SFL Corp Ltd. Q3 FY2023 Earnings Call

Welcome to SFL's Third Quarter 2023 Conference Call. My name is an analyst in SFL. Our CEO, Ole Hjertaker, will start the call by briefly discussing the highlights of the quarter. Following that, our Chief Operating Officer, Trym Sjølie, will address vessel performance matters before our CFO, Aksel Olesen, reviews the financials. The call will conclude with a question-and-answer session, and I will explain the procedure for that before we begin. Before we start our presentation, I want to point out that this conference call will include forward-looking statements as defined by the US Private Securities Litigation Reform Act of 1995. Terms like expects, anticipates, intends, estimates, or similar phrases are meant to identify these statements. Forward-looking statements are not guarantees of future performance. They rely on our current plans and expectations and are subject to risks and uncertainties that could lead to outcomes materially different from what is presented. Key factors that could cause actual results to vary include, but are not limited to, conditions in the shipping, offshore, and credit markets. Therefore, you should avoid placing excessive reliance on these statements. For a more detailed discussion of the risks and uncertainties that may affect our operating results and financial condition, please refer to our filings with the Securities and Exchange Commission. Now, I will turn it over to our CEO, Ole Hjertaker, for highlights from the third quarter.

Thank you. The charter revenues for the quarter reached $214 million, reflecting a 23% increase from the prior quarter, largely due to the return of the drilling rig Hercules to service. The EBITDA equivalent cash flow for the quarter was about $130 million, also surpassing the second quarter, and totaling $485 million over the last 12 months. Net income was reported at roughly $29 million for the quarter, or $0.23 per share. This figure was affected by some one-time items, including gains from a vessel sale in the third quarter and various mark-to-market effects. These were countered by two tankers that were not in service during the quarter and an unscheduled fire lasting around 14 days on the jack-up rig Linus due to repair work on the top drive, which contributed to higher operating costs for the quarter. In line with our enhanced results and our commitment to returning value to shareholders, we have decided to increase our quarterly dividend to $0.25 per share. Since our establishment in 2004, we have not consistently paid dividends every quarter, amounting to $30 per share or over $2.6 billion in total. Additionally, we have a strong charter backlog that supports our ongoing capacity for dividends. Our fixed-rate backlog is approximately $3.4 billion, primarily focused on long-term charters with very solid end users. Over the last decade, we have progressively shifted our business model from a maritime leasing company to a maritime infrastructure provider. This transition involved moving from mainly bareboat charters or financing arrangements to long-term time charters directed at end users. I should point out that the backlog figure does not include revenues from vessels engaged in the short-term market and also does not account for potential future profit sharing, which can significantly impact our net income. In September, we welcomed the first of our four new dual-fuel car carrier vessels, named Emden, which will be chartered to Volkswagen Group for ten years along with a sister vessel, with deliveries scheduled for Europe. The short-term market is currently very active, and we've secured a lucrative interim charter from a shipyard in Asia to Europe, generating about $8.5 million in EBITDA per vessel over just two months. Besides the new builds, we have two existing vessels on charter to Volkswagen that have been extended for an additional three years with options for extension, yielding around $23.5 million in EBITDA per vessel per year. Our strong relationship with Maersk Line includes 17 vessels on long-term charters. Recently, Maersk exercised an option to extend the time charter for a 9,500 TEU vessel until mid-2025, at a rate higher than the current charter, adding $13 million to our charter backlog. We also benefit from a profit-sharing arrangement linked to scrubber benefits on that vessel, where our share currently stands at 78%. In the third quarter, we fully repaid a bond loan in Norwegian kroner issued in 2018, with $48 million remaining at maturity, which was settled from our cash reserves. This loan was initially approximately $85 million, and the remainder had already been repurchased in the market. We have recently secured significant amounts of new debt funding on advantageous terms in Asia, and we do not anticipate needing to refinance the repaid bond loan in the near future. After extensive special purpose surveys and upgrades to our harsh environment semi-submersible Hercules in early 2023, the rig operated in Canada and drilled a well for ExxonMobil, which was completed in September. Following that, the rig moved to Namibia, with a stop in Las Palmas, and is set to begin drilling for Galp Energia next week, involving two wells with an optional well testing phase, estimated to take around four months, including mobilization. The contract value is approximately $50 million, implying a day rate of around $435,000 per day for the period. After completing operations in Namibia, the rig will return to Canada for a contract with Equinor, involving one well and one optional well, with a firm contract duration of six to seven months, including transit to and from Canada, implying a day rate of about $520,000 per day during that period. The rig will then be available for new contracts starting in the fourth quarter of 2024. This rig represents one of the few ultra-deepwater semi-submersible rigs fit for harsh environments that are available, and market analysts are optimistic about long-term market prospects based on recent tender activities and a tighter supply-demand balance. Now, I will pass the word to our Chief Operating Officer, Trym Sjølie.

Thank you, Ole. Over the years, we have transformed our fleet and structure and are now a maritime infrastructure company with 73 maritime assets in our portfolio, and our backlog from owned and managed shipping assets stands at $3.4 billion. The current fleet consists of 15 dry bulk vessels, 36 container ships, 13 tankers, two drilling rigs, and seven car carriers, with four currently active and three under construction in China. The remaining newbuilds are scheduled for delivery over the next seven months starting in November. We have transitioned from having a single asset class charter with one customer to a diversified fleet with multiple counterparties. Our fleet composition has shifted from being 100% tankers and primarily offshore assets a decade ago to container vessels now representing the largest segment, accounting for just under 50% of the backlog. Most of our vessels are on long-term charters, and over the past 10 years, we have completely transformed the company’s operating model, moving away from bareboat charters to assuming full operating exposure. This has made us relevant for large industrial end users like Volkswagen, Maersk, and Hapag-Lloyd among others. In the third quarter, 94% of charter revenues from all assets were derived from time charter contracts, while only 6% came from bareboat or dry leases. In addition to fixed-rate charter revenues, we have seen significant contributions to cash flow from profit share arrangements over time related to charter rates and fuel cost savings. Over the last 12 months, the total profit share has exceeded $16 million. Of our current 73 vessels, 13 are on bareboat contracts, and 60 are on time charter and spot contracts. Our operations are quite complex, involving vessels across multiple sectors, and we manage our own commercial operations in Oslo, along with operational management out of Singapore and Stavanger. Our philosophy regarding operational expenses is to continuously invest in our fleet to enhance vessel performance and provide a high level of service to our customers. This includes investments aimed at reducing off-hire, increasing cargo capacity, and lowering energy consumption. These objectives have gained importance with the implementation of IMO carbon intensity indicators, which will affect vessels' operational profiles, including routing and speed. The EU Emissions Trading System is another issue that will take effect next year. In Q3, we recorded over 6,300 operating days, defined as calendar days minus technical, fire, and dry dockings. Three vessels were dry-docked during the quarter, and overall fleet utilization was 99% in Q3, with drilling rigs at 80.5%. For the rigs, operating days are defined as days on rate or in transit, deducting days of fire and time spent in port not on drilling operations. A key ESG target for SFL is to reduce carbon emissions from our fleet. This can be achieved through either renewing the fleet with more efficient ships and greener fuels or increasing the efficiency of our existing fleet, or a combination of both strategies. As part of our fleet renewal program, we currently have four LNG dual-fuel carriers under construction in China. One has been delivered during the quarter, leaving three. These vessels are among the most modern and efficient in the car carrier market, featuring an improved and optimized hull form. The LNG fuel system is of a high-pressure type, and the vessels are equipped for both ship-to-ship and port-to-ship LNG bunkering. We anticipate a 25% reduction in the carbon footprint per vehicle carried in LNG mode compared to a standard conventional car carrier. The vessels also have a connection for zero-emissions operation while in port and can carry electric vehicles as well as hydrogen fuel cell vehicles. The first ship, Emden, is currently on its inaugural voyage from Asia to Europe under Hyundai Glovis and will be delivered to Volkswagen in about a week. Now, I will hand it over to our CFO, Aksel Olesen, who will walk us through the financial highlights of the quarter.

Thank you, Trym. On this slide, we present our pro forma illustration of cash flows for the third quarter. Please remember that this serves merely as a guideline to evaluate the company's performance and does not comply with US GAAP, as it is also adjusted for extraordinary and non-cash items. The company generated approximately $214 million in gross charter hire during the third quarter, which included about $2.6 million from profit sharing, with roughly 94% of the revenue derived from our fixed charter rate backlog, currently valued at $3.4 billion, giving us clear visibility on future cash flows. In the container fleet, we achieved about $91 million in gross charter hire, including around $2.6 million in profit sharing tied to fuel savings from seven of our large container vessels. During the quarter, we received our first dual-fuel LNG car carrier out of four planned deliveries. With four car carriers chartered by the end of the quarter, our gross charter hire rose by about $9 million in the third quarter compared to roughly $6 million in the second quarter. Our tanker fleet brought in about $30 million in gross charter hire during the third quarter, down from approximately $35 million in the previous quarter. This decrease occurred because two Suezmax tankers were off-hire for 46 days due to scheduled dry dockings, leading to higher operating expenses for the tankers. The company has 15 dry bulk carriers, eight of which were on long-term charters during the quarter, generating about $20 million in gross charter hire. Seven of these vessels operated in the spot and short-term market, contributing around $6.2 million in net charter hire, down from approximately $7.2 million in the previous quarter. SFL owns two harsh environment drilling rigs: the jack-up rig Linus and the semi-submersible rig Hercules. In the third quarter, these rigs brought in approximately $64 million in contract revenues, down from around $90 million in the second quarter. The Linus is currently contracted with ConocoPhillips Scandinavia until the end of 2028 and generated about $16.6 million in contract revenues during the third quarter after being off-hire for 16 days due to an unscheduled top drive repair, causing operating expenses to exceed budget by $2 million. The Hercules completed its drilling contract for ExxonMobil in Canada in September and is now on its way to Namibia, where it will soon begin work with Galp Energia. The rig recorded around $48 million in contract revenues for the quarter, with mobilization fees recognized in accordance with US GAAP throughout the drilling period. The same approach applies to mobilization fees following the completion of drilling contracts. Our total operating and general & administrative expenses for the quarter reached $86 million, compared to $68 million in the previous quarter, primarily due to Hercules resuming operations, scheduled dry dockings, and repair downtime for the Linus. This accounts for adjusted EBITDA of around $130 million in the third quarter versus $109 million last quarter. Next, we move to the profit and loss statement as per US GAAP. As mentioned in prior earnings calls, our accounting differs from traditional shipping companies. Our focus on long-term charter contracts means a significant portion of our activities are classified as capital leasing, thus excluding much of our charter revenues from US GAAP operating revenues. The third quarter results show total operating revenues per US GAAP at approximately $205 million, in contrast to around $240 million in actual charter hire received due to these factors. During the quarter, we saw profit share earnings of approximately $2.6 million from fuel savings on several large container vessels and a car carrier. With corporate and tolling taxes in Canada, we accounted for about $2.3 million in taxes in the third quarter related to the Hercules, with similar customer taxes expected in Namibia. Overall, under US GAAP, the company reported a net profit of about $29.3 million or $0.23 per share, an increase from approximately $17 million or $0.13 per share in the previous quarter. Looking ahead, we anticipate lower revenues for the Hercules in the fourth quarter due to a lengthy mobilization period from Canada to Namibia before starting the contract with Galp Energia. According to US GAAP, revenue from the Hercules will only be recognized from the start of drilling, and mobilization fees will be distributed across respective quarters of drilling operations. For our car carriers, we expect revenue growth as we are set to receive three newbuildings from Q4 to Q2, with the second vessel expected from China in late November. Following the handover of the first two newbuildings during Q4 and Q2, the SFL Conductor and SFL Composer will continue chartering to Volkswagen for an additional two years plus options, with an estimated EBITDA of $23.5 million per vessel annually. Turning to the balance sheet, by quarter's end, SFL held about $118 million in cash and cash equivalents, along with marketable securities around $6.2 million based on the vessel market prices. During the quarter, we fully redeemed a bond with $49 million outstanding using cash on hand. The remaining capital expenditure of approximately $136 million for our three under-construction car carriers has been completely financed through $194 million in net equity financing, which is yet to be drawn. Additionally, we redelivered the [indiscernible] system following our declaration of a purchase option, which had a positive cash effect of $10 million after repaying secured debt on the vessel, with a corresponding book gain of about $2 million recorded for the third quarter. Based on Q3 figures, our book equity ratio stands at approximately 28.4%. In conclusion, the company has delivered a robust quarter with growth in both revenue and EBITDA. The Board has declared a 79th consecutive cash dividend, increasing it to $0.25 per share, which translates to a dividend yield of approximately 9% based on last Friday's closing share price. The company boasts a solid balance sheet and liquidity. So far in 2023, we have secured over $1 billion in new financing arrangements and have recently repaid outstanding bonds with cash reserves. Our three newbuilds have all been financed with attractive long-term financing, ensuring additional liquidity upon delivery. With a fixed charter rate backlog at $3.4 billion, we have strong visibility on future cash flows. With Hercules back in operation and the delivery of newbuilding car carriers alongside new contracts for existing vessels, we anticipate strong revenue generation in the upcoming quarters from new charters. Let's conclude the presentation and move to the Q&A session.

Thank you, Aksel. We will now open up for a Q&A 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 your speaker to ask your question. Thank you.

Hi, guys. Can you hear me?

Absolutely.

Thank you. I couldn't find the raise hand function. So, I figured I'd just hop in. This is Greg Lewis. How are you?

Hi, Greg.

I have a few questions and I was hoping we could discuss them. It was great to see the dividend increase. As we consider the dividend's trajectory over the next one to two years, how should we think about balancing potential dividend growth with the drilling rigs? It’s evident that this is a cyclical industry, and we're currently in a strong part of the cycle. The Hercules assets appear to be capable of generating significant cash over the next two to three years, but they are definitely more volatile compared to your car carriers or container ships. I'm trying to understand your thoughts on how to use cash from the Hercules as we recontract over the next couple of years.

Yes. I appreciate that. I mean the Hercules as you mentioned, we just spent quite a bit of money on that rig in the first and second quarter of the year when it was out of service. And now it's really only just started. So the charter rate in Canada was fixed more than a year ago. So it was at a lower rate. So that charter rate should be increasing now, as it is expected to start drilling in Namibia, already next week. And the charter rate in Namibia is based on the — if we include both mobilization to and from Namibia under the drilling rate, should be well above the drilling rate we had or the rate we had in Canada. And then it's going back to Canada later next year, for an even higher rate. In fact, the drilling rate we have on Hercules, it's the highest drilling rate I would say in this cycle today. So this rig is a very capable unit and customers are clearly willing to pay for the services. Of nature, that market is a shorter-term charter market. So this is not a market where you normally get sort of 8, 10, 15-year charters. It's typically shorter charters and we have deliberately not been so keen on fixing it long term because we see this market really building and you don't want to fix something at the low end of the cycle. We think this is a cycle that has legs. And therefore, we're holding back a little bit before we want to, what we say look for really long-term charters on that unit. I think if we were to look at long-term charters for the unit you would have to accept lower rates than what we are fixing it at currently. So that's one asset. Of course, it's a big asset. But also, if you look at the history of that drilling rig, I mean, this drilling used to be on charter to SeaDrill. SeaDrill ended up in two Chapter 11 bankruptcies. We were offered in the last round a very, in our minds, very poor treatment in the restructuring. We decided to take it back. And I think we can be honest and say, it's been a really good decision from the company side to do that because the returns we've had on this rate now with the rates we see are spectacularly better than the alternative would have been. But that is the history and the setting around that rate. If you look at some of the other assets, look at the car carriers, I think it's sort of a segment. We used to have two vessels then we ordered the four vessels and we bought another vessel and then we have this quite spectacular both the transportation, if you could call it that on two of these vessels where we make more than 10% of construction costs just moving the vessel from Asia to Europe. So you have a lot of other bits and pieces here that's also generating a lot of cash flow. And then we have the re-chartering of the two older vessels to Volkswagen, where we increased the dividend by five times compared to where it was originally simply because we own those assets and we negotiated it and Volkswagen seems to be quite happy with the service we provide them. So the rig is one piece, but there are also other elements in our portfolio that are also adding. And of course, our mindset is yes, our principal objective in SFL is to return cash to shareholders. I mean, that's why we're here. Otherwise there would not be any point in having a company like SFL, if we don't really do that over time. And it's been 79 quarters now and we've always made money operationally every single quarter based on our distribution. So I think, yes, I think that we are really just at the starting point in our minds as to where we are in terms of cash flow from some of these assets. So hopefully, there is more dividend potential also going forward.

Yeah. Super helpful. Thank you for that. I did want to ask kind of a bigger picture question. Clearly, across the more conventional shipping space where it's definitely a market that you continue to look at and have assets and as SOFR has gone up, spreads have gone up. How has that changed the potential opportunities for SFL i.e. I'm talking to some ship owners and they're looking at 8%, 9% or even higher borrowing costs. Has that created more opportunities for SFL i.e. is the transactions team busy here as we sit here in November relative to maybe where they were earlier this year? Or is it hey, the market's been good for a couple of years and it's kind of steady as she goes?

It's a good question. If you look back to 2022, we examined over $20 billion in potential deals but only completed one for various reasons. This year, the overall volume has decreased. Additionally, with rising interest rates, there's a time lag in how underlying metrics and interest rates affect customer willingness to pay. This explains why the deal flow in 2023 has been somewhat lower compared to 2022, though I believe it will pick up again. Those offering more financing structures might see better deal flow opportunities now because of higher funding costs, making alternatives like bareboat leases less appealing. However, we've strategically moved away from bareboat offerings since they usually involve intermediaries rather than direct deals with end users, which brings risk that is often overlooked. Currently, many shipping segments are thriving, but that isn't commonly discussed. We've experienced cycles over the past 20 years, so our focus remains on securing deals with strong counterparts and ensuring the right deals are completed, even if it means a quieter quarter. The deal flow exists, and there is a consistent demand for transportation and logistics solutions on the water. We prioritize being disciplined in our approach, looking for the right type of asset, managing residual value exposure, and ensuring the counterparty is strong enough to meet obligations during downturns. We've learned that anyone can secure a deal in an up market, but managing through down markets is crucial, and our history gives us confidence in navigating these cycles effectively.

Okay. Great. And then I just have one other question on the balance sheet. I noticed that we saw, I guess sequentially some of the long-term lease liability went into short-term lease liabilities. Is that just going to unwind? Or should we think about that being either renewed or extended over the next call? I don’t know a couple of quarters.

It's Aksel here. So I think you should look at us like our ordinary traditional debt on the vessels that there are opportunities to basically roll this going forward as well. We haven't finally concluded if we can do it in New York or do that bit additional bank financing, but both options are likely, so could just assume rolling that on the same level.

Okay. Perfect. Thank you for that. Thanks, everybody.

Thank you.

Thank you.

As there are no further questions from the audience, I would like to thank everyone for participating in this conference call. If you have any follow-up questions to management, there are contact details in the press release, or you can get in touch with us through the contact pages on our webpage, www.sflcorp.com. Thank you very much.