SFL Corporation Ltd

NYSE:SFL

Earnings Call Transcript 2022-Q4

[Ole Hjertaker, Chief Executive Officer]

Thank you. And welcome all to SFL’s Fourth Quarter Conference Call. I will start the call by briefly going through the highlights of the quarter, and following that, our CFO, Aksel Olesen, will take us through the financials, and the call will be concluded by opening up for questions. Our Chief Operating Officer, Trym Sjølie, will also be present in the question-and-answer session.

Before we begin our presentation, I would like to note that this conference call will contain forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995.

Words such as expects, anticipates, intends, estimates or similar expressions are intended to identify these forward-looking statements. Forward-looking statements are not guarantees of future performance. These statements are based on our current plans and expectations and are inherently subject to risks and uncertainties that could cause future activities and results of operations to be materially different from those set forth in the forward-looking statements.

Important factors that could cause actual results to differ includes, but are not limited to, conditions in the shipping, offshore and credit markets. You should therefore not place undue reliance on these forward-looking statements.

Please refer to our filings with the Securities and Exchange Commission for a more detailed discussion on our risks and uncertainties, which may have a direct bearing on our operating results and our financial condition.

The total charter revenues were $208 million in the quarter, which was up 17% compared to the third quarter. The majority of the revenues were from vessels on long-term charters and around 16% from vessels employed on short-term charters and it is spot market.

The EBITDA equivalent cash flow in the quarter was approximately $135 million, which is up 7% from last quarter, and over the last 12 months, the EBITDA equivalent has been $504 million.

The net income came in at around $48 million in the quarter or $0.38 per share, which was in line with the previous quarter. This included contributions from profit share arrangements and also positive mark-to-market on interest rate swaps and equity and bond investments. We also received a delayed charter hire payment in excess of $10 million from Seadrill in the quarter.

The announced dividend of $0.24 per share is up $0.01 from the third quarter will represents a dividend yield of around 9.3% based on closing price yesterday. This is our 76th quarterly dividend, and over the years, we have paid more than $2.5 billion in total or more than $29 per share and we have a robust charter backlog supporting continued dividend capacity going forward.

Our fixed rate backlog has increased significantly over the last year and stands at approximately $3.6 billion from owned and managed vessels from acquisitions and charters, providing continued cash flow visibility.

And importantly, the backlog figure excludes revenues from vessels traded in the short-term market and also excludes future profit share optionality, which we have seen can contribute quite significantly to our net income from quarter-to-quarter.

The harsh environment semi-submersible rig Hercules was originally on a long-term bareboat charter to Seadrill. It was redelivered to SFL in December and is now managed technically and operationally by Odfjell Drilling.

Before mobilizing the rig for the drilling contract with Exxon in May, the rig will have to complete a scheduled special periodic survey or SPS. We are also preparing for some upgrades to the rig to make it more attractive for long-term contracts.

Currently, we estimate cost to approximately $80 million, including SPS costs and upgrades. There will not be any revenues on the rig in the first quarter, while this is undergoing, while operating costs will accrue.

The gross contract value of the Exxon charter in Canada is estimated to around $50 million with a duration of approximately 135 days including mobilization. The rig will then be available for new contracts from mid-third quarter and there is good progress on new charter opportunities, which will be announced in due course.

The rig is one of only a handful of rigs fully equipped to drill in the harshest Arctic environment, and market analysts are positive to market prospect based on recent tender activity and a tight supply-demand balance.

We have seen that the international market for deepwater drilling rigs without these harsh environment features has risen quickly. The harsh market has been lagging recently, but we believe prospects for 2024 and 2025 is particularly promising.

This is confirmed by recent fixtures in the North Sea, where, as an example, Transocean announced a three-year contract in Norway last autumn at a charter rate, which implies an annual EBITDA in excess of $80 million.

During the fourth quarter, we took delivery of four vessels with long-term charters. This includes the last two out of four Suezmax tankers chartered to Koch Industries, a newbuild container vessel chartered to Maersk Line and a car carrier chartered to Eukor. These four vessels added $260 million to our fixed backlog, in addition to profit share optionality on fuel saving.

In January, we raised a new $150 million sustainability-linked unsecured bond loan. The proceeds will be used to refinance bond loans maturing in 2023 and for working capital purposes.

After quarter end, we have bought back notes with nominal amounts of approximately $70 million, and currently, there is approximately $105 million remaining on a convertible note due in May and approximately $40 million in a Norwegian kroner-denominated bond due in September.

We have also today announced the sale of a 2009 build Suezmax tanker. This vessel has been trading in the spot market for a number of years now and we are taking advantage of a strong tanker market, which is also reflected in the value.

This is in line with the strategy of selling older vessels and reinvesting in newer and more fuel-efficient vessels. Net cash proceeds is estimated to approximately $23 million after repayment of associated debt and we expect a book gain of approximately $5 million this quarter.

Over the years, we have changed both fleet composition and structure, and we now have 77 maritime assets in our portfolio and our backlog from owned and managed ships stands at $3.6 billion.

Over the years, we have gone from a single asset class chartered to one single customer to a diversified fleet and multiple counterparties, and the fleet composition has varied from 100% tankers to nearly 60% offshore 10 years ago, to container vessels now being the largest segment with around 50% of the backlog.

Most of the vessels are on long-term charters, and in the fourth quarter, 93% of charter revenues from our shipping assets came from time charter contracts and only 7% from bareboat or dry lease.

In addition to fixed rate charter revenues, we have had significant contributions to cash flow from profit share over time, both relating to charter rates and fuel savings. Last 12 months, the aggregate profit share has been around $28 million, with around $7 million in the fourth quarter.

We do not have a set mix in the portfolio, focus is on evaluating deal opportunities across the segments and try to do the right transactions from a risk reward perspective. Over time, we believe this will balance itself, but we try to be careful and conservative in our investments, with a focus on technology and transition over time to more fuel-efficient vessels.

The strength of our counterparties and diversification is key when we assess our portfolio and quantify our contracted backlog. And the list speaks for itself with market leading operators like Maersk, Hapag-Lloyd, ConocoPhillips, P66, Volkswagen and lately Exxon to name a few.

Relatively few of our customers are intermediaries where we have less visibility on the use of the assets and quality of operations. Strategically, this also gives us access to more de flow opportunities such as the repeat business we have had with Maersk, MSC, Evergreen and Trafigura, for example.

Our strategy has therefore been to maintain a strong technical and commercial operating platform in cooperation with our sister companies in the Seatankers Group. This gives us the ability to offer a wider range of services to our customers from structured finance on one hand to full service time charter, which we are doing more of.

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 passed the 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 a time charter basis, and in the current environment, with rising raw material costs and inflation 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 charterer through fixed price purchase options.

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

[Aksel Olesen, Chief Financial Officer]

Thank you, Mr. Hjertaker. On this slide, we have shown a pro forma illustration of cash flows for the fourth quarter. Please note that this is only a guideline to assess the company’s performance and is not in accordance with U.S. GAAP, and also net of extraordinary and noncash items.

The company generated gross charter hire of approximately $208 million in the fourth quarter, including approximately $7 million of profit share, approximately 84% of the revenue coming from our fixed charter rate backlog, which currently stands at $3.6 billion, providing us with strong visibility on our cash flow going forward.

In the fourth quarter, the liner fleet generated gross charter hire of approximately $99 million, including approximately $6.5 million in profit share related to fuel savings on seven of our large container vessels and one car carrier.

At the end of the fourth quarter, SFL’s liner fleet backlog was approximately $2.4 billion, with an average remaining charter term of approximately 4.5 years or 7.2 years if weighted by charter hire. Our charter backlog includes approximately $0.5 billion of backlog from our seven car carriers.

In the fourth quarter, SFL had a fleet of 18 crude oil, product and chemical tankers, with the majority employed on long-term charters. Our tanker fleet generated approximately $49 million in gross charter hire during the quarter, compared to approximately $42.4 million in the previous quarter.

SFL had two Suezmax tankers and two smaller chemical tankers trading in the spot and short-term market. The net charter hire from these vessels was approximately $12.1 million in the fourth quarter, compared to approximately $11.5 million in the third quarter.

Subsequent to quarter end, SFL sold a 2009 built Suezmax tanker for a total consideration of approximately $39 million. Net cash proceeds as a sale of repayment of associated debt is estimated to be approximately $23 million and we expect to record an accounting gain of approximately $5 million in the first quarter.

The company has 16 dry bulk carriers, of which eight were employed on long-term charters during the quarter. SFL generated approximately $23.7 million in gross charter hire from the dry bulk fleet, including approximately $400,000 of profit share.

Seven vessels were employed in the spot and short-term market and contributed approximately $9 million in net charter hire during the quarter compared to approximately $10 million from six vessels in the previous quarters.

SFL owns two harsh environment drilling rigs, the 2014 built jack-up rig Linus and 2008 built semi-submersible rig Hercules. The Linus is currently under a long-term contract with ConocoPhillips Skandinavia until the end of year 2028 and the rig is employed on the greater Ekofisk field in the North Sea.

During the fourth quarter, the rig generated approximately $18.6 million in contract revenues. In addition, SFL received $10.5 million relating to catch up payments for previously reduced charter hire from Seadrill during Chapter 11.

The harsh environment semi-submersible rig, Hercules, was on a bareboat charter to Seadrill until the end of December 2022, whereupon the rig was redelivered to SFL. During the quarter, we received approximately $7 million in charter revenues.

Our operating and G&A expenses was higher in the fourth quarter as we recorded the first full quarter of operations for the liners. In addition, we had higher than normal operating expenses for shipping fee due to vessel deliveries during the quarter.

Other income of approximately $2 million is primarily derived from interest income from financial investments. This summarizes to an adjusted EBITDA of approximately $135 million in the fourth quarter, compared to $126 million in the previous quarter.

We then move on to the profit and loss statement as reported on the U.S. GAAP. As we have described in previous earnings calls, our accounting statements are different from those of a traditional shipping company and as our business strategy focuses on long-term charter contracts, a large part of our activities are classified as capital leasing.

Therefore, a significant portion of our charter revenues are excluded from U.S. GAAP operating revenues. This includes repayment of investment in sales direct financing leases and leaseback assets and revenues from entities classified as investment in associates for accounting purposes.

So for the fourth quarter, we report total operating revenue according to U.S. GAAP of approximately $198 million, which is less than approximately $208 million of charter hire actually received for the reasons just mentioned.

During the quarter, SFL received $10.5 million relating to capture payments for previously reduced charter hire from Seadrill during Chapter 11. Furthermore, the comp recorded profit share income of approximately $6.5 million from fuel savings from seven of our large container vessels and one car carrier, in addition to approximately $400,000 from our eight Capesize dry bulk vessels. Also, the company recorded a $2.9 million gain related to positive mark-to-market effects related to equity and debt investments, and a decrease of $400,000 in credit loss provisions.

And finally, the comp recorded a $1.4 million gain related to positive mark-to-market effects related to interest results. And at quarter end, approximately 70% of our financing was fixed rate or swap to fixed by financial hedging instruments, and with the recent raise in interest rates, we now see the benefits of a conservative financing strategy.

Similar to our chartering strategy, we have aimed to have significant diversification in our funding base, both in terms of structure and geography, as this has proven to give us more flexibility over time.

Based on our assumptions, we estimate that 1 percentage increase in interest rates from current levels equals approximately $0.02 per share in lower distributable cash flow per quarter and vice versa.

And then evaluating new investment opportunities with a conservative approach on assuming the interest rate costs during the light of the project and we generally seek to fix the interest rates back-to-back with a fixed charter duration or include an interest rate adjustment in the charter rates.

As previously mentioned, our operating and G&A expenses was higher in the fourth quarter as we recorded the first full quarter of operations for Linus. We had higher than normal operating expenses for a shifting fleet due to many vessels deliveries during the quarter. So, overall, and according to U.S. GAAP, the company reported a net profit of approximately $48.5 million or $0.38 per share.

Moving on to the balance sheet. At quarter end, SFL had approximately $188 million of cash and cash equivalents. Furthermore, the company had marketable securities of approximately $7 million investment market prices at the end of the quarter. In addition, the company has seven debt-free vessels at quarter end, with a combined charter fair value of approximately $180 million based on average broker appraisals.

During the fourth quarter, the company entered into long-term financing arrangements for two 4,000 TEU container vessels in the Japanese leasing market. The combined amount was $240 million and the term is seven years. SFL also secured long-term financing facilities for four newly acquired Suezmax vessels of $145 million.

In January, SFL issued a new $150 million sustainability linked unsecured bond with maturity in 2027. The proceeds will be used for refinancing of existing debt facilities and working capital purposes. As of today, approximately $105 million is current outstanding under the convertible note due in May 2023 and approximately $40 million equivalent to Norwegian kroners is currently outstanding under bond due in September 2023.

At the end of the fourth quarter, SFL had four LNG dual fuel car carriers under construction for delivery in 2023 and 2024. The remaining capital expenditures related to yard instalments was approximately $210 million at quarter end. The majority of this is expected to be financed by debt facilities in due course. And based on the Q4 numbers, the company had a book equity ratio of approximately 28.3%.

Then to conclude, the company has delivered another strong quarter with growth in both revenues and EBITDA. The Board has declared a 76th consecutive cash dividend to increase the dividend to $0.24 per share. This represents a dividend yield of approximately 9.3% based on the closing share price yesterday.

The company has a strong balance sheet and liquidity position and we recently raised $150 million senior unsecured sustainability linked bond, which, together with cash on balance sheet, addresses the upcoming maturities in the convertible note in May and the NOK bond due in September. Our fixed charter rate backlog currently stands at $3.6 billion after adding $1.4 billion in 2022, which provides a strong visibility on our cash flow going forward.

And finally, we have seen a strong recovery in the offshore drilling market since the beginning of the year and our two harsh environment drilling rigs are well positioned to benefit from the increased activity level in the sector.

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

[Operator]

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

[Greg Lewis, BTIG]

Yes. Thank you and good afternoon, everybody, and thanks for taking my questions. Ole, I did have a couple of questions around the rigs you mentioned. You mentioned the $80 million of rig CapEx ahead of the contract with Exxon Canada. You mentioned upgrades about potentially long-term work. As we think about the Hercules, it’s high quality rig. When we think about these capital upgrades, are we -- is this like MPD, is this BOP, any kind of color you could give us around the upgrades related to that rig and the costs associated with those upgrades as you bid that rig for, I guess, longer term employment?

[Ole Hjertaker, Chief Executive Officer]

Yeah. Absolutely and thanks for calling in. It -- what we are saying, drilling rigs are quite expensive to run and that goes for any drilling rig, whether it’s harsh environment or not. It consists of, you could say, two main parts. It’s the top side, where the under drilling functionality and then you have the platform itself or you can say the marine piece, where -- which is really sort of stable -- sit stable in the water under drilling operations.

And then you have relatively few drilling rigs with a steel quality and that needs to be built from the yard side. It’s got to have a steel quality that can withstand, I would say, extreme cold and also ultra-harsh weather, which is one -- and this rig is one of them, where -- and it has been drilling up in the Barents Sea during winter under pretty extreme conditions.

Over time, of course, both drilling equipment and the marine part, just like any ship, you can say, we will have to be renewed, call it, painted, parts change, generators need to be overhauled. I mean this is sort of normal procedure.

The difference with the drilling rig and a normal ship is that a ship is basically like a big bathtub, but a small engine in the end that you pushed through water and the drilling rig has a lot more equipment and a lot more high value equipment on board. And as a consequence, as you go through your scheduled maintenance, there is more work to be done.

So while it’s -- we kind of give you a bit of a full breakdown on element-by-element. But I would say that you have one piece, which is just regular standard maintenance and then you have some upgrades that are relating to, as we have mentioned, that this rig will be able to do more than it is doing today. It’s been working more as an exploration rig over the last, I would say, really, since it was new, while we are doing some upgrades, where it will also qualify for more development drilling, where we can see more, yeah.

So if you look at sort of the -- and then you also have some upgrades relating to specific contracts, for instance, for this contract in Canada, there is around $6 million of upgrades that needs to be done and really need to qualify for, call it, requirements in Canadian waters for this specific drilling rig as an example.

So it’s a mix of elements. The good thing we hear we are working with Odfjell Drilling. They have several, I would say, sister rigs, very similar spec rigs. So they have a lot of experience in this.

Also in terms of procuring the equipment and the spares and equipment, because that is now -- we have been through a period where this whole segment has been under the weather, I would say, since 2014, 2015, when the market came down. And that also -- that’s not only for the drillers themselves, but also for anyone involved in that value chain, be it parts suppliers and equipment manufacture and everyone.

So now when things are really reeving back up, you not only have sort of, of course, cost to make sure you can manage, but also facilitating all the parts in time for the drilling activities that we are going to do. So that is also an important piece here to actually get everything you need in time.

Also what we are looking for -- looking at and this is sold -- this is with any drilling rig or any equipment over time. As things, with time, you have to replace equipment, sometimes you have equipment where the manufacturer cannot longer service it because of -- from a timing perspective. So that is also something that is going into the overall cocktail.

[Greg Lewis, BTIG]

Yeah.

[Ole Hjertaker, Chief Executive Officer]

But the other side of this is cash flow potential on these drilling rigs, because we have an example, there was a drilling rig Transocean that was announced last fall on the Norwegian Continental Shelf, three years generating sort of more than $80 million in cash flow, EBITDA cash flow per year relating to that contract. So, yes, they are expensive to upgrade and maintain and take through special surveys, but there’s also very significant cash flow potential when these rigs work in a recently hot market.

[Greg Lewis, BTIG]

Yeah. No doubt about it, especially when rates are -- not that I want to spend all the time talking about the offshore rigs, but I think it is somewhat as people think about SFL, and as we try to think about the dividend, that’s obviously important to us and investors and obviously, SFL as well. I guess in previous years when the rig market, like you mentioned, was in a six-year to seven-year downturn, it was -- the assets maybe weren’t as viewed as core to the portfolio and really, I guess, what I am trying to understand is, as we think about potential for the offshore rigs to be additive to the dividend, maybe a six-month or 12-month contract on the Hercules doesn’t make it additive to the dividend. But like is that a fair way to think about it, where maybe if the rig is on a multiyear contract, generating cash flow is obviously paying back the initial investment probably in under a year. Is there any way to think about how those -- how the two rigs can impact the dividend or should we be thinking about cash flow from those rigs really being deployed elsewhere on maybe longer term business to then drive the dividend higher, any kind of color you can give around that? I realize that was a long question.

[Aksel Olesen, Chief Financial Officer]

Yeah. Thanks for that. I may attempt to answer that. I think as you see on both rigs, you start with the liners, it has a long-term contract, which is market linked. I think, as we now work ourselves through 2023 and we see the market expectations for 2024 and 2025, I think, that’s when I should expect to come in to, call it, distributable cash flow from the rigs in terms of kind of contributing to the dividend. I think that’s kind of the timeframe we are looking at.

I think if the liner is covered, it’s reset every six months that’s positive and then you basically have an interesting supply-demand for that type of rigs in the North Sea with many rigs leaving as well. And also same with the semis, we see many semis migrating out on the international market where you actually see now higher day rates than in the North Sea.

You see you have a lower OpEx, and you have more term business, and that’s really when you can see visibility on that, that we can guide on a more precise guidance on kind of the cash accessible to support the dividend, but we think indeed it looks very interesting.

[Ole Hjertaker, Chief Executive Officer]

And maybe also to add on that…

[Greg Lewis, BTIG]

Okay. Great.

[Ole Hjertaker, Chief Executive Officer]

I mean, if you look at the expense, of course, it’s an investment as you take it through this SPS, but we have quite significant cash flow or cash position at end of 2022. We recently raised that new bond loan that is effectively taking out the maturities -- bond maturities we have this year.

And on the asset side, we are effectively fully invested as the remaining installments on the car carriers that we have under construction will most likely be covered by debt facilities. So there may be actually be cash coming out of those.

So from that perspective, this is something that we have, I would say, been prepared for, for quite a while and we put down the money now, and of course, we wouldn’t do that if we don’t think that this is accretive to SFL and/or -- and the distribution capacity long-term.

[Greg Lewis, BTIG]

Yeah. No. 100%. And then just kind of pivoting more to a bigger picture how we should think about lease yields and really your returns, and clearly, interest rates have gone higher. Is -- I don’t know if the era of free money is over or not, but it looks like at least in the medium-term there is. We have also -- it looks like we have seen some crackdowns and we will just call, say it, in Asia around some leasing companies deploying capital across the maritime space. Has there been any -- has there -- is there any shakeout where we could see returns for SFL in a higher interest market? Could that actually be a positive for SFL just given the diversity and kind of your different pockets of money or is -- should we be thinking about that as neutral at best?

[Ole Hjertaker, Chief Executive Officer]

You have two sides. I mean if you look at a more financial, call it, the structured finance, we have some assets that are effectively structured finance type deals, bareboat type deals. You can say that, those are becoming more competitive in a way, because as we have seen it over time, investors -- not in SFL, but in other, call it, vehicles or companies who have that strategy, it looks like investors have more of an absolute return requirement, whereas the companies who might, call it, use those, call it, financing services, they could otherwise go to the bank and borrow at a floating rate, which was lower. That has not come off.

From our perspective, I mean, we focus more on time charter contracts, because then we have more direct interaction with the end users. But also if you look at the way we have looked, we have sort of managed interest rate risks over time, we have tried to hedge that out. So when we do a deal, we structure the financing and then we hedge the interest rate generally.

So which means that when they come up for rechartering, yes, then we have, I would -- you can call it -- then we have an interest rate exposure, but charter rates are also have an element of interest embedded in themselves because for anyone who wants to charter out a vessel, they will have to take into account their financing cost at that time.

So I would say, on the longer perspective, we are more neutral on the interest rate side. We do think there will be more, call it, bareboat type deals perhaps coming down the line. But we are looking at a lot of deal opportunities.

As an example, last year, we did a tally after end of 2022, I think, we did proper work on deals worth around $23 billion in total. Of that, we ended up doing less than $1 billion for various reasons. It could be that we didn’t like the return profile, risk reward, maybe the counterpart didn’t work for us, et cetera. So we are screening a lot of deal opportunities and try to be disciplined and then selective when we do deals.

[Aksel Olesen, Chief Financial Officer]

Yeah. And I think, a general note on our access to financing in terms of banks, and call it, Japanese leases, et cetera, I think, that has an improved over last year. I think with our name, track record, I think, we are able to achieve an extremely competitive financing.

And as Ole alluded to, the kind of the limitations you see in the Chinese market is, you could argue it’s going away more bareboat type financial providers, which we previously have been competitors to ours, although we haven’t done bareboats. So I think kind of the financing market there has -- is now smaller and that potentially gives us more opportunities.

[Greg Lewis, BTIG]

Okay. Super helpful. Thanks for the color.

[Ole Hjertaker, Chief Executive Officer]

Yeah. Thank you.

[Operator]

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

[Ole Hjertaker, Chief Executive Officer]

Thanks. Then I would like to thank everyone for participating in this conference call, and if you do have any follow-up questions, there are contact details in the press release or you can get in touch with us through the contact pages on our website. Thank you.

[Operator]

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