SFL Corp Ltd. Q1 FY2023 Earnings Call

Good day and thank you for being here. Welcome to the Q1 2023 SFL Corporation Earnings Conference Call. I will now turn the call over to Ole Hjertaker, CEO. Please proceed, sir.

Thank you and welcome to SFL's first quarter conference call. I will start by briefly highlighting the key points from the quarter. Following that, our CFO, Aksel Olesen, will present the financials, and we will end with a Q&A session that includes our Chief Operating Officer, Trym Sjølie. Before we start, I want to mention that this call will include forward-looking statements. Terms such as expects, anticipates, intends, estimates, or similar phrases indicate these statements. Forward-looking statements are not guarantees of future performance and are based on current plans or expectations, which are subject to risks and uncertainties that may lead to actual outcomes differing significantly. Factors that could affect results include conditions in the shipping, offshore, and credit markets, so please do not rely solely on these predictions. For more detailed information on risks and uncertainties, please refer to our filings with the Securities and Exchange Commission. For this quarter, total charter revenues were $182 million, down from the previous quarter mainly due to one rig being out of service and lower dry bulk rates. The previous quarter also had a one-time payment of $10 million related to the Seadrill restructuring. Most of our revenues came from long-term charters, with about 14% from short-term charters in the spot market. After selling spot-traded tankers, our long-term charter ratio will increase further. The EBITDA equivalent cash flow for this quarter was approximately $107 million, totaling $495 million for the last 12 months. Our net income was around $6 million or $0.05 per share, significantly lower than the fourth quarter, mainly due to the rig Hercules generating no revenue while incurring full operating expenses during a scheduled survey and upgrades. There were also one-off impacts from interest and currency swaps following bond refinancing. We announced a dividend of $0.24 per share, consistent with the fourth quarter, yielding over 11% based on last Friday's closing price. This marks our 77th quarterly dividend, totaling over $2.6 billion paid in dividends over the years. We have a strong charter backlog that supports our ongoing ability to pay dividends, with our fixed-rate backlog now at about $3.7 billion from owned and managed vessels, reflecting continued cash flow visibility. This figure excludes revenues from short-term traded vessels and future profit-sharing opportunities, which can significantly enhance our net income. We are pleased to have secured extended charters with Volkswagen for our two car carriers, SFL Conductor and SFL Composer. These vessels are set to be delivered as dual-fuel newbuilds later this year to Volkswagen. The charter extensions add about $155 million to our backlog, with no impact on operating and financial expenses, resulting in a fourfold increase in EBITDA contributions and a rise in net cash flow per share from these vessels. The new charter rates will begin once the new dual-fuel vessels are delivered, expected in the third and fourth quarters this year. We also recently announced a new shorter contract for Hercules in Namibia, connected with Exxon in Canada, adding over $50 million to the backlog. This quarter was active on the financing side, securing more than $1 billion in new funding for our dual-fuel car carrier program, sustainability-linked notes, and the refinancing of our drilling rigs. With this funding, we have addressed nearly all near-term financing and capital expenditure needs on favorable terms. We continue to renew our fleet and have divested all tankers trading in the spot market. As secondhand prices have increased, we've decided to sell two Suezmax tankers from 2009 and 2010 and two chemical carriers from 2008, aligning with our strategy to sell older vessels and invest in newer, more efficient ones. The Suezmax tanker Glorycrown was delivered to new owners in March, followed by Everbright in April, and the chemical tankers SFL Weser and SFL Elbe, with the latter expected for delivery in June. Post these sales, we will have no tankers in the short-term market. Additionally, our Board of Directors has approved a share buyback program of up to $100 million, which may be executed through open market repurchases, privately negotiated transactions, or accelerated repurchase programs. The timing and amount of repurchases will depend on various factors, including market conditions and the interests of the shareholders. This program is effective until June 30, 2024. Over the years, we have adjusted our fleet composition and structure and now own 74 maritime assets. Our backlog from owned and managed shipping assets has grown to $3.7 billion. We've evolved from a single asset class with one customer to a diversified fleet with multiple counterparts, transitioning from 100% tankers to nearly 60% offshore vessels ten years ago and now having container ships as our largest segment, accounting for just under 50% of the backlog. Most of our vessels are on long-term charters. In the fourth quarter, 93% of our charter revenues from shipping assets were from time charter contracts, with only 7% from bareboat or dry lease arrangements. In addition to fixed-rate revenues, we have seen significant cash flow contributions from profit-sharing arrangements totaling over $28 million in the last 12 months, including around $5 million in the first quarter. The strength and diversification of our counterparties play a crucial role in our assessment of the quality of our contracted backlog. We have relationships with market-leading operators like Volkswagen, Maersk, Hapag Lloyd, ConocoPhillips, P66, and more, with few customers acting as intermediaries, allowing us better visibility into asset utilization and operational quality. Our strategy focuses on maintaining a robust technical and commercial operating platform with our sister companies in the Seatankers Group, enabling us to provide a broad range of services to our customers. In the context of rising raw material costs and inflation affecting vessel replacement costs, we have worked to retain more residual value in our assets through time charters. In cases of bareboat deals or options for purchase, this value generally stays with the charterer. Given the significant capital invested in the Hercules drilling rig, I want to share more about its situation and potential market opportunities. SFL owns two harsh-environment drilling rigs, the jack-up rig Linus and the semi-submersible rig Hercules, both of which were previously chartered to Seadrill. We retook control of them during Seadrill's bankruptcy proceedings. Linus has a long-term contract with ConocoPhillips Skandinavia until 2028. Hercules is currently out of service for scheduled surveys and upgrades, managed by Odfjell Drilling, with costs estimated at around $100 million and completion expected in June. While we are reclaiming some expenses from Seadrill, this process may take time through legal channels. Once the rig is operational again, it will move to Canada for a contract with ExxonMobil Canada to drill one well, expected to take approximately 135 days and valued at about $50 million. Afterward, it will head to Namibia for a contract with Galp Energia for two wells plus optional testing, with a duration of around 115 days and a similar contract value. The rig will be available for new contracts from the second quarter of 2024. It remains one of the few harsh-environment ultra-deepwater semi-submersible rigs available, and market analysts are optimistic based on recent tender activity and favorable supply-demand conditions. The outlook for 2024 and 2025 appears strong, with contracts being secured for rates around $400,000 per day, suggesting potential annual EBITDA contributions exceeding $80 million when operational, and any rate increases will directly enhance net cash flow. I will now pass the microphone to our CFO, Aksel Olesen, who will provide the financial highlights for the quarter.

Thank you, Mr. Hjertaker. On this slide, there's 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 non-cash items. The company reported generated gross charter hire of approximately $182 million in the first quarter, including approximately $5 million of profit share, with approximately 86% of the revenue coming from our fixed charter rate backlog, which currently stands at $3.7 billion, providing us with strong visibility on our cash flows going forward. In the first quarter, the liner fleet generated gross charter hire of approximately $97 million, including approximately $5 million in profit share related to fuel savings on seven of our large container vessels and one car carrier. Our tanker fleet generated approximately $47 million in gross charter hire during the first quarter compared to approximately $49 million in the previous quarter. During the quarter, SFL had two Suezmax tankers and two smaller chemical tankers trading in the spot and short-term charter market. The net charter hire from these vessels was approximately $10 million. These four vessels were sold during the quarter and only one vessel has yet to be delivered to its new owners. The company has 15 dry bulk carriers, of which eight were employed on long-term charters during the quarter. The vessels generated approximately $20 million in gross charter hire in the first quarter. Seven of the vessels are employed in the spot and short-term market and contributed approximately $4.6 million net charter hire during the quarter. SFL owns two harsh-environment drilling rigs, the jack-up rig Linus and semi-submersible rig Hercules. The Linus is currently on a long-term contract with ConocoPhillips Skandinavia until the end of 2028. During the first quarter, the rig generated approximately $19 million in contract revenues in line with the fourth quarter when adjusted for approximately $10 million catch-up payments for previously reduced charter hire from Seadrill during Chapter 11, which was received in the fourth quarter. The harsh environment semi-submersible rig Hercules was previously on bareboat charter to Seadrill. For the first time since being redelivered to SFL in December 2022, we recorded a full quarter of operating expenses in Hercules, which were approximately $7 million. We also expect to record a similar level of operating expenses for the rig in the second quarter. Furthermore, there has been no revenue from the Hercules during the quarter as the rig is currently undergoing a special periodic survey and upgrades before mobilizing for a drilling contract with Exxon Canada, expected to happen at the end of the second quarter. Our operating and G&A expenses for the quarter were $75 million, which now also includes the operating costs for Hercules. This summarizes to an adjusted EBITDA of approximately $110 million in the fourth quarter and first quarter compared to $135 million in the previous quarter. The result is down predominantly due to the temporary sale of the Hercules rig and the $10 million from season Linus in the previous 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. Our business strategy focuses on long-term charter contracts; therefore, a large part of our activities are classified as capital leasing. Consequently, a significant portion of our charter revenues are excluded from U.S. GAAP operating revenues. This includes repayment of investments in sales-type direct financing leases and leaseback assets, along with revenues from entities classified as investment in associates for accounting purposes. The first quarter report total operating revenues, according to U.S. GAAP, was approximately $173 million, which is less than approximately $182 million of charter hire actually received for the reasons just mentioned. During the quarter, the company recorded profit share income of approximately $5 million from fuel savings on some of our large multi-vessels and car carriers. As mentioned, we recorded a full quarter of operating expenses on Hercules and did not record any revenue on the rig due to the temporary yard stay. We expect the rig to be recording its full first quarter of revenue in the third quarter. During the quarter, the company recorded a gain from the sale of the Suezmax tanker Glorycrown of $10.2 million and recorded an impairment of $7.4 million relating to the sale of the chemical tankers Elbe and Weser. The company also recorded a $7.4 million non-cash loss due to negative mark-to-market on derivatives linked to SFL bonds acquired during the quarter. Overall, according to U.S. GAAP, the company reported a net profit of approximately $6.3 million or $0.05 per share. Moving on to the balance sheet, at quarter end, SFL had approximately $185 million of cash and cash equivalents. Furthermore, the company's multiple securities were approximately $7 million plus market prices at the end of the quarter. In January, SFL issued a new $150 million sustainability-linked bond with maturity in 2027. Part of the proceeds were applied against the convertible note, which was repaid in cash at its maturity in May against repurchase of also NOK23 bonds maturing in September. During the first quarter, SFL established financing arrangements for each of our four car carriers currently under construction for delivery in 2023 and 2024. The combined financing amount is approximately $300 million, corresponding to the yard contract price. Consequently, the arrangements will have a positive cash flow effect post-delivery of the vessels equivalent to yard installments paid to date for approximately $100 million. Additionally, the company entered into a pre-delivery $47 million bank loan facility for two vessels to be delivered in '24, further enhancing the company's liquidity position during the period leading up to the delivery of the vessels. We also signed and drew down a $145 million financing facility on four Suezmax's during the quarter. Subsequent to the quarter end, SFL closed the refinancing of the semi-submersible drilling rig Hercules and the jack-up drilling rig Linus. The financing amount was $150 million per rig with maturity in the fourth quarter of '25 and the second quarter of '26 respectively. Additionally, SFL also closed two JOLCO financing arrangements, one for $45 million for the car carrier Arabian Sea, with a term of approximately six years, and one for $38 million for the container vessel Suezmax for approximately seven years. As these vessels are debt-free transactions, this will have positive cash flow effects in excess of $80 million combined in the second quarter. Based on the Q1 numbers, the Company's book equity ratio was approximately 28.3%. To conclude, the Board has declared a cash dividend of $0.24 for the quarter. This represents a dividend yield of approximately 11% based on the closing share price last Friday. The Board has also authorized a new share buyback program with liquidity until the end of Q2 2024. Our fixed rate charter backlog currently stands at $3.7 billion, which provides us with strong visibility on cash flow going forward. With the latest financing facilities concluded, the Company's newbuild capital expenditure program is now fully financed and all material short-term debts are refinanced with long-term loans. In summary, SFL has secured new financing arrangements, so far in 2023 totaling approximately $1 billion. The amount is split across 12 different facilities and across a wide array of products, securing a continued build diversified funding platform for the company going forward. Furthermore, with the recent contract awards for two car carriers on contract with Volkswagen, the commencement in Q3 and Q4 this year, we estimate EBITDA from these vessels to amount to approximately $47 million per year, a significant increase from existing contracts, which was approximately $9 million per year. Finally, we announced a new contract award for the harsh-environment semi-submersible drilling rig Hercules confirming a tightening supply-demand balance and a strong market outlook, which is now materializing into attractive day rates. And with that, I give the word back to the Operator, who will open the line for questions.

The first question is from Sherif Elmaghrabi from BTIG. Please go ahead. Your line is open.

Hi, good morning and good afternoon. Thanks for taking my question. So first just looking past the most recent contract for the Hercules, what are the long-term employment prospects for that rig? Is the plan to have it stay in Namibia? Yes.

Yes, thanks. This one contract after Exxon in Canada is in Namibia, and as you can imagine, it's a fairly long transit. But the oil companies are more than happy to compensate for that. This rig can work in multiple places. We are, of course, opportunistic in terms of where we want to employ the rig in order to maximize long-term cash flow. Our objective is to secure longer-term employment for the rig over time, but for now, we think that the timing is better right now to have it on relatively shorter contracts as we see the charter rates decreasing sharply as you may have also seen on the graph we included in the presentation, where we have seen the daily rates coming down very fundamentally over the last year or so.

Yes, in terms of location, we have tenders in several areas across North America, as well as multiple opportunities in the North Sea. Namibia is also becoming a popular region, and with Petrobras needing more rigs, we've recently seen two North Sea rigs head to Australia. So, I would say the opportunities are currently global.

That's helpful. Thank you. And then looking at the tanker fleet, I see two product tankers are rolling off next year. And tanker fundamentals are looking pretty constructive notwithstanding recent weakness. So are you starting to have conversations about work for those vessels and really how are charterers looking at crude and product tankers right now?

Yes, regarding the two tankers you're referring to, they are the ones chartered by P66. They seem to be quite satisfied with those vessels as they align well with their program. The current charter rates are significantly lower than the spot market rates. If you asked anyone now, they would likely be inclined to extend the charters. However, the decision to extend these charters lies with the charterers, so we will need to see if they decide to do so; if they don't, it would present an opportunity for us.

That's very helpful. I'll turn it over. Thank you.

Thank you for your question. We are now taking the next question, please standby. The next question is from Richard Diamond from Castlewood Capital. Please go ahead. Your line is open.

Good morning, good afternoon. I want to congratulate you on the buyback. Considering there is considerable disconnect between the stock price and the company's outlook, SFL is in its strongest position in terms of chartering operations and financing since I began following the company in 2014. Could you share your thoughts on how you plan to utilize the buyback now that it has been approved? I have one more question.

Thank you, Richard, for your kind words. We believe that having various quality tools available for enhancing value during investor calls is beneficial for the company. We've utilized dividend reinvestment plans and some options very sparingly in the past, and we've just renewed those now. We also think including share repurchase options in our capital allocation strategy is prudent. While we can't provide specific figures on how much we may use it, we've noticed the share price decline in a market where the underlying value of most shipping stocks is decreasing, and we own a significant portion of these assets, which is advantageous for SFL. This is evidenced by our car carrier renewals; had we approached this like previous bareboat charters, the charterer would have retained all value. Instead, we own these vessels and keep the residual value, which benefits our stakeholders significantly. The same applies to the drilling rig Hercules, which we discussed during the call. The market dynamics there are intriguing, though timing is crucial, and the SPS process is costly for us. However, we still expect this to positively impact earnings per share later this year and onwards. Given the current softness in share price, the opportunity to buy back shares occasionally could enhance long-term value for our stakeholders. I hope that provides enough clarity for you, Richard.

Absolutely. And the second question is, as you look over shipping markets and you decide where you want to allocate capital, what do you think are the most interesting areas today?

Yes, it's a tricky question. We look at market opportunities across the board in all these segments. And we see opportunities everywhere, but given where the segments are in their cycle, we would structure the deals differently. The tanker market, for instance, has come up quite rapidly with values, which means that the deal we would have done a year, year, and a half ago, where we would have accepted effectively a lower rate than a deal but with more optionality on the upside, now we would probably look more for fixed rates to ensure that we take it down to a more mid-level depreciated book or market value at the end of the charter period. At the same time, we see an underlying value, I would say the underlying floor here is coming off because there is a reduced shipbuilding capacity out there and the values measured in dollars are coming off both newbuilding prices and also secondhand prices now over time. So that means that what you pay now may serve as an inflation hedge in itself owning a maritime asset out there. So that is mitigating some of the risk you would take on if you invest a little higher in the cycle compared to our preference. So I would say it's more down to structuring. We look at deals now on the tanker side, we look at deals on the dry-bulk side, and we're also looking carefully into the container segment, although we are quite cautious there. The car carrier market has also been quite interesting over the last two years. So we are observing across the board, but we're also patient; we don't feel that we need to invest a certain amount every single quarter. It's all about finding the right deals and deploying the capital when we think that the dynamics are right for us and our stakeholders, which means that maybe in a quarter or two, we won't invest. But then, when we see the right deal, we can invest a lot more. That is the balance. And also back to the share repurchase program, having that also as a tool for capital allocation hopefully will benefit shareholders in the long term.

Thank you for your question. We are now taking the next question; please standby. And the next question from Climent Molins from Value Investor's Edge. Please go ahead.

Yes. Hi, thank you for taking my questions. I wanted to start with a modeling question about the Hercules. You've lined up two strong short-term contracts. I was wondering, do mobilization costs come on top of the contracted revenues you mentioned in the press releases?

The mobilization costs are included in the contract amounts mentioned. It depends on certain factors, but essentially, we calculate a specific number of days based on mobilization and demobilization.

All right, that's helpful. And after recent disposals in the tanker space, you have gradually reduced your overall spot exposure, but you still own some bulkers trading on the spot. How should we think about those going forward? Are they, let's say, non-core or are they still an important part of your fleet?

It's a good question. In our shop, anything can be sold at the right price if it's beneficial for shareholders. Generally, those vessels are trading in the market. We previously owned seven Handy size dry bulk vessels, which we sold at what we believe was the optimal time. For now, we are keeping these vessels, continuing to trade them, and they are generating good cash flow and a solid return on invested capital. We cannot say if we will sell them at some point as they are not currently identified as sales candidates or being marketed. However, if you have a substantial amount of cash and wish to invest, we would be open to considering an offer.

You're welcome.

Thank you for your question. There are no further questions at the moment, I will hand back the conference for closing remarks.

Thank you. Then, I would like to thank everyone for participating in the conference call. If you have any follow-up questions, there are contact details in the press release where you can get in touch with us through the contact pages on our webpage, www.sflcorp.com. Thank you.

That concludes the conference for today. Thank you for participating. You may all disconnect.