SFL Corp Ltd. Q3 FY2021 Earnings Call

Good day, and thank you for joining us. Welcome to SFL Corporation's Q3 2021 Earnings Conference Call. Please note that today's conference is being recorded. I will now turn the call over to your speaker, Ole Hjertaker. Thank you. Please proceed.

Thank you, and welcome, everyone, to SFL's Third Quarter Conference Call. I will start the call by briefly going through the highlights of the quarter. Following that, our CFO, Aksel Olesen, will take us through the financials, and the call will be concluded by opening up for questions. Our Chief Operating Officer, Trym Sjølie, will also be present for the Q&A session. 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 projections 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 a more detailed discussion of our risks and uncertainties, which may have a direct bearing on our operating results and our financial condition. The announced dividend of $0.18 per share is an increase of 20% over last quarter's dividend and represents a dividend yield of around 9% based on closing price yesterday. This is our 71st quarterly dividend. And over the years, we have paid nearly $28 per share in dividends or around $2.4 billion in total. And we have an increased fixed-rate charter backlog supporting continued dividend capacity going forward. The total charter revenues were $156 million in the quarter, with around 77% from vessels on long-term charters and 23% from vessels employed on short-term charters and in the spot market. The EBITDA equivalent cash flow in the quarter was approximately $112 million or around 10% higher than the second quarter. Over the last 12 months, the EBITDA equivalent has been approximately $419 million. The net income came in at around $33 million in the quarter or $0.26 per share. There were only minor one-offs in the quarter, including a smaller mark-to-market gain on interest hedging instruments. There were also around $900,000 higher operating costs in the quarter due to additional crew rotation costs linked to COVID restrictions. Our fixed-rate backlog has increased and stands at approximately $2.7 billion from owned and managed vessels after recent acquisitions and disposals, providing continued cash flow visibility going forward. The backlog of $2.7 billion excludes revenues from the vessels traded 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 continue building the portfolio with modern assets on long-term charters and have recently agreed to acquire 3 modern 2019 built Suezmax tankers in combination with time charters to one of the leading commodity trading companies. This deal includes some interesting optionality features if the market should strengthen during the charter period where sales can be triggered with a profit split. If not, the long-term charters amortize the vessels down to a comfortable low level with a good base return, supported by the $140 million backlog. We have also recently agreed to sell 7 Handysize vessels for an aggregate net sales price of $98 million with delivery in the fourth quarter. Compared to 1 year ago, the value of these vessels has nearly doubled. These vessels were debt-free at quarter-end, so the cash effect will be similar to the net sales price. Two of the vessels have been delivered already, while the remaining 5 will be delivered towards the end of the quarter. In addition to the sales price, we therefore estimate another around $15 million net cash flow from trading the vessels from the time we agreed on the sale until delivery. Recently, we have also agreed to charter out 2 Supramax bulkers for periods of approximately 12 months at around $24,000 per day. We have also agreed to charter out a 2005 built 1,700 TEU feeder containership for a period of approximately 3.5 years at a rate of approximately $27,000 per day. These charters alone add around $48 million to the backlog. During the third quarter, we took delivery of 5 container vessels with long-term charters to Maersk and Evergreen. These vessels represent approximately $300 million charter backlog, and we will have a full cash flow effect in the fourth quarter. With these vessels, we have 15 vessels on charter to Maersk and 6 vessels on charter to Evergreen. All these vessels are on time charter terms where we are responsible for technical management and vessel operations. Excluding the drilling rigs, the backlog from our own and managed shipping assets was $2.7 billion at the end of the third quarter. Over the years, we have changed both fleet composition and structure, and we now have around 70 vessels in our portfolio. In addition to the long-term chartered vessels, we have 15 vessels trading in the short-term market. We also had a significant contribution for profit share over time, both relating to charter rates and fuel savings. We do not have a set mix in the portfolio, as the focus is on evaluating deal opportunities across the segments, trying to do the right transactions from a risk-reward perspective. Over time, we believe this will balance itself out. However, we try to be careful and conservative with our investments, focusing on technology and transitioning over time to more fuel-efficient vessels. The 2 drilling rigs are not included in our reported charter backlog figures. With respect to Seadrill and the ongoing financial restructuring, we cannot give more details than we have disclosed in our press releases or is otherwise publicly available. After Seadrill's plan of reorganization was approved by the court 2 weeks ago, they estimate emergence from Chapter 11 around year-end. We received approximately 75% of the lease hire under the existing charter agreements for West Linus and West Hercules during Seadrill's Chapter 11 proceedings. Both rigs are active in working for all companies, and the charter rate is sufficient to cover our debt service relating to these rigs. We are, of course, pleased to see strengthening drilling markets on the back of the firm oil price. During the third quarter, we entered into amendments to the charter agreements relating to the semisubmersible drilling rig, West Hercules. Under the amendment agreement with Seadrill, the West Hercules is contracted to be employed with oil major Equinor in Norway and Canada until the second half of 2022 and thereafter, redelivered to SFL in Norway. SFL will continue to receive a bareboat hire of around $65,000 per day until Seadrill emerges from Chapter 11 around year-end, and thereafter, approximately $60,000 per day while the rig is employed under a contract and generates revenues for Seadrill at approximately $40,000 per day in all order modes, including when the rig is idle and mobilized to and from Canada for the Equinor work. Regarding the West Linus, which is on a subcharter to an oil major in the North Sea until the end of 2028, SFL continues to have a constructive dialogue with Seadrill but we have not yet agreed on terms for the period after Seadrill's emergence from Chapter 11. Given the ongoing discussions, we can unfortunately not comment anymore on this for the time being. Over the years, we have gone from a single asset class charter 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 to nearly 60% offshore 10 years ago to container vessels now being the largest segment with more than 60% of the backlog. If you look at the counterparties, it is now mainly to end users and market leaders in the respective segments, and relatively few are to intermediaries where we have less visibility on the use of the assets and quality of operations. Strategically, this also gives us access to more deal flow opportunities such as repeat business with Maersk, MSC, and Evergreen, 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. With full control over vessel maintenance and performance, including energy efficiency and emission minimizing efforts, we can impact improvements to our vessels throughout the life of the assets and not only be passively owning vessels employed on bareboat where the customers may not always have an incentive to make such improvements. In addition, we can retain more of the residual value in the assets when we charter out on a time charter basis, and in the current environment with rising raw material costs driving replacement costs for vessels, this value benefits SFL and our stakeholders. For bareboat deals, this value is usually retained by the charter through fixed price purchase options. This is illustrated by the recent sale of the 7 Handysize bulkers, where our operating platform has enabled us to trade the vessels in the spot market during the soft market for a period. Now, when the values have nearly doubled over the last year, we sell the vessels with a significant profit plus additional net cash flow from trading the vessels until delivery. And 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 third 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 also net of extraordinary and non-cash items. The company generated gross charter hire of approximately $156 million in the third quarter, including $7 million of profit split with approximately 77% of the revenue coming from our fixed charter rate backlog, which currently stands at $2.7 billion, providing us with strong visibility on our cash flow going forward. In the third quarter, the liner fleet generated gross charter hire of approximately $79 million, including approximately $2.8 million in profit split contribution related to fuel savings on some of our large container vessels. Of this amount, more than 90% was derived from our vessels on long-term charters. Following the company's recent acquisitions, SFL’s liner fleet backlog currently stands at approximately $2.1 billion, with an average remaining charter term of approximately 4.6 years or approximately 7 years if weighted by charter hire. During the quarter, SFL took delivery of 2 modern 6,800 TEU container vessels on charter to Maersk, 2 modern 14,000 TEU container vessels on charter to Evergreen, in addition to a 5,300 TEU container vessel that commenced a 7-year charter to Maersk. All these vessels will improve higher effects during the fourth quarter. Our tanker fleet generated approximately $16 million in gross charter hire during the quarter. Of this amount, about 75% was derived from our vessels on long-term charters to, among others, Frontline and Phillips 66. The net charter hire from the company's Suezmax tankers employed in the short-term market was approximately $1.7 million compared to $1.8 million in the previous quarters. During the third quarter, we also acquired 3 Suezmax tankers with 5-year charters to a world-leading commodity trading and logistics company. We expect the vessels to be delivered later this year and early in the first quarter. A dry bulk fleet generated approximately $49 million in gross charter hire in the third quarter, including approximately $4.1 million in profit share contribution from our Capesize vessels on charter to Golden Ocean. During the quarter, the company had a fleet of 22 dry bulk vessels, of which 12 vessels are employed on long-term charters and the other 10 are trading in the short-term market. In September, the company entered into an agreement for the sale of 7 Handysize vessels to a national buyer. Two vessels have been delivered and the 5 remaining vessels will be delivered before year-end, resulting in net sales proceeds of more than $98 million in the fourth quarter. The vessels were debt-free at quarter-end. This falls on to 2 drilling rigs, which have been chartered out to subsidiaries of Seadrill on bareboat terms. In the third quarter, we received charter hire of approximately $12.3 million from the rigs. This summarizes to an adjusted EBITDA of approximately $112 million for the third quarter compared to $103 million in the second quarter. We then move on to the profit and loss statement as reported on the U.S. GAAP. As we have described in previous earnings calls, our accounting statements are different from those of a traditional shipping company. Our business strategy focuses on long-term charter contracts, and 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 repayment of investment in finance leases and vessel loans, results from associates and long-term investments, and interest income from associates. For the third quarter, we report total operating revenues according to U.S. GAAP of approximately $135.4 million, which is less than approximately $156 million of charter hire actually received for the reasons just mentioned. During the quarter, the company recorded profit split income of $4.1 million from our Capesize brokers and charters to Golden Ocean in addition to $2.8 million from fuel-saving arrangements on some of our large container vessels. Furthermore, the company's operating expenses increased at the delivery of 5 vessels during the quarter. We also had approximately $900,000 higher operating expenses relating to COVID-19 measures, among other reasons, due to our efforts to maintain a normalized crew change cycle for our seafarers despite challenging travel logistics around the globe. In addition, we also saw an increase in depreciation due to the new additions to the fleet during the quarter. So overall, and according to U.S. GAAP, the company reported a net profit of $33.2 million or $0.26 per share. Moving on to the balance sheet. At quarter-end, SFL had approximately $251 million in cash and cash equivalents. Additionally, the company had marketable securities of approximately $25 million based on market prices at the end of the quarter. Furthermore, the company had 6 debt-free vessels with a combined market-free market value of approximately $185 million. Under U.S. GAAP, the wholly-owned drilling rig, West Hercules, has been accounted for as an investment in associates supplying the equity method. However, following the agreement with Seadrill to amend the charter for the West Hercules during the quarter, the rig has been consolidated on our balance sheet as vessels and equipment from the effective date of the agreement on the 27th of August. During the quarter, the company secured attractive financing for 4 large container vessels in the form of senior secured bank financing and Japanese operating leases with total proceeds of approximately $260 million. Approximately $420 million of remaining CapEx for recently accounted acquisitions is expected to be financed by debt facilities similar to SFL's other assets with long-term charters. Subsequent to quarter-end, approximately $148 million was used to repay the balance of the convertible bond due in mid-October. Furthermore, the company expects to receive approximately $98 million in cash proceeds from the sale of 7 Handysize bulk vessels during the fourth quarter as they are currently debt-free. Based on the Q3 numbers, the company had a book equity ratio of approximately 26%. In summary, the Board has declared a cash dividend of $0.18 per share for the quarter. This represents a dividend yield of approximately 9% based on the closing share price yesterday. This is the 71st 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 in dividends. SFL has successfully committed close to $850 million towards accretive investments so far this year. In the process, we have expanded our relationship with some of our key clients, investing in modern eco-design container ships while disposing of older, less efficient vessels, demonstrating our commitment to further improve our carbon footprint pursuant to our ESG strategy. Following the recent investments, our backlog from our shipping assets now stands at $2.7 billion, providing strong visibility on future cash flow, debt service and continued distribution capacity, with more than $250 million of cash at quarter-end as well as being well-positioned to execute on new accretive investments in the quarters to come. With that, I give the word back to the operator, who will open the line for questions.

And your first question comes from the line of Greg Lewis from BTIG.

Yes, I would like to see the dividend increase. So far, that looks promising. As we consider the market and the opportunities in the next 12 to 18 months, recognizing that you are focusing more on the long term and closely monitoring residuals, how does the current tightness at shipyards or within the supply chain, such as high scrap prices, affect the company's decision to seek new projects?

What we have seen is not unusual in the market. We've experienced volatility in these markets before. There has been notable demand for shipbuilding capacity, particularly in the last 12 months driven by the containership market. Over the years, the building capacity at shipyards has decreased significantly, with estimates suggesting that up to one-third of the market has been removed compared to the boom around 2008. These dynamics are certainly interesting. In a tighter market, we observe increased pressure on raw materials, which may also provide us with confidence regarding the residual values we use in our long-term calculations. Additionally, we are very aware of the technological shift that is underway. It’s a balancing act. Overall, we believe this market will remain quite strong. While there will continue to be volatility, we anticipate that both counterparty risk and asset prices will be solid moving forward.

Okay, great. I realize you successfully carried out the Suezmax transaction, which many consider a wise move and a form of countercyclical investing. As we reflect on the challenges the tanker market has faced over the past year and anticipate the development of the winter market into next year, could we be approaching a time when your value proposition becomes more appealing to tanker owners who have traditionally preferred to own their vessels? In particular, I'm curious about whether there’s an opportunity to allocate more capital in the tanker market after this winter, especially considering that spring and summer tend to follow.

Yes, we do. We're looking at projects all the time. We'll see which projects actually come together and materialize. What we see here is that we have the lowest order book on a relative scale since the mid-1990s, which is a record low order book level. We see a lot of phase-out of older vessels because a huge wave of vessels came in the early 2000s, and they are now getting to 20 years of age, and therefore, very difficult to trade and very expensive to take through special surveys. This could lead to a tightness in the market. We’ve seen now with production cuts and floating storage unwinding, the near term, call it, the market has been quite soft. This is a market that can turn very quickly, and the price elasticity here is quite interesting. Regarding tanker owners, you have two sets of charters or leases; you have what we call just straight financing, sort of financing at some advance rate, where you've seen maybe 90% to 100% of value, there both over time and a purchase obligation. In our mind, that's financing. And it’s quite different from the deal we did on those Suezmax tankers where we run and manage the vessels and have a profit split, where there is an incentive during the term of the charter to maximize returns by timing, potential sale of one or more of the vessels. It’s a much more opportunistic approach, while we think that we have our downside covered quite well through the base charter rate if it goes to the end of the charter period. So this is a market where we think being a little opportunistic can create value, but at the same time, in a defensive way.

Your next question comes from the line of Randy Giveans from Jefferies.

This is Chadd Tribo on for Randy. Just a couple of quick questions for you. I guess, first, on the decision to increase the dividend, can you talk about how that amount was kind of decided on? And then is it fair to assume that the dividend will likely remain flat here? Is there a decent kind of CapEx bill outstanding?

Yes, we reduced the dividend some time ago. However, over the past year, we have committed more than $850 million in new capital expenditures. The majority of our new acquisitions have been added to the balance sheet, generating cash flow. This has led to a higher contribution, allowing us to consider increasing the dividend. As we evaluate future acquisitions, the Board will review the dividend quarterly and determine how much to increase it. Currently, we believe there is a strong dividend or revenue contribution that aligns with our new policy of $0.18 per quarter.

Got it. Got it. That's helpful. And then in terms of your fleet, is there any appetite to sell maybe some of your older container ships, given how strong the asset values are right now?

Sorry, can you repeat that? Are you asking if we would like to sell older ships?

Yes. Yes, just given kind of how high asset values are right now just on the container ship side?

Yes. Thank you for the question. We are always looking at the older fleet as potential sales candidates, of course. But in light of the current strong market for some of these vessels, like the container ships, for instance, we just fixed our 2005, 1,700 TEU vessels at $27,000 a day for 3.5 years. We have one more vessel in the portfolio of the same type, coming open sort of second half next year. We feel quite confident about that. So we are not necessarily looking to sell more ships right now. This same sort of evaluation also goes for our sort of older, smaller bulkers at the moment.

But I think it's worth just adding to that that for the vessels that we chartered out now for 3 to 3.5 years, the EBITDA contribution from that vessel is essentially similar to the sales value. In a way, you get the value through cash flow and keep the vessel. So where we indicate, we can keep it.

And your next question comes from the line of Chris Wetherbee from Citi.

James here for Chris. I wanted to inquire about your capital structure and how you are currently approaching it. Specifically, do you believe it might be beneficial to introduce another more permanent capital source, such as a bond issuance? Or are you cautious about maintaining the current mix? I would like to understand your priorities in this area and what your near-term plans might be.

Yes. Thanks, James. I think we are quite happy with the current capital structure. Annually, we are retiring about $200 million in senior secured debt on our assets. We also recently repaid the convertible bond, as you know. For the time being, we are quite pleased. We're also pleased to see the feedback we get from financing institutions in terms of financing our recent acquisitions. I mentioned the 4 vessels we have financed already, 2 in the senior bank market and 2 with Japanese operating leases. The remaining CapEx is expected to be financed in a similar manner. I would say the financing terms are coming in quite close to this profit and loss in terms of margin cost and duration of that debt. This is a reflection of our approach to structuring deals, the type of assets, counterparty quality, and the duration of the charters. For us, I think we will continue to evaluate alternatives to see if we can improve from what we have today.

And then I also wanted to ask just what you're seeing in the market from a financing perspective? I think there has been a longer-term trend that you have been commenting on leading into the pandemic about banks exiting the shipping space, but the current surge seems to at least increase some appetite. Just wanted to understand what you're seeing in the market, if you're seeing banks that had kind of moved away from shipping reentering or new entities coming in. Just wanted to get a sense of the competitive environment from a financing perspective, if you could?

Absolutely. I think, despite, as I said, the banks kind of retracting from the market for some time now, we've been fortunate to have very good access with more than 25 international banks in our portfolio. Your observation is correct. We see many banks that, for a long time, have basically reduced their portfolios coming back with strength in the market. There’s far more competition now than we've seen in quite some time. I think that’s going to be a reflection of a strengthening market. I believe that the market will last for quite some time, given the favorable supply/demand dynamics Mr. Hjertaker talked about earlier. So we're happy to see more banks, also banks we have worked with in the past, coming back and offering attractive financing terms.

No question at this time. Please continue.

Thank you. Then I would like to thank everybody for participating in our conference call and also thank the SFL teams on board the vessels and onshore for their continued efforts in delivering value for our shareholders. 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.

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