Flex LNG Ltd. Q3 FY2024 Earnings Call

Third Quarter Results Presentation. I’m CEO Oystein Kalleklev, and I will be joined later in the presentation by our CFO, Knut Traaholt, who will discuss the financials. Before we start, I want to remind you that we will provide some forward-looking statements and non-GAAP measures, and there are limits to the completeness of detail. You can submit questions for the Q&A session through the chat function or by emailing [email protected]. As usual, we have a gift for the best question, and this time we have two gifts: our FLEX LNG perfume in His and Her Money versions, with a scent of dividends that we believe everyone will appreciate. Now, let's go over the highlights. There were no big surprises in our revenue numbers, with adjusted EBITDA revenues at $90.5 million, aligning with our guidance of roughly $90 million. This resulted in net income and adjusted net income of $17.4 and $28.7 million, respectively. The adjusted net income accounts only for realized gains and losses on derivatives. This quarter saw a significant drop in interest rates until early September when the Fed lowered rates by 50 basis points, which allowed us to expand our hedging portfolio considerably. We incurred $10.7 million in unrealized losses in Q3 but recouped more than that in October alone. The adjusted earnings per share for the quarter stood at $0.53. Recently, we announced that we are starting the fixing season for 2029 with new contracts for both Flex Resolute and Flex Courageous, which charter these ships for firm periods from 2029 to 2032 with options to extend to 2039. I will provide more details on this later. One ship is being re-delivered, which is expected given market conditions, and I will elaborate on this in the presentation. We have also secured additional financing based on our substantial backlog, which Knut will outline regarding the two refinancings completed since our last update. In total, we refinanced three ships, amounting to $430 million and yielding net proceeds of $97 million, maintaining a strong cash position of about $450 million, which is roughly 35% of our market capitalization today. The next quarter will be unusual as we will not be guiding Q4 numbers higher than Q3 for the first time. This is due to a soft spot market that will affect one ship we had on index. While all other ships are on fixed rates higher than this index rate, that one ship is expected to operate at the floor level for most of Q4, leading to projected revenues of around $90 million for Q4, slightly less than the $90.5 million reported in Q3. EBITDA is also anticipated to be marginally lower than in Q3. However, we maintain a robust backlog of over 50 years, which could extend to 82 years with option declarations, providing excellent earnings visibility alongside our cash of $450 million. We are declaring our 13th consecutive ordinary dividend of $0.75 per share. Although our trailing 12-month dividend has decreased to $3 from $3.125 last quarter, we still offer an attractive yield of 13%. To provide additional insights on guidance, our TCE rate stands at $75,400, close to our guidance of $75,000 to $77,000. As mentioned, the one ship on index will yield slightly less revenue in Q4, pulling our overall numbers down a bit but not significantly. For the full year, we project TCE at $75,000 per day, with revenues between $353 million and $355 million, and adjusted EBITDA between $271 million and $274 million. Now let’s delve into details about the two recent extensions. As noted, we have extended those ships initially chartered in November 2021 under a 3 plus 2 plus 2 structure from 2022 to 2029. They have exercised the first option for 2027, and with this recent extension, we anticipate they will also take the next option declarable in Q1 '26, leading to a new firm period into 2032. The new structure mirrors the previous one, which is front-loaded, resulting in a negative revenue recognition effect when the options were declared, but we expect a positive revenue recognition effect once we secure a firm period to 2032 from these contracts. It is likely the ships will remain with the charter for a longer duration, potentially until 2036 or even 2039, adding significantly to our backlog. Looking at our fleet portfolio, we have updated it to highlight the Flex Resolute and Courageous, indicating that the charter can take them from 2027 to 2029, which we believe will occur, embedding them into firm agreements until 2032. We also have some long charters, including FLEX LINE above 2033 and ENDEAVOR until 2032. We recently leveraged a long-term charter for one ship to secure a Japanese lease, which Knut will provide more details about. The FLEX CONSTELLATION was delivered on a 10-month charter in May, intentionally avoiding the spot market this year given the number of ships up for delivery. We fixed her until March 25, with an option that is now out of the money, allowing us to explore trading opportunities for these ships knowing they will return in March. The next ship that will be fully open will be FLEX RANGER in March 2027, which I will revisit. We believe that reintroducing ships to the market at that time will be ideal, as market dynamics are expected to improve in 2027 and 2028. With our substantial backlog of a minimum of 50 years, as previously mentioned, we can support our dividend. Again, we are declaring a $0.75 ordinary dividend, marking our 13th consecutive dividend at this rate. We have also issued special dividends during this period, totaling $569 million across 13 quarters, representing almost 45% of our market cap over just three quarters. Regarding our dividend decision factors, we see one caution sign. We may have acted prematurely when we upgraded from a yellow to a light green signal earlier this summer. The summer market was unexpectedly strong, with rates hitting about $85,000 in mid-August, which is considered historically good. However, the market declined sharply starting in September, leading to current poor conditions in the spot market. Despite this, longer-term demand remains strong, as reflected in the new contracts we are announcing, so we maintain a light green outlook on that front. Other factors are straightforward: we have strong cash flow, considerable backlog visibility, healthy cash reserves, and no near-term debt maturities. With that, I’ll turn it over to Knut to go through the financials before I return to discuss the market.

Thank you, Oystein. As already mentioned, revenues for the quarter were $90.5 million. From an operational point, it was a strong quarter with 100% technical utilization of the fleet. If we look at the 9 months, the revenues were $265 million. That translates into a time charter equivalent for the quarter of $75,400, or for the 9 months close to $75,000. If we look at the OpEx, we are at budget at $14,900 per day, and a slight improvement from last quarter. For the 9 months, we are below budget at $14,700, and today we guide that OpEx is around $15,000 for the full year. That's where we expect scheduled maintenance of some of our engines during the period, and we have experienced higher crew change costs basically since we have fewer vessels going to Europe, so more of the crew changes have been done in Asia, which is more expensive. Adjusted EBITDA was $70 million for the quarter and $204 million for the 9 months. As Oystein mentioned, in the adjusted numbers, we take out non-cash items, and primarily these are unrealized gains and losses from a derivative portfolio. So in this quarter, we have adjusted out $10.7 million and also about $600,000, which is the write-off of debt issuance costs in connection with our refinancings. Our cash position, as already mentioned, has a pro forma balance of $450 million. This came from $48 million from operations, $27 million from scheduled amortizations, and we completed two financings. First, the $270 million facility that was closed in September, which refinanced all three vessels out of the old $375 million facility. This left the FLEX ENDEAVOR debt-free at the quarter end. Thus far we don’t have $63 million as repayment within the quarter. As you can see, post-quarter on the 3rd of October, we completed the lease financing, which received $160 million. So then, net of the dividend payment of $40 million, the quarter-end was $290 million, but on a pro forma balance at $450 million. If we look at our hedge portfolio, in August and September, we saw that 5-year interest rate swaps fell about 50 basis points, making it attractive to utilize some of our positive value in the existing portfolio and amend and extend, thereby adding more duration. We see a significant change, and also improvement in our hedge ratio. Now we have $635 million of swaps with rated interest rates close to 2% with a duration of about 4 years. That gives us a good hedge in this environment where there are large fluctuations in the interest rates. Additionally, this is a combination of our interest rate swaps and fixed rate leases. Looking at a slightly different way, here we have a percent of our net interest-bearing debt, also split into what is hedged through our swap portfolio, the $635 million, and what we have in fixed rate leases or fixed rate components in our Japanese leases. That leaves us with a floating exposure of $552 million. This underscores our financial position, what we call the fortress balance sheet. We have a large contract backlog, which secures stable cash flow. We have refinanced and have $400 million in available cash. Our RCF capacity is now increased to $414 million, which is a cost-effective way of managing this cash balance. We have limited CapEx liabilities, that is for the 5-year special surveys, and we offer debt maturity in 2028. This supports the commercial and financial flexibility of FLEX. With that, I hand it back to you, Oystein.

Okay. Thank you, Knut. Let's look at the market. As you can see on this slide, it's not really growing quickly. We are experiencing 1% historical growth. LNG export volumes have been growing in the 6% to 8% range. Last time we saw 1% growth in the market was during COVID in 2020 due to low demand from shutdowns. Now, it’s a bit different. We have 1% growth, but it’s not truly demand-driven. Demand is strong as evidenced by LNG prices, but supply is the bottleneck with projects coming on stream later this year and then into '25 and '26. We see a wave of LNG arriving next year, with a much higher growth factor for exports. We estimate around 6% growth next year. This is one of the explanations for why the spot market is trading poorly. The U.S., Australia, and Qatar are the big exporters, maintaining a relatively flat position. We still see Russia managing to grow their exports despite the conflict in Ukraine. On the import side, Europe emerged from the winter season with high storage levels and has been able to source less LNG this year, which opened the market for other players, like China, with healthy growth at 10%, and India at 18% growth. Volumes have shifted from the Atlantic to Asia, which is generally good for ton mileage, especially when the volumes are not utilizing the Panama Canal or the Suez Canal, but the number of ships being delivered is still outpacing ton mileage demand. Looking at Europe in more detail, import levels are below last year as storage levels have increased, with almost full storage levels going into the heating season. Today, around 93% of storage levels in Europe puts it in a more comfortable situation. That said, the agreement between Russia and Ukraine for the transport of pipeline gas to Europe is maturing at the beginning of the year, so we expect to see less Russian pipeline gas to Europe starting January 1. So far this year, Russian pipeline gas has helped positively to imports to Europe. Norway had a big maintenance season last year and is contributing positively, and LNG is the swing factor. Depending on how cold the winter will be in Europe, we expect storage levels to be lower after this winter season, which is why LNG prices remain fairly high down the curve. Looking at Asia, the situation is a bit different. They have been picking up imports when European buyers have been less eager to buy, especially the flexible U.S. LNG. We see a mature market in Japan, Korea, and Taiwan as stable, but China is growing at 10%, and we also see healthy growth from South Central Asian nations like India, Pakistan, and Bangladesh. Canal inefficiency has been a significant driver in the last year or so. We had a drought in Panama, which reduced its transit capabilities. Water levels in Panama are back to normal, and operations are back to normal, but we still see LNG shippers avoiding the canal to the most extent. This is due to flexibility in Panama and the now-low shipping costs, which make it sensible to bypass the canal rather than pay the tariffs. The situation is slightly better for the Suez Canal, but it mostly concerns cargoes going north into Egypt, which has turned from being an exporter to an importer, and supplies to Jordan. In general, this situation is positive. Our LNG ships from the U.S. going to China via the Cape of Good Hope now travel about 15,500 nautical miles, as opposed to around 10,000 nautical miles via the Panama Canal. However, it’s still not enough to offset the delivery of new ships. Our team has mentioned in the past about the emerging dark fleet of Russian LNG. They have been buying up second-hand tonnage and have been loading cargoes from the Arctic LNG 2 project, which has started operations. The ships are loaded, but they have not been able to sell the cargoes. Compared to crude oil and petroleum, where the dark fleet and trade is massive, the sanctions from the U.S. are much tougher in LNG. If these cargoes do not enter the international market, they won’t affect the Henry Hub in the U.S. This is a smaller market, making it easier to enforce sanctions and stop these ships from selling their cargoes. We are monitoring this situation closely, and it will be interesting to see how developments unfold. Now looking at the spot market, rates are softening, falling to very low levels, levels we have never truly seen in the fourth quarter before. This is largely due to the number of ships available. Typically, one expects the market to get tighter around August and September. High gas prices might lead to floating storage, but this year they are not in contango. Therefore, the number of available ships has been increasing, with scheduled deliveries reducing demand. This leads to ample supply of LNG ships with rates dropping to around $25,000 for modern tonnage, with high fuel tonnage at $10,000 and steam ships being priced out of the market. The liquidity in the spot market in terms of available ships is not surprising, with charters favoring spot voyages this year, increasing from 157 fixtures in Q1 to Q3 last year to 278 this year. So the spot market is liquid, but rates are poor, and we expect this to remain the case for the rest of the year. This situation will have implications for steamships. We have explained in the past the huge technology change in ships. We started with steam ships, which are inefficient, while diesel-electric and dual-fuel ships have been introduced. Even modern dual-fuel two-stroke ships are now prevalent. However, many steam ships still remain in the market. These ships were fixed on long-term charters and are rolling off these charters over the next couple of years. We expect a mass extinction of steamships due to the Energy Efficiency Existing Ship Index (EEXI) regulations, intended to reduce greenhouse gas emissions for the shipping sector. These ships are becoming technically and commercially obsolete, and we believe this will help rebalance the market in 2027. In terms of building prices, they are stable, supported by continuing container orders. Prices have decreased somewhat from peak levels but remain high at around $260 million for delivery in 2028, with long-term rates staying steady at $85,000 per day. The current order book consists of around 300 ships for delivery, most of which are long-term contracted. Only about 20 are uncommitted. Looking at the supply side, we expect export growth to pick up next year, forecasting around 6% growth in '27 and '28. A new wave of U.S. LNG should occur once the export moratorium is lifted early next year. Lastly, regarding the reasons many people are questioning the impact of the recent elections, Trump won decisively. He has voiced intentions to ease regulations for the oil and gas industry, including lifting the recent moratorium on LNG export licenses. Many projects await this change. We anticipate a wave of final investment decisions (FIDs) for U.S. LNG projects next year, which will support shipping demand moving into '28 and '29. That said, Trump’s trade philosophy differs from free trading sentiments, leading to uncertainties in the market. Potential trade dynamics involving EU and China remain to be settled. So before concluding and heading into the Q&A session, I want to remind you: the highlights are numbers in line with what we have guided, no big surprises, adjusted earnings per share of $0.53, expectation of better interest rates in Q4, new charters are being fixed until 2039, a robust financial position of $450 million, which is 35% of our market cap in cash. We expect Q4 to be a bit softer due to the spot market but, with a $3 trailing dividend, we maintain a very attractive yield of 13%, supported by the backlog and our current financial standing to sustain this dividend for years to come.

Good. We have a number of questions and maybe we can start off with the last topic on the U.S. elections and Trump being President. You mentioned lifting of the permitting moratorium and shipping demand in 2028. For these projects, when do you expect they will start ordering for long-term contracts?

Of course, there are many U.S. projects nearing export readiness, such as Plaquemines and Golden Pass. These projects have secured shipping for their volumes, but not all will have contracted ships for the next wave of projects, some of which will expand existing infrastructure. If 90 million tons of new volumes are entering the market from 2028 to 2030, that creates significant shipping demands. Current shipyards are busy with orders, so we anticipate that some new projects will utilize existing ships due to the high cost of new builds, which will help maintain a balanced shipping supply from 2028 onwards.

We have a number of questions on the contracts, especially the one we just announced for the Courageous and Resolute. The charter is fixing those ships pretty far in advance. Can you explain the motivations for the charterer to fix these ships now?

Yes, it's related to their portfolio rather than specific projects. The charterer is a super major which typically has many projects and can allocate ships for various projects. The motivation to fix so far into the future includes their satisfaction with our service. They have been pleased with the operations and technical support we provide. Also, new environmental regulations have come to play, and the megaships we are discussing have much lower emissions, making them favorable for long-term contracts as they comply with upcoming regulations.

Moving on to CONSTELLATION and a question from Niels Thomassen: What's the ideal strategy for her? Should we endure short-term pain until the market tightens, or should we focus on a longer-term charter at current market rates?

That’s a good question. In 2020, when the market was difficult, we had all our ships in the spot market. We can manage that well, particularly with our strong balance sheet and liquidity position. We plan to do what is best for shareholders, evaluating options for a long-term charter as the market improves. Based on our projections, the market will look quite different in two years, so the question is how much can we gain from trading in the spot market during that time versus locking in a term rate now. Overall, it's too early to decide, but we won't give the ship away on a term rate just to remove it from the spot market. We’ll see what's in store come February when the options are reviewed.

The next two vessels are the options for Aurora and Ranger. What's your view on those options?

Aurora and Volunteer options will be declared at the end of next year, while Ranger is fixed until March '27. These are options such that if charters decline to extend, they forfeit the last option. From our analysis, we expect the market to start tightening by '27. If they don’t declare it, they lose that last option. It’s too early to tell how this will play out. In any case, we expect to see these ships back in 2026, and the term market should firm up in anticipation of improved conditions.

You mentioned a bit on MEGI and XDF technology. One of our bankers in ABN AMRO asked for your view on the sustainability and cost efficiency between MEGI, the XDF low pressure, and MEGI high pressure. Regarding the order book, it seems there are slightly more low pressures.

Indeed, when we started utilizing MEGI ships, the first was delivered at the end of 2015. MEGI ships are highly efficient, effectively utilizing boil-off gas for combustion. The guaranteed methane slip for MEGI ships is a mere 0.2 grams per kilowatt hour, which is exceptional. However, the system is complex, requiring sizable and costly compressors. Some clients prefer simpler systems like the XDF that operate at lower pressures, though recent environmental regulations have made MEGI more appealing despite their complexity. The methane emissions penalties make MEGI ships more profitable despite their initial higher cost. In this context, the MEGIs position us well, and we are pleased to have 9 out of 13 ships equipped with this engine already.

We have questions on capital allocation, dividend sustainability, and share buybacks.

Let’s start with the dividend sustainability. We had a softer quarter with $0.52 adjusted EPS against $0.56 last quarter. We aren't fully at the $0.75 dividend level. However, we have $450 million of cash, and we don't need cash to run this business. We get prepaid charter hire, allowing us to handle expenses easily. Our cash covenant requires about $70 million. Simple calculations show we have $400 million over surplus cash. Even if we weren’t making any money, which is unrealistic, we'd sustain that dividend for 10 quarters, well past 2027 when we expect market conditions to improve. We intend to maintain the dividend, and while buybacks are interesting, with having one dominant shareholder, the 43% ownership, we remain cautious on re-buying shares. We've done it before, and while we won't rule it out, we're also encouraging investors to utilize our dividend reinvestment plan if they choose.

To round off, we have two more questions. One regarding the Panama Canal. Would you lose any sleep over potential peace in the Middle East and normalization of the Panama Canal?

I'm not losing sleep over peace in the Middle East; that would be great. However, I don’t think that will happen soon. The conflict there isn’t impacting our market significantly. The Qatari volumetric changes related to the Suez Canal and Panama canal are not massive. Panama Canal is back to its normal operations. The problem is more about the inflexible booking system along with low shipping freight costs that forces people to avoid it. Overall, it would be nice to have peace in the Middle East.

That concludes the Q&A.

Yes. Thank you everyone. We will return in February with Q4 numbers, and I hope you will tune in then as well. Thank you.