SFL Corporation Ltd

NYSE:SFL

Earnings Call Transcript 2021-Q3

[Operator]

Good day, and thank you for standing by. Welcome to the Q3 2021 SFL Corporation's Earnings Conference Call. [Operator Instructions] And please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Ole Hjertaker. Thank you. Please go ahead.

[Ole Hjertaker, executive]

Thank you, and welcome, everyone, to SFL's Third Quarter Conference Call. I will start the call by briefly going through the highlights of the quarter. 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 for the Q&A session.

Before we begin our presentation, I would like to note that this conference call will contain forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. Words such as expects, anticipates, intends, estimates or similar expressions are intended to identify these forward-looking statements.

Forward-looking statements are not guarantees of future performance. These statements are based on our current plans and projections and are inherently subject to risks and uncertainties that could cause future activities and results of operations to be materially different from those set forth in the forward-looking statements. Important factors that could cause actual results to differ include, but are not limited to, conditions in the shipping, offshore and credit markets. You should, therefore, not place undue reliance on these forward-looking statements. Please refer to our filings with the Securities and Exchange Commission more detailed discussion of our risks and uncertainties, which may have a direct bearing on our operating results and our financial condition.

The announced dividend of $0.18 per share is an increase of 20% over last quarter's dividend and represents a dividend yield of around 9% based on closing price yesterday. This is our 71st quarterly dividend. And over the years, we have paid nearly $28 per share in dividends or around $2.4 billion in total. And we have an increased fixed rate charter backlog supporting continued dividend capacity going forward.

The total charter revenues was $156 million in the quarter, with around 77% from vessels on long-term charters and 23% from vessels employed on short-term charters and in the spot market. The EBITDA equivalent cash flow in the quarter was approximately $112 million or around 10% higher than the second quarter. Over the last 12 months, the EBITDA equivalent has been approximately $419 million. The net income came in at around $33 million in the quarter or $0.26 per share. There were only minor one-offs in the quarter, including a smaller mark-to-market gain on interest hedging instruments. There were also around $900,000 higher operating costs in the quarter due to additional crew rotation costs linked to COVID restrictions.

Our fixed rate backlog has increased and stands at approximately $2.7 billion from owned and managed vessels after recent acquisitions and disposals, providing continued cash flow visibility going forward. And the backlog of $2.7 billion exclude revenues from the vessels traded in the short-term market and also excludes future profit share optionality. In addition, we have excluded charter hire relating to the drilling rigs to be conservative in light of the ongoing financial restructuring in Seadrill.

We continue building the portfolio with modern assets on long-term charters and have recently agreed to acquire 3 modern 2019 built Suezmax tankers in combination with time charters to one of the leading commodity training companies. This deal includes some interesting optionality features if the market should strengthen during the charter period where sales can be triggered with a profit split. And if not, the long-term charters amortizes the vessels down to a comfortable low level with a good base return, supported by the $140 million backlog.

We have recently also agreed to sell 7 Handysize vessels for an aggregate net sales price of $98 million and with delivery in the fourth quarter. Compared to 1 year ago, the value of these vessels has nearly doubled. And these vessels were debt-free at quarter end, so cash effect will be similar to net sales price. Two of the vessels have been delivered already, while the remaining 5 will be delivered towards the end of the quarter. And in addition to the sales price, we therefore estimate another around $15 million net cash flow from trading the vessels from the time we agreed the sale until delivery.

Recently, we have also agreed to charter out 2 Supramax bulkers for periods of approximately 12 months at around $24,000 per day. And we have also agreed to charter out that 2005 built 1,700 TEU feeder containership for a period of approximately 3.5 years at a rate of approximately $27,000 per day. These charters alone add around $48 million to the backlog.

And during the third quarter, we took delivery of 5 container vessels with long-term charters to Maersk and Evergreen. These vessels represent approximately $300 million charter backlog, and we will have a full cash flow effect in the fourth quarter. With these vessels, we have 15 vessels on charter to Maersk and 6 vessels on charter to Evergreen. And all these vessels are on time charter terms where we are responsible for technical management and vessel operations.

Excluding the drilling rigs, the backlog from our own and managed shipping assets was $2.7 billion at the end of the third quarter. Over the years, we have changed both fleet composition and structure, and we now have around 70 vessels in our portfolio. In addition to the long-term chartered vessels, we have 15 vessels trading in the short-term market. And we also had a significant contribution for profit share over time, both relating to charter rates and fuel savings.

We do not have a set mix in the portfolio, focus is on evaluating deal opportunities across the segments, try to do the right transactions from a risk-reward perspective. Over time, we believe this will balance itself out. But we try to be careful and conservative with our investments with a focus on technology and transition over time to more fuel-efficient vessels. The 2 drilling rigs are not included in our reported charter backlog figures.

And with respect to Seadrill and the ongoing financial restructuring, we cannot give more details than we have had disclosed in our press releases or is otherwise publicly available. After Seadrill's plan of reorganization was approved by the court 2 weeks ago, they estimate emergence from Chapter 11 around year-end. We received approximately 75% of the lease hire under the existing charter agreements for West Linus and West Hercules during Seadrill's Chapter 11 proceedings. Both rigs are active in working for all companies and the charter rate is sufficient to cover our debt service relating to these rigs.

And we are, of course, pleased to see strengthening drilling markets on the back of the firm oil price. During the third quarter, we entered into amendments to the charter agreements relating to the semisubmersible drilling rig, West Hercules. Under the amendment agreement with Seadrill, the West Hercules is contracted to be employed with oil major Equinor in Norway and Canada until the second half of 2022 and thereafter, redelivered to SFL in Norway.

SFL will continue to receive a bareboat hire of around $65,000 per day until Seadrill emerges from Chapter 11 around year-end, and therefore, thereafter, approximately $60,000 per day while the rig is employed under a contract and generated revenues for Seadrill at approximately $40,000 per day in all order modes, including when the rig is idle and mobilized to and from Canada for the Equinor work.

With regards to the West Linus, which is on a subcharter to an oil major in the North Sea until the end of 2028, SFL continues to have a constructive dialogue with Seadrill but we have not yet agreed terms for the period after Seadrill's emergence from Chapter 11. Given the ongoing discussions, we can unfortunately not comment anymore on this for the time being.

Over the years, we have gone from a single asset class charter to 1 single customer to a diversified fleet and multiple counterparties. And over time, the mix of the assets and charter backlog has varied from 100% tankers to nearly 60% offshore 10 years ago to container vessels now being the largest segment with more than 60% of the backlog.

If you look at the counterparties, it is now mainly to end users and market leaders in the respective segments and relative few are to intermediaries where we have less visibility on the use of the assets and quality of operations. Strategically, this also gives us access to more deal flow opportunities such as to repeat business with Maersk, MSC and Evergreen, for example.

Our strategy has therefore been to maintain a strong technical and commercial operating platform in cooperation with our sister companies in the Seatankers Group. This gives us the ability to offer a wider range of services to our customers from structured financing to full service time charters. And 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 passively owning vessels employed on bareboat where the customers may not always have an incentive to make such improvements.

In addition, we can retain more of the residual value in the assets when we charter out on time charter basis and in the current environment with rising raw material costs driving replacement costs for vessels, this value is for the benefit of SFL and our stakeholders. For bareboat deals, this value is usually retained by the charter through fixed price purchase options. And this is illustrated by the recent sale of the 7 Handysize bulkers where our operating platform has enabled us to trade the vessels in the spot market during the soft market for a period. And now when the values have nearly doubled over the last year, we sell the vessels with a significant profit plus additional net cash flow from trading the vessels until delivery.

And with that, I will give the word over to our CFO, Aksel Olesen, who will take us through the financial highlights for the quarter.

[Aksel Olesen, executive]

Thank you, Mr. Hjertaker. On this slide, we have shown a pro forma illustration of cash flows for the third quarter. Please note that this is only a guideline to assess the company's performance and is not in accordance with U.S. GAAP and also net of extraordinary and noncash items. The company generated gross charter hire of approximately $156 million in the third quarter, including $7 million of profit split with approximately 77% of the revenue coming from our fixed charter rate backlog, which currently stands at $2.7 billion, providing us with strong visibility on our cash flow going forward.

In the third quarter, the liner fleet generated gross charter hire of approximately $79 million, including approximately $2.8 million in profit split contribution related to fuel savings on some of our large container vessels. Of this amount, more than 90% was derived from our vessels on long-term charters. Following the company's recent acquisitions, SFL fleet -- liner fleet backlog currently stands at approximately $2.1 billion, with an average remaining charter term of approximately 4.6 years or approximately 7 years if weighted by charter hire.

During the quarter, SFL took delivery of 2 modern 6,800 TEU container vessels on charter to Maersk, 2 modern 14,000 TEU container vessels on charter to Evergreen, in addition to a 5,300 TEU container vessel that commenced a 7-year charter to Maersk. All these vessels will approve higher effects during the fourth quarter. Our tanker fees generated approximately $16 million in gross charter hire during the quarter. Of this amount, about 75% was derived from our vessels on long-term charters to among others, frontline at Phillips 66.

The net charter hire from the company's Suezmax tankers employed in short-term market was approximately $1.7 million compared to $1.8 million in the previous quarters. During the third quarter, we also acquired 3 Suezmax tankers with 5-year charters to world-leading commodity trading and logistics company. We expect the vessels to be delivered later this year and early in the first quarter. A dry bulk fleet generated approximately $49 million in gross charter hire in the third quarter including approximately $4.1 million in profit share contribution from our Capesize vessels on charter to Golden Ocean.

During the quarter, the company had a fleet of 22 dry bulk vessels, of which 12 vessels are employed on long-term charters and the other 10 are trading in the short-term market. In September, the company entered into an agreement with sale of 7 Handysize vessels to Nation buyer. Two vessels have been delivered and the 5 remaining vessels will be delivered before year-end, resulting in net sales proceeds of more than $98 million in the fourth quarter. The vessels were debt-free at quarter end. This fell on to 2 drilling rigs, which have been charted out to subsidiaries of Seadrill on bareboat terms.

In the third quarter, we received charter hire of approximately $12.3 million from the rigs. This summarizes to an adjusted EBITDA of approximately $112 million for the third quarter compared to $103 million in the second quarter. We then move on to the profit and loss statement as reported on the U.S. GAAP.

As we have described in previous earnings calls, our accounting statements are different from those of a traditional shipping company. And as our business strategy focuses on long-term charter contracts, a large part of our activities are classified as capital leasing. As a result, a significant portion of our charter revenues are excluded from U.S. GAAP operating revenues and instead booked revenues classified as repayment of investment in finance leases and vessel loans, results from associates and long-term investments and interest income from associates.

For the third quarter, we report total operating revenues according to use GAAP for approximately $135.4 million which is less than approximately $156 million of charter hire actually received for the reasons just mentioned. During the quarter, the company recorded profit split income of $4.1 million from our Capesize brokers and charters to Golden Ocean in addition to $2.8 million from huge saving arrangements on some of our large container vessels.

Furthermore, the company's operating expenses increased at the delivery of 5 vessels during the quarter. And we also had approximately $900,000 higher operating expenses relating to COVID-19 measures, among others, due to our efforts to maintain a normalized crew change cycle for our seafarers despite challenging travel logistics around the globe.

In addition, we also saw an increase in depreciation due to the new additions to the fleet during the quarter. So overall, and according to U.S. GAAP, the company reported a net profit of $33.2 million or $0.26 per share.

Moving on to the balance sheet. At quarter end, SFL had approximately $251 million in cash and cash equivalents. Additionally, the company had marketable securities of approximately $25 million based on market prices at the end of the quarter.

Furthermore, the company had 6 debt-free vessels with a combined shot-free market value of approximately $185 million. Under U.S. GAAP, the wholly-owned drilling rig, West Hercules has been accounted for as investment in associates supplying in the equity method. However, following the agreement with Seadrill to amend the charter for the West Hercules during the quarter, the rig has been consolidated on our balance sheet on the vessels and equipment from the effective date on the agreement on the 27th of August.

During the quarter, the company secured attractive financing for 4 large container vessels in the form of senior secured bank financing and Japanese operating leases with total proceeds of approximately $260 million.

Approximately $420 million of remaining CapEx for recently accounted acquisitions is expected to be financed by debt facilities, similar to SFL's other assets with long-term charters.

Subsequent to quarter end, approximately $148 million was used to repay the balance of the convertible bond due in mid-October. Furthermore, the company expects to receive approximately $98 million in cash proceeds from the sale of 7 Handysize bulk vessels during the fourth quarter as they are currently debt-free. Based on the Q3 numbers, the company had a book equity ratio of approximately 26%.

Then to summarize. The Board has declared a cash dividend of $0.18 per share for the quarter. This represents a dividend yield of approximately 9% based on the closing share price yesterday. This is the 71st consecutive quarterly dividend. And since inception of the company in 2004, approximately $28 per share or approximately $2.4 billion in aggregate has been returned to shareholders to dividend. SFL has successfully committed close to $850 million towards accretive investments so far this year. And in the process, we have expanded our relationship with some of our key clients, investing in modern eco-design container ships and at the same time, disposal of older, less efficient vessels, demonstrating our commitment to further improve our carbon footprint pursuant to our ESG strategy.

Following the recent investments, our backlog from our shipping assets now stands at $2.7 billion, providing strong visibility on future cash flow, debt service and continued distribution capacity with more than $250 million of cash at quarter end as well as well positioned to execute on new accretive investments in the quarters to come.

And with that, I give the word back to the operator, who will open the line for questions.

[Operator]

[Operator Instructions] And your first question comes from the line of Greg Lewis from BTIG.

[Gregory Lewis, analyst]

Yes, I'd like to see the dividend going higher. So yes, that looks pretty good. I guess as we think about the market and the opportunities over the next kind of 12 to 18 months realizing that you're planning more for the long term and you guys keep a close eye on residuals. Does the current tightness, whether it's at shipyards or in the supply chain, i.e., scrap prices are high, do things -- how does that impact your -- the company's decision to look to continue to source new projects?

[Ole Hjertaker, executive]

Yes. What we have seen -- and Greg, nice talking to you, and thanks for the question there. What we see, I mean, is not uncommon in the market. We've seen volatility in these markets before. We've seen a quite interesting demand for shipbuilding capacity driven, I would say, particularly over the last 12 months by the containership market. At the same time, we've seen over the years, over the last few years, that there has been -- the capacity -- the building capacity at shipyards has shrunk quite significantly. Some estimate up to maybe 1/3 of the market has been removed compared to the boom around 2008.

So those dynamics are, of course, interesting. And so with the tighter market you see more pressure on raw material. That, of course, gives us maybe also some confidence on the residual values we use in our calculations when we look for the long term. At the same time, we're also very cognizant of the technology shift we see coming now. And so it's a balancing act. But on -- in the whole, we are -- we think this market is going to be quite robust. Of course, there will be continued volatility, but we think that both counterparty risk and asset prices could well be quite solid going forward.

[Gregory Lewis, analyst]

Okay. Great. And then just realizing you were able to execute on that, that Suezmax transaction which was -- I mean, you -- people would argue, hey, that's a good move, that's sort of countercyclical investing. Are you -- as we think about the challenges facing the tanker market over the last year, and we'll see how this winter play -- this winter market develops and into next year. Could we be at a point where, I guess, your value proposition is starting to become more palatable for some of these -- for some tanker owners that have historically always wanted to own their tonnage. Really, what I'm trying to get at is post this winter market, it tends to be a long spring and summer. Do you see the opportunity to deploy more capital in the tanker market?

[Ole Hjertaker, executive]

Yes, we do. We're looking at projects all the time. We'll see what -- which projects actually comes together and materialize this. But what we do see here is that have the lowest order book on a relative scale since the mid-1990s, which was a record low order book level. And we see a lot of phaseout of older vessels because there was a huge wave of vessels that came in the early 2000s, and they are now getting to 20 years of age, and therefore, very difficult to trade and very expensive to take through special surveys.

So that in itself could lead to a tightness of the market. But we've seen now with production cuts and floating storage on winding, we've seen that the near term, call it, the market has been quite soft. But this is a market, as we have seen in the past, it can turn very quickly, and the price elasticity here is quite interesting. But back to your question, I mean, about the tanker owners, I mean, what we -- you have 2 sets of call it, charters or leases, you have what we call just straight financing, sort of they're both financing at some advance rate, you've seen maybe 90% to 100% of value there both over time and a purchase obligation.

In our mind, that's a financing. And it's quite different from the deal we did on those Suezmax tankers where we run the vessels, we manage the vessels and where we have a profit split and there is incentive during the term of the charter to actually maximize returns by timing, potential sale of one or more of the vessels. So it's a much more opportunistic approach, while we think that we have our downside covered quite well through the base charter rate if it goes to the end of the charter period. So this is a market where we think being a little opportunistic, it can create value, but at the same time, in a defensive way.

[Operator]

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

[Chadd Tribo, analyst]

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

[Aksel Olesen, executive]

Yes. I think -- I mean, we reduced the dividend from time back. But if you see over the year, I think we have committed more than $850 million in new CapEx. We have seen, call it, the majority of the new acquisitions coming on the balance sheet, producing cash flow. And of course, you get a higher degree of contribution and you find room to increase the dividend. I think as we look on new acquisitions going forward, I think the Board will also, on a quarterly basis, we cannot take a view on the dividend to what extent they intent to increase that. But I think that is again for the Board to decide on a quarterly basis. But right now, we feel there is so good dividend or revenue contribution that is in line with the new dividend policy of $0.18 per quarter, yes.

[Chadd Tribo, analyst]

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

[Aksel Olesen, executive]

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

[Chadd Tribo, analyst]

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

[Aksel Olesen, executive]

Yes. Thank you for the question. We are always looking at the older fleet as potential sales candidates, of course. But in light of the current strong market for some of these vessels, like the container ships, for instance, these are -- we just fixed our 2005, 700 TEU vessels at 27,000 a day for 3 and 3.5 years. We have one more vessel in the portfolio of the same type, coming open sort of second half next year. And we feel quite confident about that. We -- so we are not necessarily looking to sell more ships right now. The same sort of evaluation also goes for our sort of older, smaller bulker vessels at the moment.

[Ole Hjertaker, executive]

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

[Operator]

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

[James Monigan, analyst]

James on for Chris. I wanted to ask about the capital structure and just how you're thinking about it at this point. Basically, is there any -- do you think it might make sense to put an additional slug of capital and that's a bit more permanent like another bond issuance? Or are you careful with sort of the mix that you have now? Just kind of wanted to understand sort of your priorities on that side of the house and what you might be thinking about doing in the near term?

[Aksel Olesen, executive]

Yes. Thanks, James. I think we are quite happy with the current capital structure. I think as you know, we are -- annually, we are retiring about $200 million in senior secured debt on our assets. We also recently repaid the convert, as you know. So I think for the time being, we are quite pleased. I think we're also quite pleased to see the feedback we get from financing institutions in terms of financing our recent acquisitions. I mean, I mentioned the 4 vessels we have financed already, 2 in the senior bank market and 2 with Japanese operating leases.

And as I stated, I mean, the remaining CapEx is expected to be financed in a similar manner. And I -- for us, I think we would see those financing terms coming in, I would say, close to this profit and loss in terms of margin cost and also duration of that debt. I think that's a reflection of our approach to structuring deals, the type of assets, counterparty quality, and of course, the duration of the charters. So for us, I think we will continue assets for the time being, but of course, always evaluating alternatives to see if we can kind of improve from what we have today.

[James Monigan, analyst]

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

[Aksel Olesen, executive]

Absolutely. I think -- I mean, despite, as I said, the banks kind of retracting from the market for some time now, we've been fortunate to have a very good access with more than 25 international banks in our portfolio. But your observation is correct. We see many banks that, for a long time, have basically reduced the portfolios coming back with strength in the market. And there is far more competition now than we've seen in quite some time. I think that's going to be a reflection of a strengthening market.

I believe that, that market will last for quite some time, given the favorable supply/demand dynamics Mr. Hjertaker talked about earlier on. So we're happy to see more banks, also banks we have worked with in the past coming back and offering attractive financing terms.

[Operator]

No question at this time. Please continue.

[Ole Hjertaker, executive]

Thank you. Then I would like to thank everybody for participating in our conference call and also thank the SFL teams on board the vessels and onshore for their continued efforts in delivering value for our shareholders. If you have any follow-up questions, there are contact details in the press release, or you can get in touch with us through the contact pages on our web page, www.sflcorp.com. Thank you.

[Operator]

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