Flex LNG Ltd. Q4 FY2023 Earnings Call

Hi, everybody, and welcome to Flex LNG's Fourth quarter and full year 2023 presentation. I'm Øystein Kalleklev, CEO of Flex LNG management, and I will be joined later today by our CFO, Knut Traaholt, who will run you through the numbers. As usual, we will conclude with a Q&A session, where we have a gift as customary for the best question. This time, we have some nice beanies in various colors. And also a nice neck warmer to fit together with the beanie. You can ask a question either by using the chat function in the webcast or you can also still send some e-mails to [email protected], and we will cover those questions in the end when we're doing the Q&A session. Just a reminder before we begin the presentation about our disclaimer, we will provide some forward-looking statements. There are some non-GAAP measures. And of course, there are limits to how many details we can cover in the presentation, so let's kick off. Revenues for the quarter came in at $97.2 million. This was in line with the guidance provided for Q4 of around $97 million to $99 million. Net income and adjusted net income came in at $19.4 million and $37.8 million, respectively. Just a reminder, we have a rather big portfolio of interest rate derivatives, where we've hedged ourselves against the higher interest rates we are currently experiencing. In the adjusted numbers, we only include the realized gain and loss on derivatives while the changes in unrealized value are included in the net income numbers. But as Knut will tell you shortly, we have made significant gains on derivatives during the last three years, totaling $116 million in the positive. This translates into our earnings per share and our adjusted earnings per share of $0.36 and $0.70, respectively. As we are now in February and heading out of the peak heating season, not surprisingly, rates are softening following the seasonal pattern where typically freight rates find their bottom around March before starting to rise again for the summer season. I will cover more of the freight market in detail later in the presentation. We have recently announced that we received an extension of one of our ships, Flex Resolute. She has now been on our time charter for about two years. This time charter is for three years, where the charterer, a super major, has the option to extend by two plus two years. They have now declared the first option, taking this vessel firm until at least the first quarter of 2027. As we announced on January 8, we have a redelivery of Flex Constellation either at the end of Q1 or in Q2. This ship has been on a three-year time charter with a trading house, and we will get it back and plan to carry out the dry docking of the ship before marketing it for spot, medium-term, or longer-term time charters, depending a bit on the market conditions. For the next quarter, Q1, which we are already well into, we expect rates to soften a bit, depending on where the spot market is trading, as we have one ship on a variable time charter, Flex Artemis, for which we expect time charter equivalent earnings of somewhere around $75,000 to $80,000 per day. We are also guiding in terms of revenues and adjusted EBITDA to around $90 million in revenues and $70 million in adjusted EBITDA, quite similar to the results achieved in Q1 last year. We have two dockings scheduled for this year. Last year, as some of you might recall, we carried out the dry docking of four ships altogether. This year, we only have two ships. It's the Constellation, which we will dock at the end of Q1 or Q2, depending on when we get them back, and then Courageous, which is scheduled for dry docking in the second quarter. With strong results, our very healthy backlog, which I will cover shortly, we are pleased to once again pay out a dividend of $0.75 per share for the quarter. This gives, in total, our dividend for the full year 2023, $3.125 per share, and that should provide a yield of around 11%. The stock market here in Oslo is down today; our stock has recovered a bit, down 5.5%, driven partly by the sentiment around Equinox Capital Markets Day, where they cut our dividend. Equinox is down 5%, 6% today, and lagging in the energy sector. Hopefully, we can provide you some info and give you comfort on the results of Flex LNG, despite the current sell-off in the energy market here in Oslo today. Let's review our guidance. Last year, we provided detailed guidance for the full year, given that we had 100% coverage for the year. We guided on three key measures, time charter equivalent, which is the average rate we obtained on our ships. We guided at approximately $80,000 for the full year, and delivered slightly better in Q4. That's the peak season, $81,100, with an annual average of $79,500, which is very much in line with the guidance provided. Revenues were guided at approximately $370 million, and I’m pleased to say we beat that by $1.371 million. The last measure was adjusted EBITDA of $290 million to $295 million, and we delivered $290 million. The reason we didn't meet the midpoint is that we had some technical off-hire days last year. We have had extremely few technical off-hire days during the more than five years we've been operating these ships, but we did have some last year which affected slightly the adjusted EBITDA. Looking forward to Q1, as I said, it will be more or less similar to the numbers we delivered in Q1 last year, depending a bit on the timing of the Constellation docking and also how the spot market is performing. So far, revenues amount to $90 million, adjusted EBITDA of around $70 million, and our range share on the TCE achieved of $75,000 to $80,000 per day. During the last couple of years, we took delivery of our first ship, Flex Endeavor, on January 9, 2018, followed by the sister ship on January 11, 2018. We've been building up our fleet on the water and the last ship we took delivery of was on May 30 or May 31, 2021, the Flex Vigilant. From Q3 2021, we've had our entire fleet on the water generating earnings. We started with most of our ships in the spot market, which really paid off in '21 when the market was a bit more challenging during COVID. From '21 and '22 onwards, we've mostly locked in rather long charters on all of our ships and stabilized both revenues and adjusted EBITDA since basically all our costs are fixed. As you can see, the variability in adjusted EBITDA is very small. We had a bit of a dip in Q2 last year, but that was mainly driven by the fact that we carried out dry dockings of three ships in Q2 last year. This year, as I mentioned, we only have dockings of two ships. Our backlog is backed by high contract coverage. We have very limited ships open near term. This year, we are already at 94% coverage on contracts. We have one ship, as I mentioned, the Flex Constellation coming back from a three-year time charter at the end of Q1 or early Q2. Once we dock her, this typically takes around 20 days, after which she will be available at a good time, once we're out of the seasonal low in the market. Additionally, we have one ship linked to the spot market, Flex Artemis, which is on a five-year charter but where the charter has options to extend that contract by five years. As mentioned, Flex Resolute has been extended to 2027. There is a similar option for the sister ship Flex Courageous, so we hope to add even more backlog this year. As you can see, we have very limited open availability in the near term. We anticipate a bit softer market in terms of volumes in '24 and '25, while much new LNG will be coming to the market in '26, '27, '28, and onwards. In fact, contracting of ships has slowed down due to the very high ship prices. We believe we are well positioned, with a minimum of 50 years of charter backlog. We think we will add some more charter backlog this year through the declaration of further options, which could bring the total up to 75 years. All these charters are with blue-chip counterparties. Looking at dividends, we have a stable business backed by a lot of first-class backlog, and we are generating substantial cash flow. As I've covered in the past, we are a very shareholder-oriented company, believing that all these earnings belong to shareholders, and we pay this out regularly on a quarterly basis. This quarter, we are paying out $0.75, slightly higher than the adjusted earnings, given that we have a strong financial position, with $411 million in cash, no upcoming maturities, a lot of backlog, and very limited CapEx liabilities since we have no ships under construction and CapEx liabilities are limited to dry dockings. This year, we have the dry docking of two ships, which should be in the range of $10 million altogether in CapEx for those two ships. We have generated substantial returns with this business. We listed this company almost five years ago now, in June 2019 in New York at $11. We have paid out almost the same amount, $9 in dividends. If you reinvested the dividends, your returns would be even better. On top of that, we have had share price appreciation. Right now, the stock is down today, so the total return of 280% is slightly less, but still a very good return. For those who are fans of Warren Buffett, he knows that in the short run, the market is a voting machine, while in the long run, it’s a weighing machine and gravity tends to favor good businesses. As he says in his book, Snowball, Time is the friend of wonderful businesses and the enemy of mediocre ones. We have certainly delivered on that philosophy. We are paying out our free cash flow, and in the Russell 2000, consisting of stocks in New York, we are in the top 2% of companies in terms of dividend payout, currently around 11% — I haven’t calculated, but it’s probably 12% today with the current stock price. I think it's a great time to be invested in Flex. And I will come back and give a bit more update on the market. First now, we will head over to Knut. I hope you can give him a warm welcome. Knut is 46 years today, so it's his birthday. Come on, Knut! I hope you can get yourself a beanie afterwards as well as a gift. Typically, if you're single, you opt for a green beanie. If you're not, you have red; if you're undecided, you choose a white one. I'm curious to see which kind of beanie you're going to select. Last year, there was an LNG carrier scrapped at age of 46 years, sharing the same age as you, the Gandria. But Knut is still operating in the LNG business.

Thank you, Øystein. I think we can hand over to the summary of the operational figures for the fourth quarter and for the full year. If you look at operating days in the second quarter, we had 77 days of hire related to the dry docking. In the first three quarters, we had 19 days of technical off-hire. In the fourth quarter, we had 100% technical uptime, resulting in a technical uptime and commercial availability for the year of 99.6%. That's a strong testament to our onshore technical and operations team and also our crew members on board, keeping the propeller running. If we look at the time charter equivalent per day in the fourth quarter, we had $81,100. For the full year, the average was $79,500, which is on par with our guidance. OpEx for the fourth quarter is somewhat higher than guided in the Q3 presentation, mainly related to scheduled maintenance of our auxiliary engines. However, as we guided on the total OpEx for the year, we ended up at $14,400, versus the guidance of $14,500. For 2024, we guide an OpEx of $14,900, which is primarily an increase in crew wages and some technical. This results in revenues of $97 million for the quarter and $371 million for the full year, which also aligns with our guidance. An EBITDA of $76 million for the quarter and $290 million for the full year resulted in adjusted net income of $38 million for the quarter, or $137 million for the year. In the adjusted numbers, we adjust out unrealized gains and losses from our derivative portfolio. As you may recall from the closing of our balance sheet optimization program in the first quarter, we also strip out the noncash write-off of debt issuance costs. Looking more into details, we have gone through the revenues and the OpEx. The main differences are on the derivative portfolio. The paid interest is on par quarter-by-quarter. And then for this quarter, we recorded an unrealized loss of $18.7 million and a realized gain of $7.1 million, which offsets our interest cost. That gives us a net income of $19.4 million for the quarter. If we then adjust out the noncash items, we have an adjusted net income of $37.8 million or adjusted earnings per share of $0.70. The balance sheet remains pretty much the same. We are experiencing scheduled depreciation of our vessels along with $411 million in cash on the asset side. This results in a book equity of $848 million, with a book equity ratio of 31%. These book values reflect that the vessels were ordered at a low point in the cycle and do not reflect their market value today. On the funding side, our debt portfolio has gone through a complete refinancing with the balance sheet optimization program concluded in the first quarter of last year. This has given us flexible blending of both long-term leases, up to 12 years for some of them, and the traditional bank portfolio, where we have structured $400 million of our debt as non-amortizing up to six years in our revolving credit facility. With $410 million, $411 million in cash available, we have a flexible tool for cash management, allowing us to repay the RCFs between quarters. We have also reduced interest rate costs and are paying 70 basis points in commitment fee. Our debt maturity profile indicates that our first maturity is in 2028, related to our bank financing. We have a lot of headroom ahead of us, positioning us well to support our business and business case. Over the last three years, we have been active in the interest rate market, entering with numerous long-term interest rate swaps in 2021. As interest rates have increased, we have added more and amended the duration profile to utilize the gains and reduce the tail-end risk of this portfolio. Today, we have a hedge on our interest via traditional interest rate swaps, but we're also utilizing off-balance sheet items like fixed-rate leases. For this year, we anticipate an average net hedging ratio of about 65%, tailing off fairly equally, as you will see in the forward curve of the swap rates going forward. We are monitoring the interest rate market closely and exploring when to increase our exposure on the tail to boost our hedge ratio from 2025 onwards. That concludes the financial sector, and now back to you, Øystein.

Thank you, Knut. In terms of the interest rate hedging, Jay Powell was on 60 Minutes on Sunday and discussed the interest rate market. It seems like March will be a bit premature for a cut, but May is very likely, which does not rule out larger cuts down the road. Our hedging profile is very much in line with a pivot from the Fed, which we've expected and have positioned ourselves for, as inflation is starting at least to subside a bit. The LNG market has had another eventful year. It seems this is the case every year; 2022 was all about the curtailment of Russian pipeline gas to Europe prior to the innovation and following it, we had the gas pipeline explosion. This year, however, has been relatively calmer. We have observed LNG prices migrating down to more normal levels. We had a peak in spot LNG price last August of 2022, reaching $100 per million BTU, equating to around $600 per barrel of oil. We are now down to more normal levels of $8 to $9, which means that LNG is cheap again. When things are cheap, people tend to consume more of it. Notably, we are now at a significant discount to oil and especially to diesel. This situation drives demand in new regions. In the longer term, it's preferable to have a sound price for the product. Otherwise, we risk demand destruction. In terms of exporters and importers, we are witnessing a swap of thrones. China is making a comeback, reclaiming its position as the largest LNG importer in 2023 after previously becoming the largest in 2021. The Zero-COVID policy resulted in China reducing its LNG import in 2022 by 20%, but is now bouncing back in 2023. Japan, traditionally the largest importer, is firing up nuclear power and also coal power plants, with 40 built since Tokushima. Consequently, we see demand from Japan has softened. However, certain emerging markets are seizing these lower cargo prices. Last year saw limited new capacity being installed, although we experienced volume growth of around 3%, primarily driven by the U.S., particularly the restart of Report, contributing significantly to new volumes this year. Additionally, export capacity growth has been relatively muted, with some uncertainty surrounding Arctic LNG 2. The first train, delivering 13 million tons, is operational and is expected to be commissioned in Q1. We will observe how the Russians manage to sell these cargoes. Experience from the crude markets suggests that they are proficient in finding loopholes and customers willing to purchase these cargoes. Hence, this will be key to watch this year. It is crucial that they manage their mileage inventory effectively. Fragile maritime supply chains have been a significant factor. While it may sound negative, inefficiencies can benefit shipping. Higher tonne mileage typically requires more ships for cargo transport. A drought in Panama has been ongoing, affecting water levels in Gatun Lake, which is the main freshwater supply for the canal. Water levels continue to be low, limiting ship transits, and restrictions are expected to remain until at least the summer when we will assess whether a sufficient rainy season replenishes those resources. At the end of the year, similar issues arose with the Suez Canal, where warfare and Houthi rebels are attacking maritime traffic. As of now, no LNG carriers are going through the Red Sea to utilize the Suez Canal. This situation also impacts tonne mileage, particularly for Qatari volumes, which must reroute to the Cape of Good Hope to access European customers instead of taking the shortcut through Suez. Let's explore the export and import dynamics. U.S. exports saw strong growth, up 27% in Q4 and 13% for the year, while Australia and Qatar remain flat in comparison. Russia, as the fourth largest exporter, has seen relatively stable volume exports. There are currently no sanctions on LNG, though U.S. and U.K. sanctions are hindering Russian cargoes. Meanwhile, other countries are happy to accept these cargoes, especially the EU, which has boosted Russian LNG imports. Malaysia's volumes remain flat. Algeria was an outlier last year, enjoying healthy growth throughout 2023. On the import side, China has rebounded with an increase of 16%, still slightly below the 2021 levels seen before the COVID restrictions. With LNG prices falling to competitive rates, we expect China to enjoy robust growth in 2024. Japan's imports are declining, whereas South Korea and Taiwan remain steady. India is another crucial driver of growth; the country has enjoyed a prolonged economic boom, and as prices decrease, we expect strong growth in Indian imports as well. In Q4, the growth rate was 43%, contributing to a 15% increase for the year. We anticipate this trend to continue. In contrast, the European market remains relatively flat, which I'll discuss in greater detail shortly. To summarize, the key movers include steady growth from the U.S., flat numbers from Algeria and Qatar, and some setbacks for Egypt due to issues with feed gas from Israel, which has led to reduced exports. Despite this, Egypt isn't critical to the shipping market, given its proximity to the main import nations in Europe, resulting in a lower tonne mileage on these voyages. Europe has been fortunate over the past two seasons. European LNG imports previously hovered around 80 to 85 million tons, but the reduction in Russian gas flows forced Europe to swiftly secure alternative LNG supplies, primarily from the U.S., which provided flexible cargoes. Prices were bidded up to as high as $100 per million BTU, rendering LNG unaffordable for emerging Asian nations. With two consecutive mild winters, Europe has successfully filled its inventories. I'll delve into that further in the next slide. Demand destruction due to soaring prices negatively impacts consumption behaviors. Natural gas demand in Europe plummeted, leading to a subsequent rebound, as indicated on the right-hand side of this graph, where we see European gas demand beginning to recover, driven mostly by residential and commercial sectors, though the power sector has yet to follow this trend. We expect demand recovery at lower prices to affect consumption patterns positively.

As mentioned earlier, we have some strong growth in the U.S., while slowing growth from Australia and Qatar combined with some challenges for Egyptian exports creates an interesting dynamic. Heading back to Europe, we witnessed significant LNG imports, particularly from the U.S. In recent years, we have met and often exceeded target levels, contributing to the recovery of European inventories while also benefiting from some mitigation of demand destruction. This will positively impact the broader market and could work in our favor, particularly given the considerable inventory levels.

To conclude, we are cautiously optimistic about the current market trends. While we are seeing some headwinds with fluctuating prices and geopolitical uncertainties, the underlying demand for LNG remains strong. Our positioning in the market, alongside our expanded charters and dividends, puts us in an advantageous spot for the upcoming quarters. Thank you all for joining us today. We will return in May with our Q1 numbers and provide an update on the company and our results in relation to the guidance provided.

Thank you for the questions that you have sent in. I think we start off with Omar Nokta. There are several questions regarding the Red Sea and Panama Canal. Regarding the Red Sea, these restrictions may be sufficient to offset the newbuilding deliveries and lead to a tighter market.

For the Red Sea, the restrictions primarily affect Qatar. They may find themselves short on shipping capacity and will need to relet some ships in order to maintain sufficient volume to move their cargoes to Europe. The situation largely depends on the trading pattern this year and whether Europe will act as the buyer of first and last resort or if they will leave room for Asian countries, which will have a more pronounced effect on the market dynamics.

Addressing the Red Sea situation, the increased insurance rates associated with trading in that region could impact Flex. The price for war risk insurance has increased significantly. While previously considered moderate risk, the situation has escalated. As a time-charter operator, the charterer is responsible for routing instructions, including any associated costs that arise.

Currently, there isn't a single LNG ship in the Red Sea. But before the ongoing conflict, we had ships that transited that area without issues. However, the uptick in the price of required insurance due to the conflict has risen dramatically, making the route prohibitively expensive for most operators. For us, as long as we're under a time charter, these costs are borne by the charterer, not Flex, as they dictate where the ship is to be sent.

Regarding costs and crew demand with the substantial newbuilding order book and upcoming vessel deliveries in the following years: we anticipate increased demand for skilled crew in the LNG sector. We are staying proactive to ensure recruitment and retention of top talent across our fleet as we recognize the sophisticated nature of LNG shipping operations.

We've seen a trend where the LNG sector is facing challenges in crew availability, especially with reduced numbers of Russian crew due to current restrictions. Our recruitment efforts focus on attracting skilled operators from other maritime sectors, which inadvertently places stress on the broader maritime labor pool. Retaining our crew remains a priority, as having experienced personnel is critical in navigating the technological complexities of LNG shipping.

We have received several questions regarding Flex Constellation and the options for rechartering and alternatives. We will wait for the firm redelivery date; we are already in discussions with potential charters.

Once we have a solid redelivery date, we will conduct market outreach. Our approach remains flexible. While we are open to fixed long-term agreements, we are also comfortable positioning Flex Constellation back into the spot market if we can obtain better terms and conditions than available through fixed contracts.

There are a number of inquiries regarding our readiness for the EU ETS and what this means for us. Fortunately, costs associated with compliance will be passed on to the charterers. Users will ultimately bear the costs incurred.

Yes, the logistics surrounding the EU ETS will indeed be handled within our charters. While we have amended our time charter agreements to stipulate that the charterers will either buy the necessary carbon allowances or compensate us for purchasing them, this is not an added expense for us directly. Ultimately, these costs get transferred to the end consumer.

To round out the discussion about business development and capital allocation, we regularly evaluate potential growth and how Flex LNG plans to expand beyond the current 13 vessels in the future. While we are not entirely against expanding our fleet, we are focused on maximizing shareholder returns.

We have been approached with opportunities to acquire new vessels, but we remain judicious, as the financial commitments must meet our return criteria. Presently, investing in new construction is not as attractive as returning capital to shareholders via dividends.

We are also open to considerations around share buybacks should the timing and conditions be favorable for such actions. If we observe significant fluctuations in stock performance over sentiment, we would explore this option.

We think there are opportunities for consolidation within the industry. The market is quite fragmented; however, our preference is to partner with firms that share our values and operational philosophies, particularly those with a modern, efficient fleet.

Some inquiries arose regarding our investment in operational efficiencies like the air lubrication systems being deployed. We'll monitor their performance as these technologies mature.

Air lubrication has been discussed as a technological advancement. We are aware of the potential benefits; however, we will hold any decisions until sufficient evidence corroborates its effectiveness. Our modern vessels already operate at high efficiency, and it may not be viable to retrofit unless we identify positive results.

Many questions were posed by retail investors wanting insights into tracking daily developments in the LNG spot rates.

To follow LNG freight rates, several resources are available, including CME. The Baltic LNG index is a good proxy, alongside alternative information sources like Spark and Fernplus.com, which provide broader insights into segment rates.

That concludes the Q&A session.

Thank you, Knut. I hope you enjoy your birthday celebration today. Thank you, everyone, for joining us. We will be back in May with our Q1 numbers and provide updates on the company and its results relative to the guidance provided. If you are fond of dividends, be sure to catch the advanced gas Valentine's Q4 presentation next Wednesday, February 14. Thank you, everybody.

Thank you.