SFL Corp Ltd. Q1 FY2021 Earnings Call

Good day, and thank you for joining us. Welcome to the Q1 2021 SFL Corporation Earnings Conference Call. I will now turn the call over to your speaker for today, Ole Hjertaker. Thank you. Please proceed.

Thank you, and welcome all to SFL's first quarter conference call. I will start the call by briefly going through the highlights of the quarter, and following that, our CFO, Aksel Olesen, will take us through the financials, and the call will be concluded by opening up for questions. Before we begin our presentation, I would like to note that this conference call will contain forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. Words such as expects, anticipates, intends, estimates or similar expressions are intended to identify these forward-looking statements. Forward-looking statements are not guarantees of future performance. These statements are based on our current plans and expectations and are inherently subject to risks and uncertainties that could cause future activities and results of operations to be materially different from those set forth in the forward-looking statements. Important factors that could cause actual results to differ include, but are not limited to, conditions in the shipping, offshore and credit markets. You should therefore not place undue reliance on these forward-looking statements. Please refer to our filings with the Securities and Exchange Commission for more detailed discussions of risks and uncertainties, which may have a direct bearing on our operational result and our financial condition. The announced dividend of $0.15 per share represents a dividend yield of around 7.5% based on the closing price yesterday, and this is our 69th quarter with dividends. Over the years, we have paid nearly $28 per share in dividend or approximately $2.4 billion in total, and we have a significant fixed rate charter backlog supporting continued dividend capacity going forward. The total charter rate revenues were $135 million in the quarter with more than 85% from vessels on long-term charters and less than 15% from vessels employed on short-term charters and in the spot market. The EBITDA equivalent cash flow in the quarter was approximately $98 million. Over the last 12 months, the EBITDA equivalent has been approximately $440 million. The net income came in at $31 million in the quarter or $0.27 per share. In addition to a good contribution from our operating assets, we also had a positive effect this quarter from the sale of shares in ADS Crude Carriers and positive mark-to-market relating to our interest rate hedging instruments. Our fixed rate backlog stands at approximately $2.4 billion from owned and managed vessels after recent acquisitions, providing significant cash flow visibility going forward. The backlog excludes revenues from 16 vessels trading in the short-term market and also excludes future profit share optionality. In addition, we have excluded charter hire relating to the drilling rigs to be conservative in light of the ongoing financial restructuring in Seadrill. We are pleased to execute on our commitment to invest in assets and markets with a lower carbon footprint. We have spent a lot of time evaluating various new technology initiatives that can improve performance of vessels, including existing vessels on the water. In April, we agreed with the Volkswagen Group to build and charter out 2 newbuild dual-fuel car carriers designed to use liquefied natural gas, or LNG, for propulsion. The charter period is 10 years from delivery in 2023. Until the new vessels are delivered, Volkswagen will charter our 2 existing car carriers, SFL Composer and SFL Conductor, and we intend to cooperate with our customer to use eco-friendly biofuel for the propulsion of our 2 existing car carriers. The transaction adds more than $200 million to the fixed rate charter backlog, and importantly, also added another end user to our customer portfolio. Maintaining market-leading operational standards and close relationships with end users pays off, as illustrated by another deal with Maersk Line, where we have agreed to purchase a 2020 build 5,300 TEU container vessel, in combination with a long-term charter. The delivery is expected to take place in the third quarter of 2021, and we will then have 13 vessels on charter to Maersk Line. All these are on time chartered terms where we are responsible for technical management and vessel operations. While the purchase price is confidential on this last vessel, we can confirm that it's well below current charter-free broker valuations, adding a nice offer for us. Subsequent to quarter end, the company also successfully placed $150 million in senior unsecured sustainability-linked bonds due in 2026. The bonds will pay a coupon of 7.25% per annum, and net proceeds will be used to refinance existing debt and for general corporate purposes. It was done on a very cost-efficient Norwegian documentation basis but with strong international demand from Asia, Europe, and the U.S. Excluding the drilling rigs, the backlog from owned and managed shipping assets was $2.4 billion at the end of the quarter. Over the years, we have changed both fleet composition and structure; we now have 84 shipping assets in the portfolio and no vessels remaining from the initial fleet in 2004. This slide does not include the remaining 3 offshore assets. So in total, we have 87 assets, if we include these as well. In addition to the long-term chartered vessels, we have 16 vessels trading in the short-term market. We also have significant contributions from profit share this quarter and over the long term, both relating to charter rates and fuel savings. We do not have a set mix in the portfolio; we focus on evaluating deal opportunities across the segments and try to do the right transactions from a risk/reward perspective. Over time, we believe this will balance itself out, but we try to be careful and conservative in our investments and not just invest because money is burning a hole in our pocket. Regarding Seadrill and their financial restructuring, there isn't really nothing more to report at the moment. We have entered into agreements relating to 2 of our drilling rigs where we will receive approximately 75% of the lease hire under the existing charter arrangements for West Linus and West Hercules during Seadrill's Chapter 11 procedure. Both rigs are active and working for all companies, and the charter rate is sufficient to cover our debt service relating to these rigs. We are, of course, very pleased to see a strengthening harsh environment drilling market in the North Sea on the back of a rising oil price. Regarding the rig West Taurus, this has been redelivered to SFL, and we are preparing it for recycling, which will most likely take place in the third quarter. Over the years, we have gone from a single-asset class charterer to one single customer to a diversified fleet and multiple counterparties. Over time, the mix of the assets and charter backlog has varied from 100% tankers initially to nearly 60% offshore 10 years ago to container and car carriers now being the largest segment with 77% of the backlog. If you look at the counterparties, it is now mainly to end users and market leaders in their respective segments and relatively fewer intermediaries, where we have less visibility on the use of the assets and quality of operations. Strategically, this gives us access to more deal flow opportunities such as the repeat business with Maersk and MSC, for example. Our strategy has therefore been to maintain a strong technical and commercial operating platform in cooperation with our sister companies in the Seatankers Group. This gives us the ability to offer a wider range of services to our customers from structured financing to full-service time charters, which is where most of our asset portfolio lies. With full control of vessel maintenance and performance, including energy efficiency and emission-minimizing efforts, we can impact improvements to our vessels throughout the lifecycle of the assets and not only be passively owning vessels employed on bareboat charters, where the customers may not always have an incentive to make such improvements. With that, I will give the word over to our CFO, Aksel Olesen, who will take us through the financial highlights for the quarter.

Thank you, Mr. Hjertaker. On this slide, we have shown a pro forma illustration of cash flows for the first quarter. Please note that this is only a guideline to assess the company's performance and is not in accordance with U.S. GAAP and is also net of extraordinary and noncash items. The company generated gross charter hire for approximately $135 million in the first quarter, with approximately 84% of the revenue coming from our fixed charter rate backlog, which currently stands at $2.4 billion, providing us a strong visibility on our cash flow going forward. During the first quarter, the liner generated gross charter hire of approximately $74 million, including approximately $2.4 million in profits related to fuel savings on some of our large container vessels. Of this amount, approximately 95% was derived from our vessels on long-term charters. SFL's backlog currently stands at approximately $1.9 billion, with an average remaining charter term of approximately 4.5 years or approximately 7.5 years if weighted by charter hire. With the recent acquisitions and charter extensions in the liner segment, more than 75% of our total backlog is with the world's leading container shipping lines and automobile manufacturers. Our tanker fleet generated approximately $15.3 million in gross charter hire during the quarter, including approximately $300,000 in profit share contribution from our VLCCs on charter to Frontline. Furthermore, net charter hire from the company's 2 Suezmax tankers employed in the short-term market was approximately $2.5 million compared to $1.6 million in the previous quarter. During the quarter, our dry bulk fleet generated approximately $32 million in gross charter hire. Of this amount, approximately 60% was derived from our vessels on long-term charters to Golden Ocean and Hyundai Glovis. During the quarter, the company had 10 Supramax and Handysize vessels employed in the spot and short-term markets. These vessels generated approximately $9.8 million in net charter hire compared to $6.4 million in the previous quarter. SFL owns 2 drilling rigs which have been chartered to the subsidiaries of Seadrill on bareboat terms. In the first quarter, we received charter hire of approximately $13.2 million from the rigs. In connection with the Chapter 11 filing of Seadrill in February and as previously announced, SFL has entered into interim agreements with Seadrill relating to West Linus and West Hercules, allowing the uninterrupted performance of subcharters to oil majors while the Chapter 11 process is ongoing. According to these agreements, SFL will receive approximately 75% of the invoice charter hire under the original contract for the West Hercules and West Linus. This essentially equates to the interest and amortization due on secured bank loan facilities relating to these rigs. This summarizes an adjusted EBITDA of approximately $98 million for the first quarter. We then move on to the profit and loss statement as reported under U.S. GAAP. As we have described in previous earnings calls, our accounting statements are different from those of a traditional shipping company, and as our business strategy focuses on long-term charter contracts, a large part of our activities are classified as capital leasing. As a result, a significant portion of our charter revenues are excluded from U.S. GAAP operating revenues and instead booked as revenues classified as repayment of investment in finance leases and vessel loans, results in associates and long-term investments and interest income from associates. So for the first quarter, we report total operating revenues according to U.S. GAAP of approximately $109 million, which is less than the approximately $135 million of charter hire actually received for the reasons just mentioned. During the quarter, the company recorded profit split income of $2.6 million mainly related to fuel savings on some of our large container vessels. Furthermore, the net result was impacted by nonrecurring and noncash items, including among others, a positive mark-to-market effect relating to interest rate swaps and equity investments of $9.3 million. Following the divestment of 50.1% in River Box Holding last quarter, the vessels are accounted for as investments in associates, applying the equity method. As a result of the accounting treatment, operating revenues, operating expenses, and net interest expenses in these affiliates are not included in SFL's consolidated income statement. Instead, the net contribution from these affiliates are recognized as a combination of interest income from associates and results in associates. Overall, according to U.S. GAAP, the company reported a net profit of $31.5 million or $0.27 per share. We then move on to the balance sheet. At quarter end, SFL had approximately $216 million of cash and cash equivalents, excluding approximately $8 million in cash held in a wholly owned nonconsolidated subsidiary. Subsequent to quarter end, the company successfully placed $150 million in senior secured sustainability-linked notes due in 2026. The notes will pay a coupon of 7.25% per annum, and the net proceeds will be used to refinance existing debt, including our convertible note with maturity in October, which is included in the short-term debt. As discussed on the last earnings call, the West Linus and West Taurus are fully consolidated on our balance sheet as financial leases during the fourth quarter after, among other things, changes to certain financing terms relating to the assets. Following the agreement entered into at Seadrill in connection with the Chapter 11 filing, releases for the West Linus and West Hercules have been changed to operating leases. West Linus was therefore moved from investments in sales-type, direct financing and leaseback assets to vessels and equipment on our balance sheet during the first quarter. After the recently announced transaction, we have approximately $184 million of remaining CapEx to be paid over the next 2.5 years, and we expect the majority of this to be financed with senior bank finance. Based on Q1 2021 figures, the company had a book equity ratio of approximately 27%. To summarize, the Board has declared a cash dividend of $0.15 per share for the quarter. This represents a dividend yield of approximately 7.5% based on the closing share price yesterday. This is the 69th consecutive quarterly dividend. Since the inception of the company in 2004, approximately $28 per share or approximately $2.4 billion in aggregate has been returned to shareholders through dividends. Our $2.4 billion backlog from our shipping assets gives us strong visibility on future cash flow and continued debt service. The company has significant financial strength with approximately $216 million in cash on the balance sheet at the end of the first quarter. We have recently demonstrated our commitment to investing in modern fuel-efficient vessels with a lower carbon footprint through the recent agreement with Volkswagen Group for 2 newbuilding car carriers and the issuance of $150 million of senior unsecured sustainability-linked notes. With a strong track record and affiliation with the Seatankers group of companies, we have unique access to both capital and deal flow, a great combination to continue to grow our business. With that, I give the word back to the operator, who will open the line for questions.

And we now have our first question from Randy Giveans from Jefferies.

All right. So looking at your fleet here, you've done a few acquisitions, mainly on the car carrier side. You also bought the 5,300 TEU from Maersk. At these levels, are you interested in buying or selling? And if so, what asset classes are attractive right now? Obviously, asset values are rising across all subsectors, so any sector you prefer at these levels?

Yes. Thanks. I would say we look at opportunities across our sectors, so I would say we are, of course, very much more cautious on offshore assets for natural reasons. Also, what we have seen, for instance, on the liner side and the container side, we've seen asset prices going up very quickly. There, we would be cautiously looking at opportunities. Our focus would be to do deals where we can take down our effective asset exposure to a more normalized mid-cycle-type residual value, also factoring in expectations for changes in propulsion technology going forward. If that works, and we have a good, strong charter to a strong counterparty where we are confident that they will pay even when the market cools down, we wouldn't have a problem with adding more capacity in that segment. Of course, our preference is to buy assets with long-term charters, and we have seen over the years that it's been more in the liner space where we have seen the long-term charters. We've also seen it from time to time in other sectors. Like in the dry bulk side, we've seen it, and we have looked at projects on the tanker side too. We will, of course, also follow developments in segments where we are not exposed currently. But of course, until or unless we do a deal there, we cannot really comment on specifics. But we look at many opportunities and try to be selective on which we do.

Sure. I guess did you look at or participate in the LNG-powered VLCC tenders by some of the oil majors or the cutter LNG newbuild tenders that are kind of out there currently?

What I can say there is that we have essentially seen all or certainly most of the opportunities that have been out there. We've spent more time on the opportunities where there have been new technology and dual-fuel opportunities. Our COO, Trym Sjølie, he has focused a lot on that. We are focusing on what we call a well-to-wake perspective on assets. What we have seen is that with a dual-fuel vessel, you cannot always compare a dual fuel to another dual fuel. You have different technologies there. There are technologies that we believe are better from a long-term perspective and more versatile for an owner from a long-term perspective. Many of the projects we observed, particularly during last year, were based on technology where we were not so interested in taking a lot of residual exposure, so if you combine that with shorter charters than we would prefer, we've seen others be more eager to get the projects and therefore bid lower rates or accept higher risk. We will only know later which approach was right, but we try to be cautious and mindful when we make these investments. We see a lot of focus on technology shift, and we will, of course, prepare and watch that carefully as it develops.

Got it. All right. And then for the upcoming converts maturity, I know you mentioned you did the $150 million senior unsecured bonds. I guess will that entire amount be used to repay the converts? And when will you repay those?

I think the purpose of the sustainability-linked bond was, of course, to tap into a very attractive market in terms of cost of capital. We did that with a national investor base, and proceeds for that bond will partly address the converts and for general corporate purposes. The balance can then be addressed with some cash at hand, so it’s really a combination of the above. For all practical purposes, that maturity has been addressed. We also have in the existing indenture on the new bond this year, a borrowing limit of up to $200 million, so $50 million on top of the $150 million that we have already raised, providing us additional flexibility.

Right. And can you confirm the amount and the date that you plan on repaying those converts?

I cannot confirm the exact date and amount, but...

It's early October...

I think it's mid-October. At quarter end, the outstanding amount was approximately $212 million.

And our next question comes from the line of Greg Lewis from BTIG.

I was actually hoping for a little color around interest rate guidance. Congrats on the sustainability-linked bonds. I imagine you're going to be doing more of those in the future. But I guess what I'm kind of curious about is as we think about a good run rate, just looking at your debt position at the end of Q1, any color around interest rate guidance you can give us for the next few quarters, how we should be thinking about that number?

You're thinking about the secured debt, the senior secured debt?

No. Just that if I look at the interest expense in Q1, there was a nice step down from Q4. Just how we should think about that?

Sure. I think it will be, as the base gets rather stable from what you saw in the first quarter, but the step down is really related to the divestment of 50.1% of the River Box Holding and how that's reflected. So that's basically the main difference.

Although, generally, we have a lot of interest rate hedges. So when we do a long-term charter, we typically fix the interest rate. We do not have too much market-related movements on a cash interest basis. We do see on some of the swaps we have some swaps that are designated, and we have others that are not so closely tied to the underlying loan. Therefore, we have some mark-to-market movement on the value there. But our interest swaps are really based as hedges to ensure stability in interest rates when we have visibility on cash flow.

Okay. Perfect for that. And then Ole, I was hoping you could dig in a little bit around this acquisition that would be announced with Maersk. I mean, I guess my first question is, if I were to look back when you previously worked through the uncertainty around the last Seadrill restructuring, the company was kind of quiet on the acquisition front. As I think about this acquisition, how should we think about this acquisition in terms of the company's financial position and your outlook?

Yes. You're absolutely correct. We were quite cautious through last year given the uncertainty relating to Seadrill and also whether or not Seadrill would file for Chapter 11 again or not as they did. Now as we have more clarity there, we know that the 2 rigs that are working are producing good cash flows for Seadrill, covering full OpEx for them, also providing a contribution to their G&A. That gives us, of course, better visibility on the cash flow from those 2 assets. Also, now that the convert maturity has been addressed, we are in a better position to do more transactions hopefully. But again, we are cautiously evaluating all deals, and we hope to execute on more transactions, and we will announce them and comment then. It's certainly a much better setting for us now than last year, just due to the rig situations.

Okay. Great. And then just based and realizing we don't want to talk about specific customers on the call, I would characterize a lot of liner companies, not all, but a lot of liner companies' decisions to focus on owning new tonnage. As the vessels age, typically, after they're halfway through their useful life, the liners then go out for sale and leaseback vessels. Is there anything to glean from the fact that this transaction you did was for a 2020-built vessel versus, say, a 2005 to '10 build? Is there anything changing in how the liner companies are thinking about the positioning of their fleets? And is that an opportunity for SFL going forward?

Yes. Thanks. Yes. The vessel we have agreed on is essentially a brand new vessel, but it’s been on the water for a few months. It's a secondhand vessel, but it comes with all the latest technology. If we look at the order book, there has been a lot of activity on the newbuilding ordering side over the last 6 months; however, the order book is lower than it has been historically. It's only been in the last 2 or 3 years that we have seen lower order books. The assets that have been ordered are quite conventional vessels, similar to specifications you would order 10 years ago. Only around 1/3 of the vessels have been ordered with scrubbers, based on the market data we have seen, and very few vessels have been ordered with dual fuel—around 10% to 12%. If you look at containerships and the way we see it, there was a significant technology shift from vessels ordered before the financial crisis to those ordered after it, particularly those delivered in 2013 and onwards. The initial vessels ordered before were designed for much higher speeds, larger engines, less fuel efficiency, and were built for higher speed, while the vessels built after the financial crisis have been designed with better fuel efficiency features. So, the liner companies, as we see them, are focusing more on these modern eco-type vessels built from 2013 onwards. However, in the current frenzy where there has been a shortage of capacity because of bottlenecks, they are willing to charter anything, resulting in asset values and charter rates for older vessels shooting through the roof. We believe this is something that will subside when the market cools down again, but we believe that modern vessels built after the financial crisis have much better prospects in the long run.

Okay. Great for that. And since it is topical, I will squeeze in another question. Clearly, the dry bulk market has been very strong year-to-date. As I think about that and look at many of the vessels you have on short-term charters, how should we think about the opportunity for those? Is that something where SFL would consider putting them on a 1-year charter? Or if you can't secure something multiyear, will you keep these vessels operating on short-term, spot-type market work?

Yes. So far, we've been operating them in the spot market for a while. The market has been soft for a few years, and all these were chartered on longer-term charters previously. As they came off, we traded them in the market. With our operating platform, we haven't had to flip them and recharter them at very low rates. From an asset and charter perspective, we are agnostic. We prefer long-term charters, but everything is for sale here, except my dog. We look at opportunities relating to charters. The majority of our portfolio is employed on long-term charters; the number of vessels in the short-term market is around 16, which is a very small portion of our total value—maybe 8% to 10%.

Our next question comes from Liam Burke from B. Riley.

With the stated strategy emphasizing container and dry bulk fleet assets, are you going to manage your tanker assets any differently? And as asset values or NAVs improve, how do you expect to manage that part of the fleet?

Of course, we look at transaction opportunities in all segments, and we have also looked at opportunities on the tanker side. However, we are aware of the wider shift in the market where many investors and stakeholders prefer liner and dry bulk assets over oil production and transportation assets. It's all about risk versus reward. If the opportunity is interesting enough, we could develop opportunities around tanker assets too. The reason we have focused more on the liner and dry bulk side is simply that we have seen more compelling investment opportunities that combine strong counterparties, technology, and long-term charter coverage with attractive residual values. The increase in our activity on the liner side does not exclude us from pursuing new deals; we previously did a deal with Phillips 66 a couple of years ago, and we can continue to do other deals with oil majors.

Sure. Now getting back to the dry bulk fleet, it's obviously less a smaller portion of it, and your preference is long-term charters to match your financing. Asset prices on the container side are higher. Is there anything you see in the dry bulk area that's interesting to you which would meet your criteria?

Yes. We look at opportunities there as well. But we cannot be specific about what we should pursue. We are evaluating a mix of assets, counterparties, charter tenure, and residual exposure. We may engage in further transactions in the dry bulk segment and have also seen projects with major manufacturers from time to time, but we have not announced any specific transactions at least today.

Our next question comes from Chris Wetherbee from Citi.

James on for Chris. I wanted to follow up on a couple of points Greg brought up. You mentioned that the interest rate side from a liability perspective, are there any step-ups or protections from a lease rate we should consider moving forward, where if there's a sizable increase, the spread between your financing costs and the top line might extend?

The way it works is that when we do a new long-term charter, we typically try to match the financing term with the charter term. We also normally hedge the interest rate through a fixed rate agreement with the financial institution or via interest rate hedges. When you look at the end of the charter period, you consider the new charter opportunity. Any new charter rate will have the prevailing interest rates as a factor. If the market interest rates increase significantly, you may see a higher charter rate at that time. Also, on some assets like our 8 containerships with Golden Ocean, we have an interest rate adjustment factor whereby they absorb the interest rate volatility, which allows us to finance on a short-term interest market. If the interest rates rise, they will absorb it.

Exactly. We have a very conservative strategy in terms of interest rate exposure. We do not take significant risks. The latest issuance was also a fixed rate bond, so that reflects our overall philosophy.

Owning shipping assets might actually serve as a good hedge against interest rates.

Yes, yes. Separately or in relation, the sustainability bond you issued, understanding the 7% rate you attained, what do you think it would have been had it not been sustainability-linked? Are cost savings elements something you don't foresee, or would it be reasonable to assume that future sustainability bond issuances might lower rates?

We’ve discussed this a lot internally with managers who placed the notes. I don't think there was a significant difference in pricing, but it is interesting in that you reach a much broader audience of investors in the paper, leading to greater liquidity. We had a fair proportion of international investors outside the Nordic region, which makes the bond more attractive and consequently creates better aftermarket trading.

Additionally, raising capital on Norwegian documentation is more cost-efficient from a legal standpoint; the all-in costs are more favorable compared to many U.S. issuances we have observed.

Exactly.

Understood. Given your outlook and approach to the market, are you consistent with your position relative to sectors? While you favor long-term contracts secured, in your views, how are the terms overall for deals you consider now?

In terms of deal flow, we are seeing a lot of activity these days. We are being quite selective. Some segments are becoming quite rich. A lot of cash flow has forward starting dates, and the ability to lock in interest costs is becoming crucial. We have evaluated a broad range of opportunities across all segments: liners, tankers, dry bulk; however, we remain disciplined. We have a strong focus on counterparty risk and residual value. That is a bit tricky now with numerous new propulsion technologies, and you must ensure you have a sufficiently long charter to be comfortable with residuals. Currently, we have a bank group of around 30 international banks, and we're appreciative of the strong support from our banking group.

Just for clarity, is there reluctance to take on residual value risk from your customers’ perspective?

All customers tend to put residual risk on us. You see that in the market. However, we have a great group of existing clients and strong relationships, and that's where we can often collaborate to determine reasonable residual value risk for both parties. Those are the deals we pursue.

Lastly, regarding the bank access from Eastern banks, is that broadly available throughout the market, or is that specific to SFL?

As I mentioned, there is a general flight to quality. SFL, due to our strong track record and affiliation with the Seatankers group of companies, enjoys strong access to banks. However, it's the second or third tier shipowners who may be facing difficulties in accessing bank capacity. Our Japanese and Taiwanese banks have favored our business strategy, which resonates well with them as that is how many Japanese shipowners operate.

And there are no further questions at this time. Please continue.

Thank you. With that, I would like to thank everyone for participating in our first quarter conference call. I also want to thank the SFL team on board the vessels and onshore for their efforts in a challenging time with continued uncertainty caused by the COVID-19 situation and, particularly for our vessel crews. If you have any follow-up questions, there are contact details in the press release, or you can get in touch with us through the contact pages on our web page, www.sflcorp.com. Thank you.

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.