Earnings Call Transcript - FLNG Q4 2021

Operator, Operator

Good day and thank you for standing by. Welcome to the Flex LNG Fourth Quarter 2021 Earnings Presentation Conference Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Oystein Kalleklev. Please go ahead.

Oystein Kalleklev, CEO

Thank you. Welcome everybody to FLEX LNG Fourth Quarter and Full Year 2021 Webcast. I'm Oystein Kalleklev, the CEO of FLEX LNG Management, and I will be joined today by Knut Traaholt, our CFO, who will talk you through the financial numbers as well as our recent refinancing a bit later in the presentation. As always, we will conclude with our Q&A session. If you'd like to ask a question in the Q&A session, you can either ask through our teleconference or use the chat function. So first, before we start, a reminder of our disclaimer, as we will provide some forward-looking statements in relation to future revenue guidance. We're also using terms like time charter equivalent earnings and adjusted earnings and EBITDA, which are non-GAAP measures and are all amidst through the completeness of the earnings report, which we also released today. So let's kick off with a short summary of our highlight on Slide 3. First of all, we are pleased to deliver outstanding results with the best-ever quarter on most financial metrics. Revenue came in at $215 million, slightly ahead of our revenue guidance of approximately $110 million. When I was putting the final touches on the slides last night, I noted that time charter equivalent earnings were the best ever with our average TCE of $95,900 per day in the fourth quarter. I recall that when I presented our Q4 2018 results, we highlighted a TCE for the quarter of about $95,000 in the earnings presentation. However, after our listing in the U.S. in 2019, we had to provide more stringent non-GAAP details about historical TCE earnings. Our accountants discovered that the TCE in Q4 2018 was slightly higher at $97,005. I apologize for the oversight. That said, this is probably the first time I have seen a shipping company realizing its historically accurate TCE numbers; it's usually the other way around. During 2021, we acted to improve the market and secured eight or possibly nine fixed higher contracts with minimum terms between three and five years. I believe our ability to attract long-term attractive contracts with super majors and top-tier clients benefits not only from having state-of-the-art ships in our fleet but also from all seafarers and onshore personnel delivering first-class service, both in terms of safety and reliability to our charters, as several of them are repeat customers. A special thanks to the crew and onshore staff who are keeping the propellers turning despite the many challenges caused by the COVID-19 pandemic. While many people are heading back to the office these days, I can tell you that seafarers are still facing many challenges when it comes to crew rotation, particularly in Asia where about three out of four cargos end up. We hope that restrictions and limitations will ease soon so we can get back to normal. Hence, in Q4, our spot exposure was related to four ships. Our ship, Flex Volunteer, was trading in the spot market, while three ships were on variable hire contracts linked to the spot market. With all trading ships active, our spot exposure was about 30% in the quarter, significantly less than in the past. As our cost base is relatively fixed, at least in the short to medium term, this means that higher top lines will trickle down directly to the bottom line; thus, we delivered an all-time high net income and adjusted net income of $69 million and $63 million, respectively. Adjusted earnings are slightly lower because we are accounting for our significant gains on interest rate hedges. While the Fed has been behind the curve on interest rates, we have been ahead of the curve securing a substantial part of our interest rate exposure at low levels, as Knut will explain. Earnings per share came in at $1.31 per share with adjusted earnings at $1.18 per share. Given our locked-in premium backlog coupled with our strong financial position, the board last quarter decided to increase our dividend level to $0.75 per share, which we believe is sustainable in the long run. Hence, we are again declaring a quarterly dividend of $0.75 per share, providing our shareholders with an attractive annualized running yield of about 15%. In November, we announced a balance sheet optimization program. By de-risking our commercial strategy through adding considerable long-term premium backlog, we decided to explore financial alternatives to unlock $100 million of cash on our balance sheet. Today, we are announcing $695 million of new financing. These financings will together release another minimum $87 million in cash in addition to the $38 million we released through the sale-leaseback of Flex Volunteer, executed in December. As Knut will explain, we have thus already exceeded our initial program objective set in November, unlocking a total of $125 million overall, which will contribute to further grow our cash balance, which stood at $201 million at year-end. Hence, we have a robust liquidity position, enabling us to quickly act on opportunities if they arise while still securing our ability to maintain an attractive dividend level. Lastly, I would like to highlight that 93% of available days in 2022 are already covered, providing a sturdy estimate of where revenues for the year will end up. So, turning to Page 4 and our fleet status, as indicated, charter coverage for 2022 is 93%, with substantial charter coverage also for 2023 and 2024. During Q1, we have a couple of ships exiting shorter-term charters and entering longer-term charters. In February, Flex Freedom will be redelivered for a 10-month time charter and subsequently enter a minimum five-year charter with a super major. Flex Constellation is currently serving a minimum fee time charter with a large trading company. Flex Endeavour, Ranger, and Vigilant were delivered last summer to generate time charters with a minimum duration of 3 to 3.8 years, with one or two additional vessels expected to take a similar route during the third quarter this year. In fact, while Flex — was also redelivered from a shorter-term time charter, we recently secured a short-term flexible time charter of 55 to seven months, which will precisely match the delivery window for ship number four and ship number five. In January and February, we are also delivering Flex Courageous and Flex Resolute on three plus two plus two year time charters with a super major, following their earlier shorter-term time charters in 2021. As mentioned in the third quarter, several of our ships will transition from shorter-term time charters to longer-term charters with higher earnings, resulting in a revaluation of our portfolio at better levels for extended periods. Flex Rainbow was recently extended by one year with a large trading company and will now come back in early 2023. With few modern ships available in the near term, we believe Flex Rainbow is well positioned. Flex Volunteer is the ship we chose to keep in the spot market during 2021, proving to be a smart move given the strong spot market last year. However, the spot market so far in 2022 has been quite challenging with low expectations for earnings for this ship in Q1. I will provide more information about the spot market a bit later in the presentation. Our expectation is that Flex Volunteer or Flex Aurora will be the fifth ship going through Cheniere for a minimum period of three and a half years starting in Q3. Lastly, we have three ships on variable hire contracts: Flex Artemis on a minimum five-year variable hire contract with GunVault, Flex Amber, and Flex Enterprise. Flex Amber and Flex Enterprise were both recently extended by another year, with an additional extension option for these two ships, thus they will become available during 2023 or 2024, ahead of the significant new building order book in 2025. We are cautiously optimistic about securing good contracts for these ships when they are delivered to us unless we choose to trade them in the spot market, which will depend on the market conditions for spot and term contracts and where we believe we can derive the best value. Slide 5 illustrates our earnings visibility, which I have already covered extensively. Almost all the backlog is now fixed, but we also maintain variable hire backlog, which gives us exposure to the spot market. We have ships coming available in this period, and we will decide whether to employ them in the spot market or shorter-term arrangements or fix them on longer-term contracts as we evaluate the opportunities. Now let's move to the revenue guidance, probably the analyst's favorite slide as it can simplify updating financial models. This slide shows our revenue guidance for the year. In May last year, following securing several fixtures for our ships, we provided the revenue guidance for the remaining quarter, given the de-risking of our chartering strategy. We exceeded that guidance with revenues for the year at $343 million. Given that we have covered 93% of available days in 2022, we can offer a comprehensive estimate of our expected revenues for the year. However, we still have Flex Volunteer trading in the spot market during the first half of the year, meaning that our achieved revenues will depend on the spot market development alongside our previous uptime success. As I mentioned before, the spot market has faced weaknesses in the first quarter, adversely affecting our spot ships at the start of the year. We do expect revenue levels to be slightly lower than those achieved last year when the spot market was thriving, particularly in Q1. Nevertheless, we believe this year's revenues will not fall significantly short of last year's first quarter levels. However, with higher charter coverage, we expect revenues to increase notably in Q2 and slightly in Q3. Whether we will witness another freight market boom in Q4 is currently uncertain. However, given our expectation that Cheniere will utilize the option for the fifth ship, we foresee lower spot exposure in Q4, leading us to expect a slight decrease in revenue compared to Q4 2021. Overall, revenues are expected to remain in line with the robust levels seen in 2021. Thus, we anticipate 2022 to be another strong year for us. Turning to the next slide, let’s discuss dividends, a topic of great interest to our investors. We have thoroughly covered our dividend philosophy in previous presentations. Therefore, I will not repeat all of the factors we evaluate when setting the appropriate dividend level. However, I want to emphasize that we employ a balanced and measured approach to establishing a sustainable dividend level with the aim of distributing cash flow over the cycle. I acknowledge that consensus estimates predicted an even higher dividend for the quarter given the lower earnings, and I admit that our 64% payout ratio may not appear impressive. However, when we increased our quarterly dividend level to $0.75 last quarter, we communicated our desire to set a dividend that is attainable over the long term. Despite our substantial backlog, earnings will fluctuate due to our exposure to the spot market. Overall, for the year, we generated adjusted earnings per share of $2.71. We declared dividends of $2.3 and utilized $0.15 per share for share buybacks. Hence, the total shareholder distribution for the year amounted to $2.45 per share, equating to a 90% payout ratio. We also took delivery of our last three new builds during 2021, with net CapEx relating to this around $17 million, or $0.33 per share. If we factor in these capital expenditures, we actually spent $2.78 on shareholder distribution and CapEx during the year, which exceeds our adjusted earnings per share. Despite the high payout ratio and some capital expenditures, we managed to increase our cash balance during the year from $128 million at the beginning to $201 million at year-end. At this point, I think it’s a good time for Knut to provide detailed insights regarding the financial figures and our balance sheet optimization program, before I conclude with some market updates.

Knut Traaholt, CFO

Thank you, Oystein. I will start with some key figures for 2021. On the left of the graph, we see the total operating days, which with a 70% increase in total operating days illustrates the fleet growth trend where we recognized the full earnings capacity from the second half of the year. The TCE numbers for Q4, as mentioned by Oystein, were just shy of $96,000 per day. For the year, the $15 per day increase year-on-year is mainly attributed to the strong performance by the three vessels on variable hire contracts alongside Flex Volunteer trading in the spot market. Moving to the cash-free breakeven, we’re also maintaining strong cost control with the breakeven for the year at $43,700 per day compared to the prior year's guidance of about $45,300 per day. During the year, operational expenses were impacted by COVID-related costs averaging approximately $600 per day, with $400 per day from direct COVID-related costs and about $200 per day being indirect COVID-related costs. These stem from typical terminal restrictions, making crew handovers more challenging and thus more expensive. Despite the Western world opening up and easing travel restrictions, as Oystein mentioned, we still face restrictions affecting crew changes and expect COVID-related costs to carry into 2022. Now, transitioning to slide nine, with an expanded fleet, we achieved all-time high revenues for the quarter at approximately $150 million, exceeding the guidance provided in Q3 of $110 million. We also recorded all-time high revenues for the year at $343 million, which translates to adjusted net income of $63 million for the quarter and $145 million for the year. That represents a significant leap from 2020, reflecting our fleet growth, market exposure strategy, and favorable LNGC market conditions. The adjusted EPS stood at $1.18 per share for the quarter, achieving a solid $2.71 per share for the full year. The adjusted net income and adjusted debts are adjusted for fluctuations in the fair value of interest rate swaps, where we recorded gains of $7.4 million for the quarter and $18 million for the year. As interest rates have continued to increase during 2022, our interest rate portfolio's fair value has further risen by a million so far this year. If we move to Slide 10, examining cash flow, despite our $0.75 per share dividend total of $40 million paid out this quarter, we elevated our cash balance by $63 million to a total of $201 million at year’s end. This strong increase is driven by robust cash flows from operations and the release of approximately $38 million from our balance sheet optimization program related to the Flex Volunteer refinancing. Now moving on to slide 11 and our extremely straightforward balance sheet, we have a fleet of state-of-the-art LNGC vessels with an average age of 2.2 years, with a book value of about $2.4 billion, averaging about $180 million per vessel. We also have a solid cash position of $201 million, as previously mentioned. The balance sheet is supported by an attractive portfolio of long-term leases and bank facilities totaling $1.6 billion or 65% of our balance sheet. This results in $890 million in equity, translating to a 35% equity ratio. On the subsequent slides, we will dive into the development of our balance sheet optimization program. We announced the Flex Volunteer transaction in November, executed in December, as the first step in freeing up $100 million in liquidity. Today, we revealed two new financing arrangements that will support our liquidity target while simultaneously reducing our cost of debt and maintaining industry-leading cash breakeven rates. We secured credit-approved term sheets for an aggregate amount of $695 million to finance five ships, along with an uncommitted accordion option to upsize the bank facility by $125 million, potentially adding another ship to the facility. The new financings are subject to final documentation and normal closing conditions, which we expect to close during the second quarter. The bank facility is split into a $250 million non-amortizing revolver and a $125 million term loan facility, both likely amortizing over a six-year period. The total facility will follow an average age-adjusted repayment schedule of 22 years, with all amortizations allocated to the term loan, allowing us a bullet RCF. This arrangement provides us with significant financial flexibility and reduces interest costs by managing the utilization of the RCF when we have ample free cash. The accordion option offers the flexibility to consider the best funding alternative for the final vessel identified, which is Flex Enterprise. The two 10-year leases will release a significant amount of cash, allowing us to part-fund payouts for higher-level vessels, such as Flex Endeavor and Flex Enterprise, both of which are funded via two existing leases. Ultimately, the net proceeds amount to approximately $87 million. Moreover, if we choose not to refinance Flex Enterprise with the accordion option, we might free up even greater amounts. Based on these financings, we are increasing our target from the original $100 million to a minimum of $125 million and anticipate completing the program ahead of the targeted timeframe of 12 months. We are pleased with the terms offered, which reflect our attractive position and track record within the credit market. These two transactions align with our objective of extending durations, enhancing financial leverage while maintaining reduced operational leverage, minimizing debt costs, and extending repayment profiles. Lastly, we extend our gratitude to our lease providers and banks for their ongoing support and commitment to Flex LNG. Let’s transition to the next slide.

Oystein Kalleklev, CEO

Thank you, Knut. Knut joined Flex in May last year after working as a senior banker for the last 15 years. Some of his fellow bankers asked him what he was going to accomplish as CFO of Flex, considering our fleet financing was already secured. We have proven our ability to effectively utilize his expertise in our balance sheet optimization program. This signifies not only satisfaction with our fleet utilization during 2021 but also confidence in Knut’s performance. So keep up the great work in 2022, Knut! 100% utilization is the minimum expectation. Moving on to the market overview, our November market update revealed strong figures for LNG, with a growth of 17 million tonnes between January and October. LNG export growth slowed in the final two months of the year due to outages and diminished export growth in the U.S., which recorded zero cargo cancellations during November and December of 2020. Nevertheless, the U.S. managed to boost exports by an impressive 23 million tonnes in 2021, achieving 120% of the market goal. We ended up with 19 million tonnes of export growth, equivalent to about 5% in 2021, which, while decent, fell short of our expectations at the onset of 2021 due to lower exports primarily from Nigeria and Trinidad and Tobago stemming from feed gas issues. Norway's decline was anticipated as LNG plants at Melkoya are set to resume operations in Q2. Meanwhile, Egypt made a significant comeback in 2021 with a 5 million tonne growth in exports and potential for further expansion in the future. On the imports side, demand was largely driven by China, which added 10 million tonnes, South Korea with 6 million tonnes, and Brazil, which surprisingly contributed 5 million tonnes due to drought conditions from La Niña that impacted hydroelectric supplies. This highlights the advantage of having LNG import terminals, as LNG can promptly provide flexible capacity when necessary. I think this serves as a lesson for major natural gas consumers in Europe, especially Germany, which currently lacks an LNG import terminal. Germany has faced delays in developing several projects due to political negotiations and energy policies. In our Q3 presentation, we noted that Europe imported 9 million tonnes less than in 2020, approximately 12%. With improved flows in November and December, new LNG imports were down only by 2 million tonnes for the full year compared to the previous year. Moving to Slide 15, let's take a look at U.S. exports and their significant growth. In 2021, U.S. exports rebounded strongly, with consistent growth through the end of the year, excluding a brief period in February when exports were curtailed. In December and January, the U.S. was the world's largest LNG exporter, surpassing both Australia and Qatar. This was before the new liquefaction projects called Calcasieu Pass and Sabine Pass Trend 6 commenced operations, which will add an additional 15 million tonnes of U.S. export capacity this year. This year, we can expect an exciting competition for the title of largest LNG exporter. Our forecast suggests that Australia and the U.S. will compete neck and neck at around 82 million tonnes, closely followed by Qatar’s expected exports of 79 million tonnes. With current LNG prices, we anticipate exporters will optimize their output, striving to maximize throughput at the liquefaction facilities. Now on Slide 16, while we presented information about cargoes headed to Asia in our third quarter report, this time it's vital to discuss the shift toward Europe. Generally, we observed that European imports skyrocketed nearly 400% from low levels recorded in July of last summer and January of 2021 when imports were around 4 million tonnes. Let me further elaborate on this as January 2022 depicted a notable shift in LNG purchases from Asia to Europe as Europe scrambled to secure flexible LNG cargoes. To highlight this further, returning to Slide 17, with Europe facing an acute energy crisis in November and December, U.S. LNG exports proved to be a lifeline. It's worth mentioning that Europe benefitted from relatively mild winter conditions, which contributed positively. Keep in mind that the majority of LNG is sold on long-term contracts, typically featuring destination clauses that restrict cargo deviation. However, the majority of U.S. volumes lack such clauses, allowing for greater flexibility to shift volumes to Europe. Consequently, the market share of U.S. LNG in Europe surged from only 15% during July and August to around 75% by January of this year. This reinforces my earlier point about the strategic advantages of having LNG import terminals to mitigate risk effectively. Moving to Slide 18, we observe Europe's market share more broadly on a global scale. The data shows Europe doubled its share in the global LNG market from around 15% or 16% during the summer to approximately 33% in January 2022, with U.S. providing a significant amount of the cargo. As we progress to Slide 19, it’s crucial to discuss why the spot freight market softened in December. If you've been paying attention, you may already know that the west-east arbitrage plays a critical role. As of November 30, spot prices were around $37 per million BTU in Asia, while prices in Europe were lower by $6. This disparity incentivized a substantial influx of cargoes from the Atlantic basin to Asia. During January, we faced a different scenario with Europe consuming flexible LNG cargoes to alleviate the energy crisis. We were presented with a stark contrast in January's circumstances compared to the previous year when we witnessed significant cargo movement towards Asia. As we analyze slide 20, on the public market today, reflecting on the tensions in Ukraine, we observe gas prices in Europe have dropped significantly, settling around $22 per million BTU. It's evident that the gas market is characterized by considerable volatility, with prices fluctuating dramatically. Let's transition to the outlook on the stock market for 2021. We began 2021 at peak levels. As I previously explained, the pull towards Asia was predominantly linked to Europe's inability to secure U.S. cargoes back in January. Our market faced a brief dip in March and April when JKM experienced lows of $5.7, but the market rapidly rebounded in April and May, spurred by significant demand from South Korea and China. We enjoyed a reasonably robust summer market with LNG spot market rates for modern tonnage fluctuating between $70,000 to $100,000, a solid performance during summer. Rates further escalated as we approached the heating season, peaking around $300,000 in November and early December. Subsequently, as mentioned, the arbitrage opportunities closed, and spot market values decreased, dropping to approximately $40,000 by early January. Regarding the recent inquiries on our operation indicators, one notable observation flagged by investors and reported by Bloomberg was the freight rates for energy carriers dipping below zero. This raised questions regarding the apparent discrepancy between the headline rates quoted at $40,000 and the negative numbers reflected in indices such as the Baltic Index. It’s essential to clarify this dynamic; the prevailing economic circumstances resulted in LNG operations transitioning from typical market performance, exemplified during the summer months, to softer market scenarios that we are experiencing at present. Concluding, we achieved stellar results with revenues totaling $150 million for the quarter and a TCE of $96,000 per day. Our earnings per share are fantastic, at $1.31 and $1.18 adjusted for all derivative gains. We maintained a charter coverage rate of 93% for the year and continue to return the $0.75 dividend, which yields a very attractive return for our investors amid the current low-interest rate climate. Although we are pleased with the market conditions, we acknowledge that the market faced softness in Q1 primarily due to the west-east arbitrage constraints. As it stands, we have a robust cash balance of $201 million, and with new financing discussed by Knut, our liquidity will increase further by an additional $87 million. Thank you all for your participation! I believe it’s now time to address some questions.

Operator, Operator

Dear Speaker, there are no questions on audio at this moment.

Oystein Kalleklev, CEO

Okay. I believe we have received some chat questions, so please feel free to send them over to me.

Unidentified Company Representative, Representative

Yes, we have a question from the web. Hello, congratulations on the Q4 results. Can you please comment on the EU Emission plan for shipping?

Oystein Kalleklev, CEO

Yes, I touched upon it earlier. We’ve decided to expand the scope of the emission trading system, which will impose obligations on shipping, starting in 2023. This means that vessels operating in Europe will need to purchase carbon permits for both CO2 and perhaps CH4 emissions, although the specifics around CH4 remain unclear. European carbon prices have risen dramatically, now around €90 per tonne. This system will significantly enhance the attractiveness of modern, efficient ships, providing us with a competitive edge. However, we await further clarity on the regulations, particularly concerning CH4 emissions, and how they will be factored into this framework.

Unidentified Company Representative, Representative

There are three questions related to the use of proceeds from our cash balance. What are our priorities: new building orders, fleet expansion, or consolidation?

Oystein Kalleklev, CEO

All of these priorities are critical for us. We are all main shareholders and one of our principal stakeholders has been in the shipping game for 60 years, hence we are very well aware of market cycles. Shipping operates in cycles; it never changes. We recognize the elevated new building prices and inflation pressures. We’re taking a measured approach with no rush towards acquiring new ships. Our focus is currently on optimizing the ships we already own. As noted, several of our ships will become available over the upcoming years, and we believe we can lock them on attractive contracts, especially given the robust market for term rates. However, it is also worth highlighting that the credit terms for reputable clients are exceptionally favorable at this time. I have not witnessed the financing market being this conducive since 2014, prior to the oil price downturn. With solid clients, we can access favorable capital, optimizing our liquidity while continuing to pay dividends even if earnings may dip modestly in Q1. We perceive this as strategic insurance for potential opportunities that might arise. But we do not intend to treat this available capital as a credit card for new acquisitions.

Unidentified Company Representative, Representative

What is the current fuel mix used by our fleet?

Oystein Kalleklev, CEO

The primary fuel used is compliant fuel, which, to clarify, when we transport LNG, the cargo temperature is around minus 162 degrees Celsius. Our ships are thermally insulated. It’s important to note that boil-off rates have significantly improved, allowing us to use this boil-off gas to fuel our vessels. We also utilize marine diesel oil or marine gas oil. However, with recent elevated LNG prices, we have observed some charterers opting to fully gas out their loads for the purpose of cooling down the tanks instead of retaining some quantity for fuel. Therefore, while the predominant fuel is LNG, marine diesel, and gas oil may still be in use depending on price conditions.

Unidentified Company Representative, Representative

To conclude, could you provide guidance on our cash breakeven level for 2022 and whether there's a possibility to switch to more fixed spread contract arrangements?

Oystein Kalleklev, CEO

Sure, regarding fixed-rate contracts, we have established eight or nine fixed-rate contracts this year, and we expect to finalize nine as we anticipate Cheniere to utilize the fifth vessel, contingent upon the current term rates. We've locked a substantial portion of our revenue stream into fixed contracts, driven by optimistic market beliefs. However, whether we extend fixed contracts to additional vessels depends on the terms available at that time. We do prefer retaining some exposure in the spot market. Regarding breakeven, based on 2021 guidance, we anticipated approximately $45,300, and for 2022 we around $45,000 seems on target. Although we raised $125 million through our balance sheet optimization program, we do not foresee an uptick in financing costs. Our favorable terms for raising capital and extending payment profiles contribute to our confident forecast.

Unidentified Company Representative, Representative

If there are any questions that have not been addressed, we will follow up with those individuals. For further assistance, feel free to contact us via email at IR at flexlng.com.

Oystein Kalleklev, CEO

Thank you everyone for listening. We will be back with Q1 numbers in May. We hope you can join us then. Have a good day. Thanks.

Operator, Operator

That does conclude our conference for today. Thank you for participating. You may all disconnect. Have a nice day.