Earnings Call Transcript - FLNG Q1 2023

Oystein Kalleklev, CEO

Hi, welcome everybody to Flex LNG's First Quarter Results Presentation. I'm Oystein Kalleklev, CEO of Flex LNG Management and will be joined by our CFO, Knut Traaholt, who will walk you through the numbers a bit later in this webcast. As usual, we will conclude with our Q&A session where the best question can win our Flex on the Beach Summer kits which I will be presenting a bit later in the presentation. Please use the chat function to pose a question or you can also send an email to [email protected]. So, before we start, just a friendly reminder about our disclaimer in the presentation. We will be giving some forward-looking statements and there are also limitations to the completeness of details we can provide in such a presentation. So, with that let's review the highlights for the quarter. Revenues came in at $92.5 million, which was in line with our guidance of $90 million to $93 million. Average time charter equivalent earnings for the ships were slightly above $80,000 per day, also in line with the guidance for the year of about $80,000. This resulted in strong numbers with adjusted net income of $35.2 million for the quarter, translating into $0.66 per share. During the quarter, we completed the balance sheet optimization program, where we have refinanced all the 13 ships in our fleet with attractive long-term financing. Through this process, we have also released $387 million of cash proceeds in total, and this boosted our cash balance at quarter end to $475 million, an all-time high which translates into about $9 per share in cash. We have also recently carried out the first two dry dockings of Flex Endeavour and Flex Enterprise, both according to schedule and budget. During Q2, we will do another two dockings, so in total three dry dockings for Q2 and this results in revenues for this quarter being guided at $85 million to $90 million. Once we have completed the dry docking program in June, our quarterly revenues will pick up in Q3 and Q4 with quarterly revenues of around $90 million to $100 million for these two quarters. So, we are also reaffirming our revenue guidance of $370 million for the year, which should translate into an expected adjusted EBITDA of around $290 million to $295 million. So, with quite a strong financial position and minimum 57 years of contractual backlog, our Board has decided to once again pay out our quarterly ordinary dividend of $0.75 per share. During the last 12 months, we have thus paid out $3.75 per share in dividends and this has given our investors an attractive yield of around 11%. So, that's the highlight. Let's continue. So, as I mentioned, we are reaffirming our revenue guidance of $370 million for the full year 2023. As you can see here in the graph, Q1 revenues this year were significantly stronger than last year as we had limited our spot exposure to one ship on variable higher time charter and actually the spot market was pretty firm during Q1. For Q2, as I mentioned, we have three ships which will be doing dry docking during this quarter and Q2 is also usually the softer spot market and this will affect the one ship we have on variable TC. Once we are done with June and getting into Q3 and Q4, all these 13 ships will be in operations and usually, we will see the seasonal uptick in charter rates during Q3 and Q4, which is also evident from the forward prices and thus revenues will grow to closer to $100 million for those quarters. So as I mentioned dry docking, we have been doing our first dry docking the two first ships Flex Enterprise and Endeavour was delivered early 2018 and I will now do for the five-year special survey. Flex Enterprise carried out this in March while its sister ship Flex Endeavor carried out a five-year special docking in April, both in Singapore. In our last presentation, we guided that in total these four dry dockings would take out 80 days to 90 days of operations of 20 days to 22.5 days. On average, we have managed to do this within 18 days. So we are slightly below time and we are also on the low side of the budget. CapEx in total for each ship is $4.5 million versus guided $4.5 billion to $5 million. So in Q2 as I mentioned Ranger and Rainbow will also be docked and these are to be completed within June and the ships will then be in operation for the full Q3 and Q4. So as I mentioned high contract coverage 57 years of minimum contractual backlog. This slide is the same as we had in our Q4 presentation. During last year, we did extend the contractual backlog on several ships as you can see here with rainbow being extended for 10 years and the vigilant amber enterprise and range. All these ships were extended for longer durations. And the first fully open ships we have today are Flex Ranger in early parts of 2027 and Flex Constellation in mid-2027 if the charter elects to extend for the three years which they have an option to do. So I think in terms of these durations we have a good coverage now. In the near term, when export growth is expected to be muted, we have open ships from 2027 once a lot of new LNG is coming on stream where we are also competing against new buildings at very high prices as I will come back to in the market section of the presentation. And once again, our dividend decision factors. As you can see here for this quarter we are paying out the $0.75 of ordinary dividend per share. We have paid out two special dividends last year $0.50 for Q2 and $0.25 for Q4. So in total the last 12 months we have paid out $3.75 of dividend which gives a yield of 11% or 12% depending on where the share price is. So we think this should give our investors an attractive yield. All the parameters here are green. We have good earnings. The market outlook is good. We have this large contractual coverage. Liquidity at $475 million is super strong and we don't have any debt maturities before 2028 at the earliest. On the considerations right now, I think most people are a bit focused on the aggressive Fed ramping up interest rates on the short-term side where we do have a very inverted yield curve and Knut will discuss a bit what kind of opportunities this has given us in the swap market. So with that, Knut, I'll hand it over to you. Thank you.

Knut Traaholt, CFO

Thank you, Oystein. Revenues for the quarter reached $92.5 million, resulting in an average time charter earnings for the fleet of nearly $80,200. We had another strong quarter in terms of operational expenses, maintaining control with an OpEx per day of $13,400. When looking at the details, revenues decreased by $5.5 million compared to last quarter, primarily due to lower seasonal earnings from the variable hire contract and off-hire days related to the dry docking of the Flex Enterprise. Additionally, there are non-cash items on the income statement, including a net loss on derivatives of $2.8 million. The notes indicate a $7.8 million unrealized mark-to-market loss from derivatives, while we also realized $5 million in gains from the swap portfolio, which is part of our carrying costs. Following the completion of our balance sheet optimization program, we have incurred exit costs associated with our debt, totaling $8.8 million in write-off for debt issuance costs and a termination fee of $1.4 million. This leaves us with a net income for the quarter of $16.5 million or earnings per share of $0.31. Adjusting for non-cash items, our adjusted net income stands at $35.2 million, which results in adjusted earnings per share of $0.66. Examining the adjustments that led to our adjusted net income, the quarter-on-quarter comparison shows operating income decreased by $6 million, driven by the off-hire from the dry docking of Flex Enterprise and lower seasonal revenues from the variable hire contract for the Flex Artemis. Adaptation costs quarter-on-quarter were $8.5 million, linked to the refinancing completion under the optimization program. The mark-to-market loss on derivatives amounted to $7.7 million, and when accounting for other foreign exchange factors, we arrive at a net income of $16.5 million. Reconciling to adjusted net income includes adding back non-cash items, totaling $10.2 million for debt issuance cost write-off plus the termination fee. Additionally, we add the unrealized market loss on derivatives of $7.9 million and a minor foreign exchange effect on our NOK portfolio, which gives us an overall adjusted net income of $35.2 million. Our balance sheet remains strong and well-structured, featuring an all-time high cash position of $475 million and equity of $871 million, resulting in an equity ratio of 31%. Reviewing cash movements for the quarter, we increased our cash balance by $143 million, mainly due to the completion of the balance sheet optimization program, which provided a net proceed of $196 million. After accounting for $54 million in dividends paid last quarter, we conclude with a record cash position of $475 million. During the quarter, we've been active in managing our hedging portfolio, utilizing market conditions to lock in market values on some swaps when interest rates were high. For instance, we had a 2.5-year $181 million swap at a fixed rate of 0.9%, and when the market rate hit 4.8%, we executed a mirror swap to receive 4.8% fixed while paying 0.9% to the bank, securing $15 million in market value to be realized over the life of that swap. We also expanded our hedging portfolio when short-term interest rates were lower. Overall, we increased it by $260 million and added another $50 million in a 10-year swap, bringing our total swap portfolio to $820 million at attractive rates. Together with the fixed-rate elements of our leases amounting to $205 million, we achieved a net hedge ratio of 62%, with expectations around 60% to 65% for the coming quarters. Regarding our financing, last quarter we completed a refinancing exercise involving six vessels. Our debt funding portfolio now consists of approximately 50% long-term leases and $441 million in amortized term loans, alongside a $400 million revolving credit facility, which is bullet for the full duration of the loans. This refinancing has extended our debt maturity profile, with the first maturity not occurring until 2028. By exercising a cost-free extension option on two leases, the latest refinancing is now scheduled for 2035. Now, I’ll pass it back to Oystein.

Oystein Kalleklev, CEO

Thank you, Knut. Let's examine the market. In the first four months of the year, from January to April, we observed approximately 5% growth in the LNG export market, primarily driven by North America due to the Freeport export terminal outage in the US. Significant contributions came from Qatar and Australia, as well as Norway with the Hammerfest plant operating for the entire quarter. Other countries added around 2.5 million tonnes in exports. On the import front, Europe continues to aggressively buy spot cargoes to offset reduced Russian pipeline gas supplies. Meanwhile, China's demand has started slowly, remaining flat in January and February, but began to increase in March as they eased COVID restrictions. Regarding gas prices, we've seen considerable volatility. During the COVID summer, European gas prices dropped to as low as $1 per million Btu, equivalent to about $6 per barrel of oil. Following the Russian invasion of Ukraine, global LNG prices surged, with European gas prices peaking around $100, translating to approximately $600 per barrel of oil. Recently, however, there's been a decline in gas prices due to a mild winter in Europe and decreased consumption, settling around $10 to $11 per million BTU. LNG has become competitive with oil at about $60 per barrel of oil equivalent, increasing demand from Asia. In the US, despite some past cargo cancellations due to various issues, we anticipate exports to rise again. S&P Global reports 128 canceled cargoes totaling 9.5 million tonnes, but we expect the US to emerge as the largest LNG exporter in 2023, with projected growth of 14% according to EIA. China became the biggest importer in 2021, surpassing Japan, and we will continue to monitor how China's reopening affects demand. Though growth was flat at the start of the year, we noted a pickup in demand during March and April, averaging 17% growth for those months. EIA and Energy Aspects project a 10% to 15% increase in Chinese LNG demand this year, which should help lift imports from 64 million tonnes last year to about 70 million tonnes, still below 2021 figures. The European gas market remains under scrutiny, especially with the ongoing situation in Ukraine and we are seeing a lesser demand in Europe this year due to a mild winter and higher prices, which have kept storage levels above historical averages. The key concerns moving forward include how strong Asian import demand will be and how competition for prices will develop. Regarding the shipping sector, we aren't heavily exposed to the spot freight market anymore, as most of our ships are on long-term charters. We are currently at our average rate levels from the past two years, and we expect freight rates to reach plus $200,000 by the year's end based on market guidance. With many major players securing long-term charters, there are fewer independent owners actively participating in the spot market, which bodes well for long-term prices as demand for new builds rises. As of March, the installed capacity for LNG exports was about 465 million tonnes, with expectations of total exports reaching between 415 million and 420 million tonnes for 2023. Notably, around 90% of ships under construction are committed to long-term contracts, providing stability to the market. In summary, our revenue for the quarter aligns with our guidance at $92.5 million, with average time charter earnings around $80,000, leading to an adjusted net income of $35.2 million, or $0.66 per share. We have successfully completed our balance sheet optimization, with a cash balance of $475 million at quarter-end. Our dry docking process is on track, with all operations running smoothly. We are maintaining our revenue guidance for the year at $370 million, although we anticipate a slight dip in revenues next quarter due to ongoing dry dockings, with expectations for a rebound in Q3 as operations resume to full capacity. We are proud to declare a dividend of $0.75 per share, totaling $3.75 over the past 12 months, providing an attractive yield for our investors. After a short break, we’ll return for the Q&A session where you can also win our Flex on the beach summer kit.

Knut Traaholt, CFO

Okay, Knut. I think before we start with questions maybe we can show the gift we have this time. This time, we have a summer team as I mentioned Flex on the beach, beach towel, together of course you need some protection with Flex on the Beach sunscreen or cap of course. We have to include the isle of dividends shot this time as well. And lastly, our sunglasses. So, let's see who will win this nice summer package – and I think we have a lot of questions today, Knut. Thanks a lot for the questions coming in. There's a lot of questions, and we'll try to take them in order and sequence. But maybe, we can start off a question forwarded from the investor Janne Harrington. She was on CNBC and put up a couple of questions and they've been forwarded.

Oystein Kalleklev, CEO

Okay.

Knut Traaholt, CFO

So, how do the low natural gas prices in the US affect Flex LNG?

Oystein Kalleklev, CEO

It's a complex question with both short-term and long-term implications. In the long term, persistently low natural gas prices in the US could hinder new drilling activity, which is essential for maintaining production levels. So far, this hasn't been an issue as we continually set new records for US gas production. One reason is that the productivity of wells is increasing as more are drilled. However, we prefer higher prices to ensure a sustainable return on equity from our investments. In the short term, low prices can actually benefit exports from the US, as the price difference between US gas and international markets is significant, leading to increased profits for those exporting LNG and even LPG. It's a matter of finding a balance; neither excessively high nor low prices are ideal. Additionally, many wells are drilled for oil, with gas being a byproduct. As long as oil prices remain stable, drilling will continue, usually resulting in finding associated gas. However, for targeted dry gas drilling, higher US prices are likely needed. It's also worth noting that US gas prices have been quite volatile, with fluctuations affecting domestic sales.

Knut Traaholt, CFO

And then it's a question on shipping, and shipping has historically been a volatile sector, or there are different segments into it, but mentions that historically investors have been burned on shipping companies. What's the difference with Flex? Does the charter agreements make it different than other shipping companies?

Oystein Kalleklev, CEO

Yes, of course. Shipping has always been volatile. So it's a derivative of the global GDP, and usually trade historically at least has been growing quicker than GDP. But this was also a problem on the downside when GDP growth slows less shipping activity. I think what makes Flex different from most commodity shipping segments is, of course, the fact that we have taken out a lot of this commercial risk by fixing our ships on long-term charters, where we have a very high level of earnings visibility. And this you can also see reflected in earnings and revenues. So if you look at the revenue graph, we're showing for the guidance for this year, there were small changes in the revenues from one quarter to the next because of the stability we have ensured with our long-term charters. And actually revenues are quite stable over the years not only the quarters. So I think we are different in that regard, because we have a bit different commercial strategy than most commodity shipping companies.

Knut Traaholt, CFO

And that brings us into the dividend and how secure it is with the U.S. treasury yielding 5%. Is Flex an attractive alternative for people looking for higher yield?

Oystein Kalleklev, CEO

Yes. Those who have struggled since the global financial crisis have really faced challenges for the past 40 years as interest rates have declined, leading to lower yields on savings each year. Recently, rates have been rising, but real interest rates remain low due to high inflation. Currently, the short-term interest rate is 5%, but the market suggests that yields won’t stay elevated in the short term. For instance, one-year treasury yields are at 4.8%, three-year at 4%, and ten-year yields drop to 3.5%. If you are looking for income, safe U.S. government bonds yield around 3.5%, while we are providing a much better return, with an approximate 11% yield over the last 12 months based on dividends. This dividend is secure since we have no ships open this year, and the earliest possible ship opens next year with 95% coverage expected. The first open ship isn’t until 2027, giving us clear visibility on cash flow. As we've stated in our presentation, these earnings belong to our shareholders, and we are committed to distributing them as dividends, which should offer a significantly better yield than current government bonds.

Knut Traaholt, CFO

So then let's turn to the questions on the market. What's your outlook for LNG transport out of the US for 2023, 2024?

Oystein Kalleklev, CEO

I think last quarter, our Q4 report, we had a graph on our projected supply situation for 2023. We are assuming 16 million tonnes of growth, growing global exports going from 400 million to 416 million. This might be a bit low when we see the EIA numbers. But half of that is US. So kind of the Freeport coming back on stream is most of this effect. And then the remaining growth is from the rest of the world. 2024 will be a year where we will have very muted export growth. But then from 2025 and onwards there will be more exports. So that's why we feel it's been a good strategy for us to fix our ship in this window where global growth in exports will be low before this all takes off again from 2025, 2026, 2027 onwards when our ships are coming up.

Knut Traaholt, CFO

And we then look at the import regions. Last year and this year, there's been a lot of imports to Europe. Is Europe and EU an important market for Flex?

Oystein Kalleklev, CEO

Yeah. It's not really us who decide where the cargoes will be flowing. We charter our ships on time charter. So the charter will then have the opportunity to trade the ship worldwide including Europe and they actually instruct us where the ship will be going. So we don't really have an impact on that. They are deciding where they find the best price for the cargoes. But, of course, with all the Russian gas coming through pipelines being shut down, this means that Europe has a large deficit of gas. And basically what they have been doing now for the last year or so is to replace some of that Russian pipeline gas with LNG. Of course, there are not enough LNG to fill the whole gap and that's why Europe needs to be a bit patient here until new LNG is coming on stream. And until that, you will have a pretty tight market where we have seen prices at a level which has been demand destructing. Right now, prices have come down to more fairly normal levels, but expectations are for higher prices when we are coming into the peak winter season.

Knut Traaholt, CFO

And now with LNG pricing being more moderated. Have you seen Asia return to imports?

Oystein Kalleklev, CEO

Yes. We've shown it in a couple of graphs here that we see some more growth from Asia. We do see this also in the routing of our ships. We see more ships going to Asia than have been the case recently. And of course, suddenly then when LNG in all ways, let's call it 20% to 25% discount to oil and coal prices are pretty elevated as well. That is stimulating demand. And I think it's stimulating demand and at a good time also because inflation has been high in Europe because of the high gas prices with the energy prices coming down now that will put less pressure on inflation. And of course, with China reflecting their economy, having actually cheaper energy prices will probably help in the recovery of the Chinese economy as well.

Knut Traaholt, CFO

Then we have a question from Mike Ott, which goes more on the fleet and the steam tankers. It's a topic you've covered over the years. But it's been mentioned that this will be uncompetitive and scrapped and that has not materialized that. There's been some scrapping, but it's been very low. And, of course, the reason for that is that the shipping market has been tight. There has been a total lack of ships available in the market. So when we have such high rates, people are trading the ships longer because still even our steamship, which has a lot of disadvantages compared to modern ships, they can still make a decent return. And I think as long as that is the case, people have been trading them. And also keep in mind a lot of new regulations came in force from 2023 and onwards. So eventually as this regulation is tightened in terms of the CII requirements and also the European carbon taxation, which is becoming increasingly more expensive to comply with. That will reduce the fleet of steamships going forward. So it's taken maybe a bit more time than some people expected, but this is mostly due to the very favorable freight economics, which results in those ships leaving a bit longer than maybe some people anticipated.

Oystein Kalleklev, CEO

Then we have questions on the open vessels in 2027. So if we start off with the timing of securing a contract, is it more realistic that these charters will be signed in 12, 24, or 36 months?

Knut Traaholt, CFO

I think we evidenced it last year. When I went to our fleet list, we showed several of our ships. We extended quite a lot of ships last year. Most recently in November, we extended ships which were not coming open before 2026 for longer durations all the way possibly to 2033. So we do see people now looking for ships for 2027, even people looking for ships for 2028. There are tenders, there are discussions in the market. So I think we are well-positioned to participate in those discussions. And as I mentioned here, we are competing against very expensive ships that need a high charter rate and probably a duration in order to defend that investment. So I think I wouldn't rule out that we will be able to also this year add more backlog to the fleet. Let's say we have 13 ships in operation. So every year we are losing 13 years of backlog. Hopefully we will be able to add more than 13 years of backlog so that actually we are not eating off the backlog but rather expanding our backlog. I would say that would be the aim and I don't rule out that happening within 12 months rather than the 24 or 36 months.

Oystein Kalleklev, CEO

And a question from Min-Jung. Considering the aging technology gap between 2027 new buildings and the two stocks in the Flex fleet, will the vessels achieve the same market rates as a new building?

Knut Traaholt, CFO

I believe the abrupt changes in technology have had a significant impact. We transitioned from steam to four-stroke medium-speed diesel electric ships, and later to Direct Drive slow-speed two-stroke ships. The images show that our vessels are in excellent condition when they leave the yard; they appear as good as new. The propulsion systems are similar to those in new builds. Newer ships, expected for delivery in 2027-2028, may have additional features like an air lubrication system, but the overall satisfaction with these systems varies, as their benefits are not universally accepted. Some vessels might include a shaft generator, but this doesn't greatly influence fuel consumption; its effects are more pronounced in operational and maintenance costs, with no significant change in fuel expenses. Among our fleet, three ships have full reliquefaction systems and four have partial systems, making them comparable to modern vessels priced around $260 million. Another advantage is that many of our ships are sister ships that have been navigating major export terminals and are already approved. New terminals usually require compatibility studies, which we've already undertaken for nearly all our ships globally. While there may be a slight discount due to their age, the underlying technology remains essentially the same. Moving on to the balance sheet and financing, Scott McFadden has been examining our long-term debt and total liabilities, which have been increasing over the past quarters. He would like us to discuss our approach to the total debt levels and any plans we have to reduce it.

Oystein Kalleklev, CEO

Maybe you should answer that.

Knut Traaholt, CFO

We have completed our balance sheet optimization program by refinancing our entire fleet of 13 vessels. This move was motivated by the growing backlog of contracts, which has allowed us to secure new capital or debt at more favorable terms. As a result, we have enhanced our repayment profile, reduced our credit margins, and improved our maturity profile. This is the rationale for refinancing the entire fleet. We haven't actively sought to increase leverage, but we've released nearly $400 million in cash, structured as a bullet revolving credit facility. This allows us to reduce the revolving credit facility if we have excess cash, effectively lowering our debt level as long as the cash is not needed. It also provides us with the flexibility to support the business moving forward.

Oystein Kalleklev, CEO

It means it's not applying to those outside the refining sector. We have a substantial $400 million credit line available with just three days' notice. We only pay about 0.7% interest annually in commitment fees to maintain it, providing significant financial flexibility. While we don't use it continuously, we tapped into it at the quarter end to demonstrate our cash availability, and its cost is minimal. Additionally, we are currently experiencing the best financing market since 2007, a time I was involved in ship financing. The last comparable market scenario was in 2014 when our CFO and I secured about $2 billion in financing that year. I believe 2022 has actually offered us better financing conditions. Knut has been instrumental in financing around $2 billion and has secured that financing for an extended period, from 2028 to 2025, on very favorable terms. I don't think these terms can be replicated today due to rising funding costs since the collapse of Silicon Valley Bank, Credit Suisse, and First Republic. We're in a strong position; financing should be secured when it's affordable, and that's precisely what we've accomplished.

Knut Traaholt, CFO

On the graph or slide showing the balance sheet, you can observe that the book values on our balance sheet are based on nearly all-time low vessel values at the time of acquisition. Therefore, when examining the leverage levels in relation to these book values, they appear quite conservative when compared to the market values, especially in light of our contract backlog.

Oystein Kalleklev, CEO

Yes. And we are contracted ships when they were cheap we tried to as good as we can lock them in on long-term charters when rates are high and then finance them when liquidity is plentiful and cheap. So, I think we've done a pretty good job so far.

Knut Traaholt, CFO

And that comes back to the recurring question about how to expand it. What's the plan for growth? How do you plan to spend the large pile of cash? Is it a reduction of debt, acquisitions, buyback, fleet growth?

Oystein Kalleklev, CEO

Yes, the primary focus for us is dividends. Over the last 12 months, we distributed $200 million in dividends, making it our main expenditure. Current building costs are high; we're uncertain about ordering new ships for 2027, possibly aiming for 2028 instead. We have two ships scheduled for delivery in 2027 and two more in early 2028. Our strategy has been to secure long-term contracts for our existing ships rather than invest in new builds, as that aligns better with our business model. We've been careful and have structured our financing to maintain low debt costs. This is a long-term LNG business, so we remain cautious about the high new building prices. We have access to affordable capital to capitalize on opportunities when they arise, but if not, we will continue maintaining our ships and paying dividends, which we trust will be valued by our investors.

Knut Traaholt, CFO

I think, we'll round off then. Do you ever get tired of winning?

Oystein Kalleklev, CEO

Well.

Knut Traaholt, CFO

You don't have to answer. But I think we round it off and now it's a time to disclose.

Oystein Kalleklev, CEO

Let's talk about the window because that's going to be a good question regarding technology on new buildings compared to the ships we have in our fleet. It’s something we’ve discussed in the past, but it’s been a while. Congratulations to you; you will have the full summer kit. Before we adjourn, I want to express my gratitude to all our seafarers and the people at the docks who have done a fantastic job with the Flex Endeavor and Flex Enterprise dockings, which have been perfect in terms of budget and timing, and the ships are back with our charters who are pleased to trade them again. We have two more to go this year, and next year, we will only have two dry dockings. I would also like to wish our Norwegian viewers a happy constitution day tomorrow, May 17, the biggest day in Norway with a lot of celebration. Thank you, everyone, and we will return in August for our second quarter presentation. We will also be in New York starting June 20 for presentations, so for those who are interested, you can join the Marine Money Conference where we will also present. Thank you.