternative return on the capital being tied up throughout the investment. Therefore, it isn't particularly attractive for us right now. Nonetheless, if there is a tender involving long-term contracts with given elevated new building prices, I believe a scenario would require contracts ranging from 10-15 years to confidently justify such an investment. Hence, I believe there remains a favorable window for us to fix our existing ships. We're also open to consolidation opportunities. Whether with the sea tankers group of companies like Frontline, Golden Ocean, or SFL, we maintain a flexible approach and will act in what is beneficial for the shareholders, only pursuing consolidation options that serve to enhance value to our stakeholders.

As we discuss capital, we have this ATM program. Numerous inquiries have come about its background, rationale, and how you'll utilize the proceeds?

Yes, when we began considering a U.S. listing back in 2018, we made the transition from IFRS to U.S. GAAP at that point. Capital markets for LNG shipping companies were starkly underwhelming in 2019. What we executed was a direct listing of the company in the U.S. market in June 2019. A direct listing implied we never made any new shares available in the U.S. Thus, it took time before the stock’s liquidity approached the current level. Concurrently, following COVID's market slump in 2020, our stock price was adversely impacted, leading us into a stock buyback, where 980,000 shares were bought back during that period. So, the ATM serves to enhance stock liquidity, as no new stocks have been issued in the U.S. To supplement this, we chose to distribute a special dividend today of $0.25 in addition to the $0.75 dividend—something I believe investors will appreciate on Valentine's Day.

Turning back to shipping-related queries, we’ve received various questions on termination risk if natural gas prices drop. How do you view stability for the charters adjusting their contracts?

Yes, we experienced a tremendous stress test in 2020 during COVID when LNG prices in Europe plummeted below $1.00 per MMBtu, while in August, they rose above $100 per MMBtu. Certainly, Asian prices also dipped to around $1.80. Nobody has, historically, ever seen the termination of these contracts over the last half-century— not even during that turmoil in 2020. These contracts are hell-or-high-water agreements. Generally, those who ship rely on their ability to ship cargo to operate; the cost of freight is typically minor compared to the cargo's intrinsic value. It's not something we've ever actually observed before, even amid financial challenges; all companies honored their contracts. Note that LNG is indeed a major operation. The supermajors have comparatively small shares in oil markets alongside traders and national oil companies; hence we mostly deal with reputable counterparts, which formulates our reliable partnerships for freight.

Regarding LNG, is Flex planning to engage in buying and trading LNG, apart from just transport?

Handling LNG buying and selling is remarkably complex. We would require a wholly different organizational structure to facilitate effective S&P transactions alongside a complete mastering of all relevant buyers and sellers. Furthermore, considering the substantial values of cargoes that may reach $200 million, we'd also need to possess significant working capital to manage such activities. There's an additional consideration where we would be competing directly with our clients for spot cargoes, potentially leading some charters to shy away from engaging our ships if we compete directly. Thus, we prefer to concentrate on transportation services, which we identify as an attractive business model, allowing us to maintain a lean organizational structure that we could not sustain through LNG trading initiatives.

In terms of shipping logistics, approximately how many days does it take for a ship to cross the Atlantic?

To cross from the U.S. to Europe is usually about five to six days; primarily around 6,000 nautical miles. If you operate at standard speed of 18 knots, you can calculate that means traveling around 432 nautical miles per day, which amounts to about 14 days from the U.S. to Europe. Loading and unloading do take additional time, so typically that results in one cargo per month. Thus, each ship can transport around 900,000 tonnes per year, give or take.

Concerning decarbonization, how will that shape the LNG shipping landscape and operations at FLEX particularly?

To us, the primary competitor remains coal. Here, I’ve demonstrated that overall coal consumption jumped significantly in 2022, not only in Europe but in China too. It's crucial to note this peak coal consumption illustrates an ongoing trend. What's worse is we observe numerous expansions within the coal sector driven by affordability, particularly in developing nations unable to shoulder LNG costs. However, the current low prices of gas, oil, and LNG in Europe restore us into coal-to-natural gas switching territory, which hasn't occurred in a long time due to carbon pricing. With natural gas representing a cleaner alternative, we’re motivated to stimulate demand amidst lower prices, which typically leads to greater consumption of LNG, specifically in Asia. In terms of EGS, we aim to replace coal with natural gas, thereby mitigating CO2 emissions while enhancing local air quality, reducing particulate matter emissions and NOx by 85-99%. Another critical point is that CO2 pricing now extends to shipping in Europe, confronting ships docking at European ports with CO2 pricing for emissions. Our vessels are significantly more efficient than the outdated steam generation ships, leading to substantially lower CO2 footprints, allowing our ships to benefit from reduced CO2 taxes compared to older generation vessels. This competitive edge will further enhance as CO2 pricing eventually spreads beyond Europe.

Can you clarify whether our revenues are sensitive to the LNG commodity price fluctuations?

We have 12 ships operating under fixed hire rates. This means their rates are stable and not directly influenced by commodity prices. One ship operates under variable hire; however, it’s not linked to commodities but to spot freight rates. Our actual revenue sensitivity to LNG pricing fluctuations is minimal.

Is there a Phase 3 of your balance sheet optimization program? Could you provide insights? We've completed Phase 1 and 2, and now we have introduced 2.1. This can be viewed as Phase 3, but we have efficiently refinanced all 13 vessels with considerable maturity periods. We're satisfied with the outcome for now.

That's accurate.

Let’s wrap up the Q&A session and get to the big question: who will be the recipient of the reward?

Let's find out who's going to have a good night's sleep. Thank you for your questions. You have not only sent questions today but have also been actively engaging with queries over the last two years. I genuinely appreciate your efforts, especially in sending us questions in the middle of the night from U.S. time. We will send over a Flexington bed linen kit to you along with two T-shirts, ensuring even better sleep for you. This concludes today’s presentation. Thank you for joining us, and I appreciate the trust and support from our financing partners who have provided about $2 billion in new financing. A big thanks to all our investors and especially to our onshore and offshore teams, whose efforts allow operations to run smoothly despite numerous challenges including COVID. Our operational excellence remains a proud achievement. Thank you, and I hope you enjoy Valentine’s Day. We will return for updates in May during our Q1 presentation.

Thank you.