SFL Corp Ltd. Q4 FY2022 Earnings Call

Thank you. And welcome all to SFL’s Fourth 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. Our Chief Operating Officer, Trym Sjølie, will also be present in the question-and-answer 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 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 a more detailed discussion on our risks and uncertainties, which may have a direct bearing on our operating results and our financial condition. The total charter revenues were $208 million in the quarter, which was up 17% compared to the third quarter. The majority of the revenues were from vessels on long-term charters and around 16% from vessels employed on short-term charters and in the spot market. The EBITDA equivalent cash flow in the quarter was approximately $135 million, which is up 7% from last quarter, and over the last 12 months, the EBITDA equivalent has been $504 million. The net income came in at around $48 million in the quarter or $0.38 per share, which was in line with the previous quarter. This included contributions from profit share arrangements and also positive mark-to-market on interest rate swaps and equity and bond investments. We also received a delayed charter hire payment in excess of $10 million from Seadrill in the quarter. The announced dividend of $0.24 per share is up $0.01 from the third quarter and will represent a dividend yield of around 9.3% based on the closing price yesterday. This is our 76th quarterly dividend, and over the years, we have paid more than $2.5 billion in total or more than $29 per share, and we have a robust charter backlog supporting continued dividend capacity going forward. Our fixed rate backlog has increased significantly over the last year and stands at approximately $3.6 billion from owned and managed vessels from acquisitions and charters, providing continued cash flow visibility. Importantly, the backlog figure excludes revenues from vessels traded in the short-term market and also excludes future profit share optionality, which we have seen can contribute quite significantly to our net income from quarter to quarter. The harsh environment semi-submersible rig Hercules was originally on a long-term bareboat charter to Seadrill. It was redelivered to SFL in December and is now managed technically and operationally by Odfjell Drilling. Before mobilizing the rig for the drilling contract with Exxon in May, the rig will have to complete a scheduled special periodic survey or SPS. We are also preparing for some upgrades to the rig to make it more attractive for long-term contracts. Currently, we estimate costs to be approximately $80 million, including SPS costs and upgrades. There will not be any revenues on the rig in the first quarter while this is undergoing, while operating costs will accrue. The gross contract value of the Exxon charter in Canada is estimated to be around $50 million with a duration of approximately 135 days including mobilization. The rig will then be available for new contracts from mid-third quarter and there is good progress on new charter opportunities, which will be announced in due course. The rig is one of only a handful of rigs fully equipped to drill in the harshest Arctic environment, and market analysts are positive about market prospects based on recent tender activity and a tight supply-demand balance. We have seen that the international market for deepwater drilling rigs without these harsh environment features has risen quickly. The harsh market has been lagging recently, but we believe prospects for 2024 and 2025 are particularly promising. This is confirmed by recent fixtures in the North Sea, where, as an example, Transocean announced a three-year contract in Norway last autumn at a charter rate which implies an annual EBITDA in excess of $80 million. During the fourth quarter, we took delivery of four vessels with long-term charters. This includes the last two out of four Suezmax tankers chartered to Koch Industries, a new build container vessel chartered to Maersk Line, and a car carrier chartered to Eukor. These four vessels added $260 million to our fixed backlog, in addition to profit share optionality on fuel savings. In January, we raised a new $150 million sustainability-linked unsecured bond loan. The proceeds will be used to refinance bond loans maturing in 2023 and for working capital purposes. After quarter end, we have bought back notes with nominal amounts of approximately $70 million, and currently, there is approximately $105 million remaining on a convertible note due in May and approximately $40 million in a Norwegian kroner-denominated bond due in September. We have also today announced the sale of a 2009 build Suezmax tanker. This vessel has been trading in the spot market for a number of years now and we are taking advantage of a strong tanker market, which is also reflected in the value. This is in line with the strategy of selling older vessels and reinvesting in newer and more fuel-efficient vessels. Net cash proceeds are estimated to be approximately $23 million after repayment of associated debt and we expect a book gain of approximately $5 million this quarter. Over the years, we have changed both fleet composition and structure, and we now have 77 maritime assets in our portfolio and our backlog from owned and managed ships stands at $3.6 billion. Over the years, we have gone from a single asset class chartered to one single customer to a diversified fleet and multiple counterparties, and the fleet composition has varied from 100% tankers to nearly 60% offshore 10 years ago, to container vessels now being the largest segment with around 50% of the backlog. Most of the vessels are on long-term charters, and in the fourth quarter, 93% of charter revenues from our shipping assets came from time charter contracts and only 7% from bareboat or dry lease. In addition to fixed-rate charter revenues, we have had significant contributions to cash flow from profit share over time, both relating to charter rates and fuel savings. In the last 12 months, the aggregate profit share has been around $28 million, with around $7 million in the fourth quarter. We do not have a set mix in the portfolio, the focus is on evaluating deal opportunities across the segments and trying to do the right transactions from a risk-reward perspective. Over time, we believe this will balance itself, but we try to be careful and conservative in our investments, with a focus on technology and transition over time to more fuel-efficient vessels. The strength of our counterparties and diversification are key when we assess our portfolio and quantify our contracted backlog. And the list speaks for itself with market-leading operators like Maersk, Hapag-Lloyd, ConocoPhillips, P66, Volkswagen and lately Exxon to name a few. Relatively few of our customers are 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 the repeat business we have had with Maersk, MSC, Evergreen and Trafigura, 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 finance on one hand to full-service time charter, which we are doing more of. With full control over vessel maintenance and performance, including energy efficiency and emission-minimizing efforts, we can impact improvements to our vessels through the life of the assets and not only be passed the owning vessels employed on bareboat where the customers may not always have an incentive to make such improvements. Additionally, 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 and inflation driving replacement costs for vessels, this value is beneficial for SFL and our stakeholders. For bareboat deals, this value is usually retained by the charterer through fixed price purchase options. 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 fourth 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 of approximately $208 million in the fourth quarter, including approximately $7 million of profit share, approximately 84% of the revenue coming from our fixed charter rate backlog, which currently stands at $3.6 billion, providing us with strong visibility on our cash flow going forward. In the fourth quarter, the liner fleet generated gross charter hire of approximately $99 million, including approximately $6.5 million in profit share related to fuel savings on seven of our large container vessels and one car carrier. At the end of the fourth quarter, SFL’s liner fleet backlog was approximately $2.4 billion, with an average remaining charter term of approximately 4.5 years or 7.2 years if weighted by charter hire. Our charter backlog includes approximately $0.5 billion of backlog from our seven car carriers. In the fourth quarter, SFL had a fleet of 18 crude oil, product and chemical tankers, with the majority employed on long-term charters. Our tanker fleet generated approximately $49 million in gross charter hire during the quarter, compared to approximately $42.4 million in the previous quarter. SFL had two Suezmax tankers and two smaller chemical tankers trading in the spot and short-term market. The net charter hire from these vessels was approximately $12.1 million in the fourth quarter, compared to approximately $11.5 million in the third quarter. Subsequent to quarter end, SFL sold a 2009 built Suezmax tanker for a total consideration of approximately $39 million. Net cash proceeds from the sale of repayment of associated debt are estimated to be approximately $23 million and we expect to record an accounting gain of approximately $5 million in the first quarter. The company has 16 dry bulk carriers, of which eight were employed on long-term charters during the quarter. SFL generated approximately $23.7 million in gross charter hire from the dry bulk fleet, including approximately $400,000 of profit share. Seven vessels were employed in the spot and short-term market and contributed approximately $9 million in net charter hire during the quarter compared to approximately $10 million from six vessels in the previous quarters. SFL owns two harsh environment drilling rigs, the 2014 built jack-up rig Linus and the 2008 built semi-submersible rig Hercules. The Linus is currently under a long-term contract with ConocoPhillips Skandinavia until the end of year 2028 and the rig is employed on the greater Ekofisk field in the North Sea. During the fourth quarter, the rig generated approximately $18.6 million in contract revenues. In addition, SFL received $10.5 million relating to catch-up payments for previously reduced charter hire from Seadrill during Chapter 11. The harsh environment semi-submersible rig, Hercules, was on a bareboat charter to Seadrill until the end of December 2022, whereupon the rig was redelivered to SFL. During the quarter, we received approximately $7 million in charter revenues. Our operating and G&A expenses were higher in the fourth quarter as we recorded the first full quarter of operations for the liners. Additionally, we had higher than normal operating expenses for shipping fees due to vessel deliveries during the quarter. Other income of approximately $2 million is primarily derived from interest income from financial investments. This summarizes to an adjusted EBITDA of approximately $135 million in the fourth quarter, compared to $126 million in the previous 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 and as our business strategy focuses on long-term charter contracts, a large part of our activities are classified as capital leasing. Therefore, a significant portion of our charter revenues are excluded from U.S. GAAP operating revenues. For the fourth quarter, we report total operating revenue according to U.S. GAAP of approximately $198 million, which is less than approximately $208 million of charter hire actually received for the reasons just mentioned. During the quarter, SFL received $10.5 million relating to catch-up payments for previously reduced charter hire from Seadrill during Chapter 11. Furthermore, the company recorded profit share income of approximately $6.5 million from fuel savings from seven of our large container vessels and one car carrier, in addition to approximately $400,000 from our eight Capesize dry bulk vessels. Also, the company recorded a $2.9 million gain related to positive mark-to-market effects related to equity and debt investments and a decrease of $400,000 in credit loss provisions. Finally, the company recorded a $1.4 million gain related to positive mark-to-market effects related to interest results. At quarter end, approximately 70% of our financing was fixed rate or swapped to fixed by financial hedging instruments, and with the recent raise in interest rates, we now see the benefits of a conservative financing strategy. Similar to our chartering strategy, we have aimed to have significant diversification in our funding base, both in terms of structure and geography, as this has proven to give us more flexibility over time. Based on our assumptions, we estimate that a 1 percentage increase in interest rates from current levels equals approximately $0.02 per share in lower distributable cash flow per quarter and vice versa. Evaluating new investment opportunities with a conservative approach in light of the project we generally seek to fix the interest rates back-to-back with a fixed charter duration or include an interest rate adjustment in the charter rates. As previously mentioned, our operating and G&A expenses were higher in the fourth quarter as we recorded the first full quarter of operations for Linus. We had higher than normal operating expenses for a shifting fleet due to many vessel deliveries during the quarter. Overall, and according to U.S. GAAP, the company reported a net profit of approximately $48.5 million or $0.38 per share. Moving on to the balance sheet. At quarter end, SFL had approximately $188 million of cash and cash equivalents. Furthermore, the company had marketable securities of approximately $7 million investment market prices at the end of the quarter. In addition, the company has seven debt-free vessels at quarter end, with a combined charter fair value of approximately $180 million based on average broker appraisals. During the fourth quarter, the company entered into long-term financing arrangements for two 4,000 TEU container vessels in the Japanese leasing market. The combined amount was $240 million and the term is seven years. SFL also secured long-term financing facilities for four newly acquired Suezmax vessels of $145 million. In January, SFL issued a new $150 million sustainability-linked unsecured bond with a maturity in 2027. The proceeds will be used for refinancing of existing debt facilities and working capital purposes. As of today, approximately $105 million is currently outstanding under the convertible note due in May 2023 and approximately $40 million equivalent to Norwegian kroner is currently outstanding under a bond due in September 2023. At the end of the fourth quarter, SFL had four LNG dual fuel car carriers under construction for delivery in 2023 and 2024. The remaining capital expenditures related to yard installments were approximately $210 million at quarter end. The majority of this is expected to be financed by debt facilities in due course. Based on the Q4 numbers, the company had a book equity ratio of approximately 28.3%. Then to conclude, the company has delivered another strong quarter with growth in both revenues and EBITDA. The Board has declared a 76th consecutive cash dividend to increase the dividend to $0.24 per share. This represents a dividend yield of approximately 9.3% based on the closing share price yesterday. The company has a strong balance sheet and liquidity position and we recently raised a $150 million senior unsecured sustainability-linked bond, which, together with cash on the balance sheet, addresses the upcoming maturities in the convertible note in May and the NOK bond due in September. Our fixed charter rate backlog currently stands at $3.6 billion after adding $1.4 billion in 2022, which provides strong visibility on our cash flow going forward. Finally, we have seen a strong recovery in the offshore drilling market since the beginning of the year and our two harsh environment drilling rigs are well positioned to benefit from the increased activity level in the sector. With that, I give the word back to the Operator, who will open the line for questions.

Thank you. And the first question comes from Chris Wetherbee from Citi. Your line is open. Please ask your question. Chris Wetherbee, your line is open. We are going to take the next question and the question comes from the line of Greg Lewis from BTIG. Your line is open. Please ask your question.

Thank you and good afternoon, everyone. I appreciate the opportunity to ask my questions. Ole, I have a few inquiries about the rigs you discussed. You mentioned an $80 million capital expenditure for the rig ahead of the contract with Exxon Canada, along with potential upgrades for long-term projects. Regarding the Hercules, which is a high-quality rig, could you provide some details about these capital upgrades? Specifically, are they related to MPD or BOP, and what insights can you share about the costs associated with those upgrades as you consider bidding the rig for longer-term work?

Thank you for your question. Drilling rigs are quite costly to operate, regardless of the environment. They consist mainly of two components: the top side, which has the under-drilling functionality, and the stable platform that operates in the water during drilling. There are not many drilling rigs built with the steel quality required to endure extreme cold and harsh weather, and this rig is one of those. It has successfully operated in the Barents Sea during winter under tough conditions. Over time, both the drilling equipment and the marine aspect, like any ship, need regular updates, painting, part replacements, and generator overhauls. Unlike a standard ship, which functions primarily to float, a drilling rig has much more complex and valuable equipment on board, resulting in more extensive scheduled maintenance. We provide a detailed breakdown of everything involved. One aspect is routine standard maintenance, while the other includes upgrades to enhance the rig's capabilities, allowing for development drilling in addition to its previous focus on exploration. For instance, specific upgrades related to a contract in Canada will cost around $6 million and are necessary to meet the requirements for this drilling rig in Canadian waters. We are collaborating with Odfjell Drilling, which operates several similar rigs and possesses considerable expertise in procuring equipment and spare parts. The industry has faced challenges since 2014-2015, affecting not just drillers but the entire supply chain. As the market improves, we must manage costs effectively while ensuring all parts are available on time for our drilling operations. Over time, equipment needs to be replaced, and there may be cases where manufacturers can no longer service certain equipment. All of this factors into our overall strategy. However, it's important to note the cash flow potential of these drilling rigs. For example, Transocean announced a drill rig contract last fall on the Norwegian Continental Shelf, projecting over $80 million in annual EBITDA cash flow from that contract. While upgrades and maintenance can be expensive, the cash flow potential in a revived market is substantial.

Absolutely. There's no question about it, especially considering the current rates. I don’t want to focus solely on the offshore rigs, but it's important as we consider SFL and the dividend, which is crucial for us and our investors. In previous years, during the rig market downturn that lasted six to seven years, these assets may not have been seen as vital to the portfolio. What I'm trying to understand is how we view the potential of offshore rigs contributing to the dividend. A six-month or 12-month contract on the Hercules might not enhance the dividend, but is it reasonable to consider that if the rig has a multiyear contract, it would generate enough cash flow to recoup the initial investment likely within a year? Can we assess the impact of those two rigs on the dividend, or should we see the cash flow from them being utilized for longer-term projects that would increase the dividend? Any insights on this would be appreciated, even though that was quite a lengthy question.

Yeah. Thanks for that. I may attempt to answer that. I think as you see on both rigs, you start with the liners, it has a long-term contract, which is market linked. As we now work ourselves through 2023 and we see the market expectations for 2024 and 2025, I think, that’s when I should expect to come in to, call it, distributable cash flow from the rigs in terms of kind of contributing to the dividend. I think that’s kind of the timeframe we are looking at. I think if the liner is covered, it’s reset every six months that’s positive and then you basically have an interesting supply-demand for that type of rig in the North Sea with many rigs leaving as well. Also same with the semis, we see many semis migrating out of the international market where you actually see now higher day rates than in the North Sea. You see you have a lower OpEx, and you have more term business, and that’s really when you can see visibility on that, that we can guide on a more precise guidance on kind of the cash accessible to support the dividend, but we think indeed it looks very interesting.

If you examine the expenses, you'll see that they represent an investment related to the SPS. However, we ended 2022 with a strong cash flow and cash position. We recently secured a new bond loan that will cover the bond maturities due this year. On the asset side, we are nearly fully invested, as the remaining payments for the car carriers under construction will likely be financed through debt facilities, and there may even be cash generated from those. From this standpoint, we have been preparing for this for quite some time, and we have made the investment now, knowing that it will benefit SFL and enhance our long-term distribution capacity.

Absolutely. Looking at the broader picture regarding lease yields and your returns, it's evident that interest rates have increased. I'm not sure if the period of low borrowing costs is finished, but it seems likely for at least the medium term. Additionally, we've observed some regulatory actions in Asia affecting leasing companies that invest in the maritime sector. I’m curious if this has caused any shifts that might lead to improved returns for SFL in a higher interest environment. Could this actually present an opportunity for SFL, considering the company's diversity and various funding sources, or should we anticipate it to be neutral at best?

You have two sides. If you consider the financial aspect, particularly structured finance, we have some assets that resemble structured finance or bareboat deals. These have become more competitive over time. Investors, not specifically in SFL but in other companies with similar strategies, appear to have a higher requirement for absolute returns. Meanwhile, companies that might utilize these financing services could alternatively borrow from banks at a lower floating rate, which hasn't declined. Our focus is more on time charter contracts as they provide us with direct interaction with end users. We've managed interest rate risks by hedging them out over time. When we make a deal, we structure the financing and usually hedge the interest rate. This means that when a deal comes up for rechartering, we may have interest rate exposure, but charter rates inherently include an interest component since anyone looking to charter a vessel must consider their financing costs. In the long run, we feel neutral about interest rates and anticipate more bareboat deals could emerge in the future. We are currently evaluating numerous deal opportunities, and for various reasons, such as return profiles or risk-reward considerations, some deals may not be suitable for us. We are committed to being disciplined and selective in our approach to new deals.

I think, a general note on our access to financing in terms of banks, and call it, Japanese leases, I think that has improved over last year. I think with our name and track record, we are able to achieve an extremely competitive financing. As Ole alluded to, the kind of limitations you see in the Chinese market is, you could argue it’s going away more bareboat type financial providers, which we previously have been competitors to ours, although we haven’t done bareboats. I think kind of the financing market there has shrunk and that potentially gives us more opportunities.

Okay. Super helpful. Thanks for the color.

Thank you. There are no further questions. I would now like to hand the conference over to our speaker Ole Hjertaker for closing remarks.

Thanks. Then I would like to thank everyone for participating in this conference call, and if you do 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 website. Thank you.

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