Flex LNG Ltd. Q2 FY2023 Earnings Call

Hi, everyone. I'm Oystein Kalleklev, CEO of Flex LNG, and today we're here to discuss our second quarter results. Joining me is our CFO, Knut Traaholt, who will go over the financial details later in the presentation. Before we start, I want to remind you that we’ll have a Q&A session at the end where you can submit your questions either through the chat function or email us at [email protected]. And if you ask the best question today, we have some gifts for you. The first is our Flex LNG boiler suit, which is great for any maintenance or improvement projects at home since we've just docked four of our ships. We also have our Just Flex It running T-shirt that we'll be using in the Oslo Marathon next month. Lastly, we've added Flex LNG sunglasses to our gift lineup. I look forward to seeing your questions, as they are always the most enjoyable part of these presentations. Now, I’ll briefly go over our disclaimer. We’ll be making some forward-looking statements during this presentation and using non-GAAP measures such as TCE and adjusted figures. We can’t cover everything in detail today, so please refer to the earnings release we’ve also presented. Let’s get started with the highlights. Our revenues for the quarter amounted to $86.7 million, aligned with our guidance of $85 million to $90 million. This led to strong earnings of $39 million, equivalent to $0.73 per share. The adjusted net income, which includes only realized gains on other derivatives and not unrealized gains, was $28.2 million or $0.53 per share. During the quarter, we completed the drydocking of three ships on schedule and within budget, finishing our drydocking plan for the year with four drydockings in the first half. The three drydockings in Q2 were the main reason for the lower revenues compared to Q1. However, with all ships back in operation for the second half of the year, we are reaffirming our revenue guidance of $90 million to $95 million for Q3, and we expect even higher revenues in Q4, ranging from $90 million to $100 million, depending on the strength of the spot market for our ship on variable higher time charter. Thus, we are also reaffirming our revenue guidance for the year at $370 million, with adjusted EBITDA estimated to be between $290 million and $295 million. Today, we are also pleased to announce that Cheniere has extended the Flex Vigilant time charter from the end of 2030 to the middle of 2031, as anticipated. Last year, we extended three ships with Cheniere, which included an early option to extend for 200 days, allowing us the option to extend for an additional two years. In total, we now have 55 years of minimum firm backlog, which could be extended by up to eight years if all charter extension options are utilized. With our robust backlog and a strong financial position of $450 million in cash and no debt maturities until 2028 after our recent refinancing, it’s no surprise that our Board has declared a dividend of $0.75 per share for the second quarter. Over the last 12 months, this brings our dividends to $3.25 per share, giving us a yield of approximately 10%. As noted, we have been busy with drydockings this year. We docked Flex Endeavour in March in Singapore, followed by Flex Enterprise in April in Singapore and the sister ships Ranger and Rainbow docking in June, with Ranger in Denmark and Rainbow in Singapore. We expected these drydockings to last between 80 and 90 days, and we finished them in 77 days, slightly ahead of schedule. Our CapEx for these four drydockings was about $20 million. As it stands, there are no more drydockings scheduled for this year. Looking ahead, we anticipate two drydockings next year, likely four in 2025, and three in 2026, with no drydocking scheduled for 2027. This slide will look familiar as we reaffirm our annual guidance of $370 million in expected revenues. We generated approximately $92.5 million in Q1, slightly lower in Q2 due to three drydockings and a softer spot market affecting our ship on variable higher time charter. With all ships back in operation, we expect revenues to rebound in Q3, estimating between $92 million and $95 million, and variability in Q4 will depend significantly on the spot market, especially with recent winter coverage fixtures. We anticipate Q4 revenues to be between $90 million and $100 million, leading to total revenues around $370 million. Notably, revenues are higher than last year when we reported about $348 million, despite taking four ships for drydockings this year, attributed to our ability to reprice our fleet, with expected time charter equivalent earnings this year around $80,000, surpassing last year’s figures. Regarding our backlog, as mentioned, Flex Vigilant will run from the end of 2030 to the middle of 2031. We maintain a substantial backlog with 54 years in minimum contract terms. The two stars on the slide signify Flex Ranger, recently drydocked and available in Q2 2027, and Flex Constellation in mid-2027. I will touch on these later in the presentation. These are attractive terms in comparison to term rates and newbuilding prices for shipments scheduled for delivery in 2027 and beyond. Once we finalize marketing for these ships, we will proceed to the next available positions, Flex Aurora and Flex Volunteer, fixed to Cheniere with re-delivery in early 2028, assuming they exercise their options, which we anticipate they will. We expect many of these options will be declared given the direction of term rates. Additionally, we have Flex Artemis, the only vessel on variable hire time charter, with rates adjusted based on spot market conditions, which appear strong for the second half of the year. This is why we have a broader revenue range for Q4 compared to Q3. In this slide, our adjusted earnings per share stand at $0.53 for the quarter, about $3 per share over the last 12 months. Ordinary dividends have been $3, along with several special dividends due to our robust financial performance over the last year. We're reducing our running dividend from $3.75 to $3.25 per share, but this still represents a comfortable level, yielding 10% for our investors. The decision factors were discussed earlier. Traditionally, Q2 is the weakest quarter for earnings from spot ships, but most indicators are positive. With that, I’ll pass it over to Knut for the key financial highlights.

Thank you, Oystein. Let's review the key financial highlights for the quarter. Revenues reached $86.7 million, which was affected by 57 days of scheduled drydock for three vessels in the second quarter. Additionally, seasonal lower earnings from the variable hire contract for the Flex Artemis had an impact. Operating expenses saw a slight increase this quarter to $17.3 million, attributed to timing effects of spares and maintenance. Last quarter, we were below budget, and this quarter we have incurred some of those operating expenses. Therefore, operating expenses per day are $14,600, while the average for the first half of the year is $14,000. Interest rates continue to rise, leading to an increase in interest expenses to $27.2 million, which is offset by our gain on derivatives of $17.1 million. This includes realized gains of $6.2 million compared to $5 million in the first quarter. When comparing with the first half of the year, we have realized gains of $11.2 million against a loss of $2.4 million last year. Despite the rapid increase in interest rates, our hedging strategy has yielded positive results, with unpaid interest only $10 million higher. Last quarter, we completed the balance sheet optimization program and recorded a write-off of debt issuance costs of $10 million, which is not relevant this quarter. Thus, for the second quarter, we reported a net income of $39 million or $0.73 per share. After adjusting for unrealized gains on derivatives, our adjusted net income is $28.2 million, resulting in adjusted earnings per share of $0.53. Regarding the balance sheet, it remains robust and straightforward, comprising cash of $450 million and 13 vessels with an average age of 3.6 years valued at approximately $2.3 billion, yielding an equity of $870 million and a solid equity ratio of 31%. In the cash flow statement for the quarter, we saw $47.5 million in cash flow from operations and $9 million in changes to working capital. We incurred $16 million in drydock expenses and amortized about $26 million. We distributed $0.75 per share in dividends last quarter, totaling $40 million, which allowed us to maintain a solid cash position of $450 million. Examining our interest rate portfolio, we made no adjustments to the derivatives this quarter, maintaining a high hedge ratio of 62% to 65% in the coming periods. This includes a combination of SOFR-based interest rate swaps and LIBOR-based swaps, which will transition to SOFR swaps in the third quarter due to LIBOR ceasing to be quoted. Our swaps total $820 million, and we also have $201 million in fixed-rate leases. The interest rate swaps are currently valued at $58.7 million on our balance sheet, providing a strong hedge and cost visibility for the forthcoming quarters. Looking at our funding portfolio, we completed the balance sheet optimization program in Q1. Our funding portfolio is split evenly between long-term leases and debt, including term loans and a $400 million non-amortizing revolving credit facility. The revolver offers us cash management flexibility, allowing us to repay it anytime and reduce interest costs. The maturity profile has been extended; the first maturity is in 2028, with the last expected in 2035, assuming we exercise the two extension options available. A diverse and reliable group of banks backs this portfolio, which spans different regions including the US, Europe, and increased exposure in Asia, establishing a solid foundation for the company's future. I will now pass it back to Oystein for an update on the markets.

Thank you, Knut. Let's review the market, starting with the volumes. From January through July, export growth is around 3%. In the U.S., volumes were stable in the first quarter due to the Freeport shutdown, but as Freeport resumes operations, U.S. volumes are on the rise, driving volume growth. Norway also experienced shutdowns but has resumed exports, contributing an additional $1.6 million, similar to Algeria. On the import side, Europe has shown robust growth, adding 5 million tonnes in the past seven months. Meanwhile, demand from Japan has decreased following nuclear restarts, though China is recovering. After easing COVID restrictions, Chinese demand started bouncing back in March, with import growth at about 20% in the second quarter. Gas prices have been extremely volatile over the past couple of years, primarily due to supply disruptions and COVID impacts. Over the last 1.5 years, we've witnessed high gas prices following the Ukraine invasion and strong demand in late 2021. The Freeport shutdown last year also pushed prices up, alongside the Nord Stream explosion significantly reducing Russian gas supply to Europe, which drove prices to as high as $100 per million BTU—equivalent to about $600 per barrel of oil. This spike in prices decreased demand, leading to a shift back to coal or propane. With prices peaking, demand in Europe, which relies on the spot market, fell, and we saw gas prices drop from $100 in August to around $10. Recently, prices have settled to levels where natural gas competes favorably with oil. However, there are ongoing discussions of potential strikes by Australian workers that could significantly disrupt up to 50% of Australian gas volumes or 10% globally, presenting an even larger potential impact than previous events like the Freeport explosion, which affected about 3.5% of global volumes. This situation has triggered a recent increase in European gas prices, and we anticipate further price rises as winter approaches, correlating with demand increases. In Australia, we face uncertainties around three major projects that accounted for nearly 50% of all Australian exports last year. Indications suggest industrial actions affecting key facilities operated by Woodside and Chevron could lead to significant supply shortages, pushing Asian buyers to compete for limited Atlantic Basin cargoes, further escalating prices. While we don't foresee simultaneous shutdowns like those seen with the Freeport explosion, similar strikes occurred last year affecting the Prelude project. This ongoing situation is closely monitored. Turning to Russian gas supply, Europe has decisively reduced its reliance on Russian pipeline gas, largely due to the Nord Stream explosion, and has switched to LNG. Europe's inventory levels are currently high, nearing the EU's targeted threshold of 90% for November 1st, although this will decline as winter progresses and storage is utilized. Analysis from the IEA indicates that Europe is vulnerable to supply crunches, particularly considering the winter's severity and LNG sourcing challenges. The recent surge in gas prices suggests that competition for marginal spot cargoes may reduce LNG supply. In terms of the freight market, the spot market has softened following winter but is rising again as we approach the cold months. Day rates for modern ships have surpassed $100,000, and future projections indicate that rates may exceed $200,000 during peak winter. Concurrently, newbuilding prices have risen about 30% over the past two years, impacting long-term charter rates, which currently hover above $100,000 for ten-year contracts and around $150,000 for five-year charters. Notably, the LNG supply landscape remains promising, with significant investment decisions being made, including Next Decade's Rio Grande project moving forward. Currently, about 100 million tonnes of projects are under construction in North America, with additional projects anticipated. This underlines strong market growth potential, with the nameplate capacity currently at 465 million tonnes, projected LNG supply at roughly 420 million tonnes, and future capacity significantly exceeding demand numbers. In conclusion, for the quarter, revenues align with our guidance, showing stronger earnings of $39 million or $28.2 million adjusted for unrealized gains on derivatives, resulting in earnings per share of $0.73 or $0.53 respectively. All drydocking was completed on time and budget, and we've extended our time charter for Flex Vigilant through 2031. As we anticipate increased revenues in the second half of the year alongside a strong spot market, we confirm our earlier guidance of $370 million in revenues for the year and adjusted EBITDA between $290 million to $295 million, driven by enhanced earnings in Q3 and Q4. Additionally, we are pleased to declare a dividend of $0.75, bringing the total for the last 12 months to $3.25, representing a 10% yield, which we can comfortably support due to our strong backlog and financial standing. Thank you for joining the presentation; we will now move to the Q&A session. Thank you. Okay. Let's start the Q&A session, Knut. And I think we have received quite a lot of questions today as well. Even though I think most of the analyst reports coming out this morning were, this is boring stuff. No news. Everything as expected, but we would rather be boring and profitable than funny and losing a lot of money. So let's see. Okay.

We have a good group of questions. So thank you for sending them in. Let's start with the contracts. And Wolfsburn, he questions if it's a surprise that Cheniere declared the option on the Vigilant that early, and can we expect any other options to be declared by Cheniere any time soon?

Yeah. Well, he is a loyal shareholder. Now it's not a surprise at all. Actually, if you read the press release we sent out last year when we did this deal with Cheniere for three ships which we extended then, we noted the fact that the Vigilant had an early option, due in Q3 this year, it's now Q3, even though we are reporting Q2. So, it comes as no surprise. And they also have an early option to extend Endeavour in spring next year where the period is slightly bigger or longer, 500 days. So I would expect that to happen as well. So, no surprise, as planned.

And then a follow-up on the contracts from Eirik Haavaldsen in Pareto Securities. In the fixed rate contracts, are there any inflation adjustments?

No. We have them on a fixed rate level. Of course, there are some facts in those contracts. That's why we're making some money. However, we have hedged the risk in terms of inflation. Usually, there is a strong correlation between interest rates and inflation. So if inflation goes up, interest rates tend to go up as we have seen very much so the last couple of years. So, as Knut has shown, we hedged a lot of our interest rates, so we have covered the inflation risk in that sense. And actually, our cost of interest rates per day is higher than OpEx per day. So it's actually a more important risk to cover.

Yeah. Then we have some questions around the contract portfolio. We today announced 54 years of firm backlog and 80 years including the options and then we talk about open vessels in 2027 and '28. So the question is, what's the likelihood of the options to be declared?

Currently, considering the term rates for ships, they have become significantly more expensive. Newbuilding prices have increased by 30% over the past two years. We placed orders for ships back in 2017 and 2018, and their prices have risen from 180 to 265. Newbuilding rates are around $100,000, which are lower than previous rates. However, most of the options we hold are generally at a higher rate than our firm contracts. Therefore, it's very likely that options will be extended. While it's uncertain if all options will be exercised, it's reasonable to believe that most will be called by the charters, which suggests that our backlog is likely to extend beyond the 54 years of firm contracts we currently have.

Okay. Moving on to drydock, we have a question from Haakon Lunder, who is involved in the offshore drilling industry. There is a concept in that industry called continuous class, which involves performing maintenance and class renewal while the operation is ongoing to minimize yard time and off-hire. Could this concept be applicable for LNG and FLEX during drydocks?

It's somewhat different when you are operating on a semi-submersible drilling rig. You could invest between $50 million and $100 million for a specialized survey on the vessel. We consistently perform maintenance and conduct cash inspections regularly. Before heading into dry dock, we aim to shorten our time there, so we prepare everything ahead of time. During discharge, we utilize the ballast leg to organize all required maintenance and begin dismantling equipment for servicing. We've demonstrated this by guiding an average of 80 to 90 days in dock time for the four ships planned this year, while actually spending only 77 days on those four dockings, averaging 19 days each. Compared to most other LNG owners, we have performed very well in terms of both timing and costs, as being in a dock can be quite expensive.

And he follows up with another question on the new buildings. It's been mentioned that there have some new gadgets slightly different from our vessels. So while we are in drydock, do you plan to do any upgrades of the vessels?

It's not major upgrades. Of course, we always do software upgrades, might be some new energy-saving devices. So we are putting in some more sensors, but not major upgrades. We have the most efficient engines. That's a two-stroke. People oiling ships today is still the two-stroke. Actually, very few people are ordering the mega-ships, which we have nine out of 13 in our fleet is mega-ships, because they are quite expensive. Usually, they have one or two high-pressure compressors running at 300 bar. People today are maybe often opting for cheaper engines with lower pressure, which results in not as good combustion and more methane slip. There are some other gadgets. You have the air lubrication system, but so far there are some mixed results on these systems. I think if you are to order new ships today, of course, a shaft generator is quite popular. It's basically if you have a bicycle and you have a dynamo on the bicycle in order to make lights, rather than running the auxiliary engines, you can use the dynamo. But of course, if you use the dynamo, you also create friction. So it's not like you get free electricity. You have to build more on the engine, but you can use less of the auxiliary engines. But that's a roundabout way of saying that we plan no big upgrades because the ships are state of the art, and we ordered them because we could get state of the ships at the right time, at the right price, compared to what it is today.

We have been receiving questions about our cash reserves, particularly regarding our decision not to pay down debt to reduce interest expenses. This relates to our revolving credit facility, which we utilize for cash management. Between quarters, we use available cash to lower interest costs, which is the primary concern here. Our current strategy allows us to have cash and funds ready when needed, in line with traditional capital-raising principles. For this revolving credit facility, when it’s not in use, we incur a commitment fee of 70 basis points, which is an inexpensive way to maintain access to capital. Transitioning to market-related inquiries, we have a question from Charles at Namohan asking if winter is approaching.

Yes, it is August now, and as we approach October, winter will arrive. I believe he might be alluding to storage levels of gas in Europe, which are currently very high due to reduced demand last winter, influenced by a total La Niña and a mild winter in Europe. This year, circumstances are different from the past three years. In those years, we experienced La Niña, but this year we have El Niño, which usually leads to colder winters in Northern Europe, wetter conditions in Southern Europe, and warmer winters in Asia. Although inventory levels seem high at present, it's essential to consider that the supply of Russian gas in Europe has significantly diminished. Consequently, storage has become increasingly vital, and any drawdown of these levels may happen more rapidly, particularly in a cold winter, due to the lack of a stable gas supply in the market. Winter is indeed approaching, and it will be interesting to see how it unfolds. We need as much LNG in the market as possible to avoid the significant price fluctuations we've observed in the past.

Yeah. So that brings us to another question from Sherif Al-Magaby. We have in the presentation deck and there is also in the news now about a potential strike in Australia. So what's the impact on the ton-mile and is there a risk of a seaborne volume will drop and where will then the importers pick up the slack?

This is an unprecedented amount of volume, with 10% of our volumes disappearing. We observed a 3.5% decline, and if this continues, prices will rise dramatically. There will definitely be a shortage of LNG in the market, and we can only hope that this situation doesn't persist for long. We've seen something similar occur in Norway, where oil and gas workers were considering strikes. The government intervened, citing the significant consequences. As the largest gas exporter to Europe, we have a public arbitrator setting terms. Australia should definitely look into a similar approach. If that occurs, it would free up many ships in Australia that typically transport LNG to Japan, Korea, China, and Taiwan. We're talking about around 40 ships, potentially increasing to 60 when factoring in their capacity. However, these ships might not be available immediately because operators tend to hold back when the duration of the strike is uncertain. They can't commit to short-term charters if there's a chance the strike could end unexpectedly. This will create inefficiencies and lead to vessels taking longer routes to the US and Asia. The shipping market will likely become constrained due to uncertainty around volume recovery. Unlike the situation when Freeport shut down, where a timeline was provided for volume resumption, a strike introduces more unpredictability, prompting operators to hold their vessels. Consequently, the LNG market will be extremely tight, and the shipping market may benefit from this, but this is not an ideal scenario. I truly hope it doesn’t come to this, as we need LNG prices to remain low to attract new consumers.

And on top of that, we have the problems with the Panama Canal. So how is that affecting Flex and the LNG industry, in general?

We experienced the most severe drought in Panama since the canal was opened in 1914, resulting in very low water levels. The canal is substantial, and when ships pass through, water is lost to the sea. To maintain water levels, we need to refill from reservoirs, which are currently low. Typically, one transit results in the loss of 50 million gallons of water, which is approximately 190 million liters. Consequently, Panama has had to limit the number of transits to sustain water levels, leading to an extremely tight market in the Panama Canal. If ships don't have a scheduled slot, waiting times are nearly 20 days today, compared to 26 days last November, which is typical of the busier winter season. The winter months usually see heightened activity due to increased container shipping for the holiday season, along with higher exports of LNG and LPG, and more routes to Asia. The congestion in Panama is an ongoing issue. Even though the drought may pass, the canal remains congested. This challenge arises because the Panama Canal was designed for container traffic and increased container movements, particularly for Neo-Panamax ships, before the United States emerged as the largest LNG and LPG exporter. The canal hasn't been adapted to handle this influx of traffic, creating inefficiencies. We have observed this more on the LPG side at Avance Gas, where we have been rerouting ships away from Panama due to excessive waiting times and the challenges of scheduling repairs when the timetable is uncertain.

So, then there is a bit of a crystal ball question, what's your view on the LNG commodity prices in the short and longer terms?

Right now, forward rates are not always a reliable predictor of prices, but I believe they are fairly accurate in the near term. Prices will likely remain tight in the medium to short term due to high demand for the winter market, leading to price increases. There isn't much new LNG entering the market in the near term, contributing to this tightness. Additionally, Europe will not have access to Russian pipeline gas, which will further tighten the market. Starting in 2025, we expect many new liquefaction plants to come online, which could lower prices. Reducing prices to around $10 or less is crucial, as it would enable us to address coal consumption. LNG should not only replace Russian pipeline gas but also help reduce coal use, which is vital for minimizing pollution and greenhouse gas emissions. It's essential to ensure that prices are affordable for developing countries and not just for European consumers.

So that rounds up the questions. But we'll include one more. It's Lucy Hine from TradeWinds. What's your guidance for your time to complete the Oslo Marathon?

We are planning to attend the Oslo Marathon, but the entire team will be participating in the Half Marathon instead of the Full Marathon to avoid exhaustion. My goal is to challenge my team to outperform me, and hopefully, I can manage to beat a few of them. Since my last Half Marathon, I've conducted 24 quarterly presentations, which hasn't helped with my weight, resulting in me running slower this time. I expect my finishing time to be around 15 minutes longer than before, aiming for a time below 150 minutes.

Good.

Yeah.

That rounds up the questions. Thanks a lot for the questions.

And Lucy, if you're attending Gastech in early September for the big Gas Conference, I know you enjoy running marathons. So, I'll bring you one of those Just Flex It T-shirts for your next full marathon, not the half marathon like Knut and I do, but the full one.

Then we need to round off with the winner of the Flex kits for the questions.

I wonder if this is Hawken Lunder from my childhood. Let's reach out to him and give him the T-shirts so he can also run a Half Marathon or Full Marathon, along with the Flex glasses and the boiler suits. If he does walk spot drilling, I'm sure we all will have a boiler suit.

Congratulations and thank you for all of your questions.

Okay. Thank you, guys. And we'll see you in November. Thank you.