SFL Corp Ltd. Q2 FY2023 Earnings Call

Welcome to SFL’s Second Quarter 2023 Conference Call. My name is Marius Furuly, and I’m Vice President for Investor Relations at SFL. We have a new format for the conference call this time using Zoom. I hope this will be both as informative as usual and easier to navigate afterwards for you. Our CEO, Ole Hjertaker, will start the call by briefly going through the highlights of the quarter. Following that, our Chief Operating Officer, Trym Sjølie, will comment on vessel performance matters before our CFO, Aksel Olesen, takes us through the financials. The call will be concluded by opening up for questions, and I will explain the procedure to do this before 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 expectations and are inherently subject to risks and uncertainties that could cause future activities and results of operations to differ materially 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 risks and uncertainties, which may have a direct bearing on our operating results and our financial condition. Then I will hand over to our CEO, Ole Hjertaker, for the highlights of the second quarter.

Thank you, Marius. The total charter revenues were $174 million in the quarter, which was down from the previous quarter, primarily due to the sale of 4 spot traded tankers earlier this year. Over the last 10 years, we have changed the business model from a maritime leasing company to maritime infrastructure with long-term time charters to end users. Only around 9% of our charter revenues were from 7 bulkers and the container vessels employed on short-term charters and in the spot market. The EBITDA equivalent cash flow for the quarter was approximately $100.9 million, in line with the previous quarter. Over the last 12 months, the EBITDA equivalent has been $480 million. The net income came in at around $17 million in the quarter or $0.13 per share. The net income continues to be impacted by the drilling rig Hercules, which had no revenues in the second quarter but with full operating expenses while we finalized its comprehensive special survey and upgrades. The SPS was finalized in mid-June, and we then started the mobilization to Canada. We received the mobilization fee from Exxon for the transit, but due to U.S. GAAP accounting rules, all of this will be recognized in the third quarter, together with mobilization costs. There was also a $6 million gain in the quarter relating to the sale of the last spot traded Suezmax tanker. This represents our 78th quarterly dividend. Over the years, we have paid more than $2.6 billion in total, approaching $30 per share, and we have a robust charter backlog supporting continued dividend capacity going forward. The announced dividend of $0.24 per share is in line with the previous quarter and represents a very strong dividend yield at current share price levels. Our fixed-rate backlog continued to increase and now stands at approximately $3.6 billion from owned and managed vessels after recent charters. This provides continued cash flow visibility going forward with significant additional cash flow from the drilling rig, Hercules, and the new build car carriers from the third quarter onwards. Importantly, the backlog figure excludes revenues from the vessels traded in the short-term market and also excludes future profit share optionality, which we have seen can contribute significantly to our net income. The SPS and upgrade work on the harsh environment semisubmersible, Hercules, was completed in mid-June, and the rig then moved under its own power to Canada to commence a contract with ExxonMobil Canada to drill 1 well, starting mid-July. The duration is estimated to be approximately 135 days, including mobilization to and from Canada, and the contract has an estimated value of $50 million, implying a day rate of approximately $375,000 per day for the period. Following this, the rig will move to Namibia to commence a contract with a subsidiary of Galp Energia for two wells plus an optional well testing. Excluding optional days, the duration will be approximately 115 days, including mobilization, with an estimated contract value of another $50 million, implying a day rate of approximately $435,000 per day for that period. After Namibia, the rig will move back to Canada to commence a recently announced contract with a subsidiary of Equinor. The contract is for 1 well plus 1 optional well. The duration for the firm contract period is approximately 200 days, including transit to and from Canada, implying a day rate of approximately $520,000 per day for this period. The secured backlog for the Hercules is now in excess of $200 million, and we estimate approximately $100 million EBITDA from the rig over the next 12 months. This rig is one of only a handful of harsh environment ultra-deepwater semisubmersible rigs available, and market analysts are positive about market prospects based on recent tender activity and the tight supply-demand balance. The harsh market prospects into 2025 are particularly promising. We now see day rates exceeding $500,000 per day, as evidenced by our recently announced contract with Equinor for next year. This is up 50% from last year, with most of that contributing to the bottom line. We continue to renew our fleet and divest our older tankers. Earlier this year, we sold 4 tankers traded in the spot market, and we have now sold the Landbridge Wisdom, which is the only remaining bareboat charter tanker in our fleet. This is a VLCC on a relatively low bareboat charter rate, and the charter has exercised the fixed price purchase option, where we will sell the vessel back to them later in August. The net cash proceeds are estimated to be approximately $10 million, with a book gain in the third quarter estimated to be around $2 million. In May, the Board of Directors authorized the repurchase of up to $100 million of SFL shares. So far, around 1.1 million shares have been repurchased at an average cost of $9.27 per share, just over 10% of the authorized amount, leaving $90 million remaining. Further purchases may be made at our discretion in the form of open market repurchase programs, privately negotiated transactions, accelerated share repurchase programs, or a combination of these methods. The timing and amount of any repurchases will depend on legal requirements, market conditions, stock price, alternative uses of capital, capital availability, and the company’s determination that share repurchases are in the best interest of our shareholders. This share repurchase program is valid until June 30, 2024. With that, I will give the word over to our Chief Operating Officer, Trym Sjølie.

Thank you, Ole. Over the years, we have changed both fleet composition and structure, and we now have 73 maritime assets in our portfolio. Our backlog from owned and managed shipping assets stands at $3.6 billion. The current fleet is made up of 15 dry bulk vessels, 36 container ships, 13 tankers, 2 drilling rigs, and 7 car carriers, with 3 around the water and 4 under construction in China. The new buildings are scheduled for delivery over the next 10 months, starting in September. We have transitioned from having a single asset class charter to one single customer to a diversified fleet with multiple counterparties. The fleet composition has varied from originally 100% tankers to a majority of offshore assets 10 years ago, to container vessels now being the largest segment, making up just under 50% of the backlog. We are now a maritime infrastructure company. Most of our vessels are on long-term charters, but over the last 8 to 10 years, we have completely transformed the company’s operating model, moving away from financing type bareboat charters and instead assuming full operating exposure, which makes us relevant for large industrial end users like Volkswagen, Maersk, Exxon, and others. In the second quarter, 92% of charter revenues from all assets came from time charter contracts, while only 8% originated from bareboat or dry leases. In addition to fixed-rate charter revenues, we have had significant cash flow contributions from profit share arrangements over time, both related to charter rates and cost savings on fuel. Over the last 12 months, the aggregate profit share has been more than $25 million. Out of the current 73 vessels, we have 13 under bareboat contracts and 60 on charter and spot trading. Our operation is quite complex with vessels across multiple sectors. We have our own commercial operation out of Oslo and operational management from Singapore and Stavanger. Our OpEx philosophy is to continuously invest in our fleet to optimize the vessels’ performance and maintain a high level of service to our customers. This includes investments to minimize off-hire as well as increase cargo carrying capacity and reduce energy consumption. Such investments have become increasingly important with the implementation of IMO carbon intensity indicators, which will impact vessels’ operational profiles, including routing and speed. In Q2, we had over 6,000 operating days defined as calendar days less technical off-hire or off-hire for drydocking. Our overall utilization across the fleet was 99.4% in Q2, a number we strive to maintain as high as possible. Net charter revenue from our fleet was $174 million in Q2, and the OpEx in the quarter was $38 million. One of the key metrics for SFL is the reduction of carbon emissions by improving our fleet weighted average AER or Annual Efficiency Ratio. AER is a carbon intensity indicator calculating emissions per actual capacity and distance sailed. As the MARPOL Convention and IMO have implemented requirements for reducing carbon intensity of all ships larger than 5,000 gross tons from 2023 onwards, obtaining an acceptable CII rating will become gradually stricter each year towards 2030. Such requirements can be met by fleet renewal, increased efficiency of the existing fleet, or a combination of both. Although CII compliance is challenging, SFL is well positioned to manage the IMO’s trajectory towards 2030. As part of our fleet renewal program, we have 4 LNG dual-fuel car carriers under construction in China that, when entering service, will be among the most modern and efficient ships in the car carrier market. On the energy efficiency front, we have carried out an investment program for all vessels in our fleet, including energy-saving devices and technology to capture and analyze data from onboard sensors for real-time performance management and voyage optimization. Furthermore, we are cooperating closely with several key charterers on further vessel upgrades. This scope includes exhaust gas scrubbers, cargo intake boosts, all modifications, new propellers and fixtures, as well as enhanced antifouling systems. We also collaborate with key charterers on data integration for optimal weather routing and performance management. In addition to reducing carbon emissions, we believe these investments will make our vessels more attractive in the market when they are either up for redelivery or potential charter extensions. And with that, I will give the word to our CFO, Aksel Olesen, who will take us through the financial highlights of the quarter.

Thank you, Trym. On this slide, we have shown a pro forma illustration of cash flows for the second quarter. Please note that this is only a guideline to set 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 cash flow gross charter hire of approximately $174 million in the second quarter, including approximately $2.2 million of profit share, with approximately 92% of the revenue coming from our fixed charter rate backlog, which currently stands at $3.6 billion, providing us with strong visibility on cash flow going forward. In the second quarter, the container fleet generated gross charter hire of approximately $90 million, including approximately $2 million in profit share related to fuel savings on 7 of our large containers. Our tanker fleet generated approximately $35 million in gross charter hire during the second quarter, compared to approximately $47 million in the previous quarter. Charter hire from our vessels operating in the spot market in the second quarter was $2.2 million, compared to $10 million in the first quarter, following the sale and delivery of the 3 remaining spot vessels in the second quarter. Consequently, we do not expect any contribution from tankers trading in the spot market starting Q3 onwards, as the remaining 13 tankers are employed on long-term contracts with high-quality charters. The company has 15 dry bulk carriers, of which 8 were employed on long-term charters during the quarter. These vessels generated approximately $24 million in gross charter hire in the second quarter. Seven of these vessels were employed in the spot and short-term market, contributing approximately $7.2 million in charter hire during the quarter, compared to approximately $4.6 million in the previous quarter. SFL owns 2 harsh environment drilling rigs, the jack-up rig Linus and the semisubmersible rig Hercules. The Linus is currently on a long-term contract with ConocoPhillips Skandinavia until the end of 2028. During the second quarter, the rig generated approximately $19 million in contract revenues, consistent with the first quarter. Similar to the first quarter, we recorded operating expenses on Hercules, which were approximately $7 million. Furthermore, there were no revenues from the Hercules during the quarter due to the special periodic survey and upgrades, which were completed in mid-June before the rig mobilized to Canada to commence the drilling contract with Exxon Canada. Although the Hercules commenced mobilization towards Canada in mid-June, we recorded no revenue in the second quarter due to U.S. GAAP accounting standards for drilling service contracts, which recognize revenue only from the drilling commencement date. Accordingly, mobilization and demobilization revenue and cost for Exxon contracts will therefore be amortized over a drilling basis in the third quarter and reflected in the Q3 P&L. Finally, our 3 car carriers generated gross charter hire of approximately $6 million during the second quarter, including approximately $200,000 net profit share related to fuel savings on one of the vessels. Our operating and G&A expenses for the quarter were $68 million, compared to $75 million in the previous quarter. This summarizes into adjusted EBITDA of approximately $100.9 million in the second quarter, compared to $110 million in the previous quarter. Moving on to the profit and loss statement as reported on the U.S. GAAP, as described in previous earnings calls, our accounting statements differ from those of a traditional shipping company. Our business strategy focuses on long-term charter contracts; therefore, a large part of our activities is classified as capital leasing. Consequently, a significant portion of our charter revenues are excluded from U.S. GAAP operating revenues. The second quarter reported total operating revenues according to U.S. GAAP were approximately $165 million, which is less than the approximately $174 million of charter hire actually received for the aforementioned reasons. During the quarter, the company recorded profit share income of approximately $2.2 million from fuel savings from some of our large container vessels and a car carrier. We also recorded almost a full quarter of operating expenses on Hercules without recording any revenue from the rig during the quarter. As just mentioned, revenue from the Hercules will be recognized only from the drilling commencement date and has been reflected in our P&L in the third quarter. Furthermore, the net results were impacted by non-recurring, non-cash items, including a gain from the sale of the Suezmax tanker Everbright of approximately $6.4 million, a net positive mark-to-market effect of $1.9 million, a negative mark-to-market effect from equity investments of $1 million, and a decrease of $200,000 on credit loss provisions. So overall, according to U.S. GAAP, the company reported a net profit of approximately $17 million, or $0.13 per share. While reporting on the transitional quarter, it’s worthwhile to mention that we expect revenue to increase from Q3 onwards as we will record the first quarter of revenue from the Hercules rig following the commencement of the Exxon contract in July. Additionally, we expect revenue effects from our 4 new build car carriers to be delivered over the next 3 quarters. Moreover, the new 3-year charter for 2 car carriers, Composer and Conductor, will commence in Q4 and Q1, with estimated EBITDA from these being approximately $47 million per year, a significant increase on existing contracts, which was approximately $9 million per year. Moving on to the balance sheet, at quarter end, SFL had approximately $201 million in cash and cash equivalents. Furthermore, the company held marketable securities of approximately $5.9 million based on market prices at the end of the quarter. In June, SFL has not filed about the purchase option on VLCC on bareboat charter, with delivery taking place at the end of August. A $10 million positive cash effect is expected after repayment of secured debt relating to the vessel, with a corresponding book gain of approximately $2 million to be recorded in the third quarter. In May, the company announced a $100 million share buyback program. So far, approximately 1.1 million shares have been acquired at an average price of approximately $9.27 per share. During the quarter, SFL refinanced the drilling rigs Hercules and Linus into two separate loan facilities of $150 million per rig. The refinanced Hercules and Linus loans mature in the fourth quarter of ‘25 and in the second quarter of ‘26, respectively. Furthermore, the company arranged 2 JOLCO for 2 existing vessels, the car carrier Arabian Sea and the container vessel Maersk Pelepas. The financings are secured at attractive rates, matching the maturities that correspond to the long-term chartering contracts, yielding a net positive cash flow effect of $180 million in the second quarter, as the vessels are debt-free. The outstanding capital expenditure is $194 million on our car carriers under construction, of which the first vessel is expected to be delivered during the third quarter, secured through JOLCO arrangements. During the second quarter, we drew down $33 million on a pre-delivery facility concerning the last 2 car carriers under construction. The remaining CapEx to be paid for the special periodic survey and upgrades on the Hercules, now completed, will be funded with cash on hand—this applies to the outstanding amount of approximately $48 million, maturing in September. Based on the Q2 numbers, the company has a book equity ratio of approximately 27.6%. To conclude, the Board has declared a cash dividend of $0.24 per share for the quarter. This represents a dividend of approximately 9% based on the closing share price yesterday. In May, the company announced a $100 million share buyback. So far, the company has acquired approximately 1.1 million shares at an average price of approximately $9.27 per share. Our fixed charter rate backlog currently stands at $3.6 billion, which provides us with strong visibility on cash flow going forward. The latest financing facilities concluded the company’s new building and capital expenditure program is now fully financed, as nearly all short-term debt has been refinanced with new long-term loans. In summary, SFL has secured new financing arrangements so far in 2023 in excess of $1 billion. The amount is split across 12 different facilities and a wide array of products, securing a continued well-diversified funding platform for the company going forward. Furthermore, with the recent contract awards for 2 car carriers in contract with Volkswagen, commencing in Q4 and Q1, the estimated EBITDA from these vessels is 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 a harsh environment semisubmersible drilling rig, Hercules, confirming a tightening supply-demand balance and a strong market outlook, which is now materializing in attractive day rates and strong cash flow generation. With that, we conclude the presentation and move on to the Q&A session.

Thank you, Aksel. We will now open up for a question-and-answer session. For those of you who are following this presentation through Zoom, please use the raise hand function to ask a question. When your name is called out, please unmute to ask your question. Thank you. Our first question comes from Richard Diamond. Please unmute to ask your question.

Yes. Good afternoon, everyone. Given the lack of shipyard capacity and rising ship values, is it fair to assume the purchase options in general will represent significant value to SFL shareholders going forward?

Yes, you could say that with the newbuilding prices rising significantly, this is supported by a full order book at the shipyards, where they are now starting to make a bit of profit instead of losing a lot of money as they used to. You also have inflation in both raw material costs that go into building the ship and the labor involved in its construction. Therefore, when you look at the ownership normally, second-hand values over time will be linked to newbuilding prices. In our previous model as a financial leasing provider in the shipping sector, we would typically have to relinquish purchase options just to secure deals. But now, we can hold onto them at higher rates than in earlier charters, which ultimately benefits our shareholders. Rising newbuilding prices are definitely advantageous for existing shareholders.

Thank you.

Thank you, Richard. We will take our next question from Climent Molins. Please unmute to ask your question.

Hi, Ole and team. Thank you for taking my questions. I want to start by asking about the West Linus, which is employed on our contract earning and market adjusted rate that is, if I remember correctly, adjusted semiannually. How should we think about the vessel's contribution going forward given the strengthening market environment?

That is correct. The Linus is on contract with ConocoPhillips until the end of 2028 on the Ekofisk field on the northern side in the North Sea. The contract is adjusted semiannually, with the rate currently at just shy of $200,000 per day. For the time being, the market is somewhat neutral. However, we expect activity on the Norwegian continental shelf to increase over time, which could reflect positively in the rig’s contribution.

I also wanted to ask about the car carriers to be delivered over the next year. Could you provide some commentary on the cash flows these vessels are expected to generate? Also, is the incremental debt drawn down to finance the vessels hedged?

The cash contribution from new builds is expected to be substantial, especially for the first 2 vessels, considering the initial voyage where we will earn additional income. The spot market for car carriers is currently very strong. We anticipate a significant contribution during the voyage from Asia to Europe, where current rates are well in excess of $100,000 per day. With an OpEx of around $6,000 per day for similar vessels, it’s clear there is a lot of cash flow coming from this. Once they commence their 10-year charters at the pre-agreed rates, we will notably see cash contributions from those vessels. The numbers included in our full charter backlog will illustrate the charter rates being generated by these vessels.

We do not disclose contributions per vessel individually. As Trym noted, we'll benefit from the initial voyage, and then the vessels will commence their respective long-term charters. Additionally, we expect the new charter rates will be effective on our existing vessels as well. We haven’t provided a detailed breakdown, but we’ll offer access to full charter backlog data to indicate potential future contributions.

Our strategy is to fix these vessels on long-term charters with Conoco, targeting low teen returns on equity. The contribution will reflect accordingly. The financing will be fully drawn down for the first two vessels upon delivery, secured via Japanese operating leases at very attractive terms. Overall, the financing is competitive compared to traditional banking options.

Final question from me: Looking at the second half of the year and into 2024, it is clear that cash flow will improve significantly. How should we think about potential dividend raises going forward, and how do you plan to balance potential dividend increases with share repurchases?

We see both as vital for shareholder returns, direct and indirect. Our goal is to build distribution capacity for shareholders. However, we do not provide specific dividend guidance for upcoming quarters. Historical patterns show that when we increase dividends, we typically maintain those levels. Each quarter, the Board considers the long-term sustainability of the dividend level. As you noted, Q3 onwards will yield significantly more cash flow than the first two quarters due to one rig resuming operations, and we also have new builds coming online. Although we don’t specify how much we’ll buy back in shares, we've already repurchased just over 1 million shares, around 1% of shareholding, and the Board has authorized additional purchases, which we will communicate in our quarterly reports.

Makes sense. That's all for me. Thank you for taking my questions.

Thank you.

Thank you.

Thank you, Climent. Our next question comes from Arif Hamid. Please unmute.

Yes. Hello. First, I’d like to compliment the management team for continuing to do a good job. I have two questions. The first is you’ve reduced some inventory and certainly have cash to reinvest. What areas appear attractive right now for new builds and used assets?

We are looking across the maritime space without specific segment bias. This is evident in our diversified vessel mix. Last year, we screened transactions worth around $23 billion but executed only a small fraction because we are selective about counterparty quality, asset type, long-term financing, and expected returns. Our focus is to deliver long-term value for shareholders and maintain specific allocations of capital across segments as market conditions fluctuate. Some segments offer fewer long-term charter opportunities, which we prefer due to increased cash flow visibility. We have invested in the energy space and container ships, but our attractions change based on market dynamics.

So there's no specific area that looks favorable right now?

Not particularly; the tanker market has a record low order book, garnering attention. However, when we make a deal, we need to consider a 10-year charter, examining long-term cycles rather than short-term fluctuations. It is more critical to find the right technology, the right counterparty, and structure agreements generates residual value at the end of a charter to manage counterpart risks effectively. Our business model has shifted from financial-oriented structures through intermediaries to more integrated maritime logistics, which we believe improves our operational risk/reward balance over time.

Okay, your ongoing selectivity in acquisitions is why I wanted to offer my compliment. My next question is regarding the anticipated increase in cash flow in coming quarters: Could you estimate the operating income jump?

We prefer to guide somewhat, but we're hesitant to be specific about quarter-to-quarter forecasts. However, in Q3, we expect to see significant contributions from the Hercules, which is now operating, while costs were previously incurred without revenue. Q4 should reflect the initial cash flow from our car carriers delivering a built-up effect moving into Q1. While Q1 will show the total contribution from the Hercules, we anticipate notable increases in cash flow.

As for the charter rates on the drilling rig, the first charter is around $375,000 per day; then the recently announced charter exceeds $500,000, with most going to the bottom line. The overall outlook supports significant gradual revenue improvement going forward and into next year.

It appears there may be a modest jump in Q3, but expect steady growth with much improvement by mid-next year. Is that accurate?

Yes, the transition into Q3 will reflect a modest increase due to 14-15 days from Q2 transferring into Q3, but it won’t be excessive.

That sounds great. I have one request. While you do not disclose deal specifics, can you share changes in cash position post-deals? It would be beneficial.

Absolutely. We currently report cash position quarterly and adapt quickly to closing transactions. Occasionally, we utilize cash on hand for immediate closings before sourcing optimal financing, thus reporting new cash positions on closing could enhance transparency.

That sounds very good. Also, I want to thank you for fixing the sound issues from last quarter; it's all been clear on Zoom this time. Thank you for taking my questions. Goodbye.

Thank you.

Thank you.

As there are no further questions from the audience, I want to thank everyone for participating in this conference call. If you have any follow-up questions for management, contact details are in the press release or visit our contact page at www.sflcorp.com. Thank you very much.

Thank you.