FLEX LNG Ltd. (NYSE:FLNG) Q2 2023 Earnings Call Transcript

FLEX LNG Ltd. (NYSE:FLNG) Q2 2023 Earnings Call Transcript August 16, 2023

FLEX LNG Ltd. misses on earnings expectations. Reported EPS is $0.52 EPS, expectations were $0.64.

Oystein Kalleklev: Hi, everybody. I’m Oystein Kalleklev, CEO of Flex LNG and today we are presenting our second quarter numbers. I will be joined today by our CFO, Knut Traaholt, who will walk you through the financials a bit later in the presentation. Before we begin, I would just also mention we do have our Q&A session at the end of the presentation where you can send in your questions either using the chat function or sending an email to ir@flexlng.com, and if you have the best question for today, we do have some gifts for you. So gift number one is our Flex LNG boiler suit. We just completed the docking of four of our ships. So — and these are very nice when you do some improvements or maintenance. So, you can have it while doing some home improvements.

Maxim Tupikov/Shutterstock.com

We also have, then your Just Flex It, Running T-Shirt, which we will be using in Oslo Marathon next month. And lastly, we have a new addition of Flex LNG sunglasses. So I hope you do send in some good questions. It’s always the most fun part of these presentations. So before I begin, I will also highlight our disclaimer. We will be providing some forward-looking statements in this presentation. We will be using some non-GAAP measures as TCE and adjusted numbers and of course, we cannot cover everything in detail during this short presentation. So we would also like you to highlight the fact you can read our earnings release, which we also presented today. So, let’s kick off with the highlights. So let’s begin with the highlights. Revenues for the quarter came in at $86.7 million, in line with our guidance of $85 million to $90 million.

This resulted in strong earnings, $39 million translating into $0.73 per share. Adjusted net income where we only include the realized gains on other derivatives, not the unrealized gains, came in at $28.2 million or $0.53 per share. During the quarter, we carried out drydocking of three ships according to time and budget and that means we have completed the drydocking schedule for the year with four ships being drydocked in the first half of the year. These three drydockings in the second quarter was then the main reason why we have lower revenues in Q2 compared to Q1, but with all ships back in operation from the second half of the year, we are reaffirming our revenue guidance of $90 million to $95 million in the third quarter and somewhat higher expectation in Q4, $90 million to $100 million, depending a bit on how strong the spot market will be for a ship we have on variable higher time charter.

So with that we are reaffirming also the revenue guidance for the year, $370 million and adjusted EBITDA of somewhere between $290 million to $295 million. We are also today pleased to announce that Cheniere has — as expected, extended the Flex Vigilant time charter from end of 2030 into middle of 2031. As some of you might recall, we did extension of three ships with Cheniere last year where they had this early option to extend that ship by 200 days, and then get our option to extend her a further two years. So in total, today we have 55 years of minimum firm backlog, which can be extended up to eight years if charters are utilizing all extension options. So, with our very healthy backlog, our strong financial position with $450 million of cash and no debt maturities prior 2028, after all refinancing, we just carried out, we therefore, should come as no surprise that the Board is declaring a dividend of $0.75 per share for the second quarter.

This brings the dividends, the last 12 months to $3.25 per share or a yield of about 10%. So, as I mentioned, we’ve been busy doing drydockings this year. We docked Flex Endeavour in March, Singapore. We did our sister ship Flex Enterprise in Singapore in April and then we had two ships, the sister ships Ranger and Rainbow docking in June; Ranger in Denmark and Rainbow in Singapore. We guided in our Q4 presentation that we expected these drydockings to take somewhere between 80 days to 90 days and we ended up at 77 days. So slightly ahead of our guidance on time. CapEx, also in line with estimates about $20 million of CapEx associated with these four drydockings. And with that, we don’t have any more drydockings for the remainder of the year.

As mentioned, we will have two drydockings next year, probably four in ’25, three in 2026 and then we have a holiday in 2027 with zero drydocking schedule for that year. So this slide is the same slide you saw last quarter. We are reaffirming the guidance of the year, $370 million of expected revenues. We had $92.5 million or so in Q1, slightly lower had in Q2 because of the three drydockings, and also because somewhat softer spot market impacting the ship we have on variable higher time charter. With all ships back in operation, we expect revenues to jump in Q3, somewhere between $92 million and $95 million and then a bit more variability in Q4 as spot market can really take off especially when we look at the winter coverage fixtures being done recently.

So, we expect somewhere between $90 million to $100 million of revenues in Q4 and that in total should be around $370 million. So — and you also see that then the revenues are higher than last year, where we recorded about $348 million of revenues. And that’s despite the fact that we are taking four ships doing drydocking this year and it’s driven by the fact that we have repriced the portfolio of ships and expect the time charter equivalent earnings this year to be around $80,000, which is higher than last year. So looking at the portfolio of backlog, as mentioned Flex Vigilant extended from end of 2030 to the middle of 2031. And as you can see, we have substantial backlog with 54 years of minimum contract backlog. We have these two stars.

That’s the first open — fully open ships, Flex Ranger which was recently docked. She is open in Q2 2027 and Flex Constellation in the middle of 2027. I will come back to this later in the presentation. These are very attractive positions when you are comparing to the term rates and newbuilding prices for ships for delivery at 2027 and onwards. So, once we have finalized marketing of these ships, we will move forward to the next open position which is Flex Aurora and Flex Volunteer which are fixed to Cheniere with re-delivery early 2028, if they exercise the options for these ships which we do expect them to do. We do, in general, think that a lot of these options there will be declared given where the term rates are heading. As you can see, we also have on the bottom half Flex Artemis, the only ship that’s on our variable higher time charter where the rate is adjusted according to the conditions of the spot market and the spot market looks very strong for the second half of the year and that’s why we have a bit — bigger range in expected revenues in Q4 compared to Q3.

Looking at this slide, we have used this a couple of times. Just looking at where our adjusted earnings per share is $0.53 for this quarter. Last 12 months, it’s been about $3 per share. Ordinary dividends been $3 and then we have paid out a couple of special dividends, given the various strong financial position of the company last 12 months and we are down from the $3.75 per share of running dividend to $3.25, but still a comfortable level and giving our investors a 10% running yield. The decision factors were also covered in great details. In the past, Q2 is of course usually the softest quarter in term of the earnings on the spot ships, but as you can see, most of these colors are green, as I explained the reasons for — already. So, with that, we will jump into the key financial highlights.

Knut?

Knut Traaholt: Thank you, Oystein. Let’s have a look at the key financial highlights for the quarter. Revenues came in at $86.7 million and was impacted by that 57 days of scheduled drydock of the three vessels in the second quarter. It’s also impacted by seasonal lower earnings of the variable hire contract for the Flex Artemis. On the operating expenses, we see a slight increase this quarter to $17.3 million and this is explained by timing effects of spares and maintenance. Last quarter, we were bit below budget and this quarter we have paid some of those OpExes. So OpEx per day is $14,600, but if you look at the first half of the year, the average OpEx per day is at $14,000. Interest rates continue to increase. So, we have an increase of interest expenses to $27.2 million.

However, this is offset by our gain on derivatives of $17.1 million. Included in that is realized gains of $6.2 million versus $5 million in the first quarter. And if we look at the comments on this slide, we also then compare with the first half of the year. So, we see, we have realized gains of $11.2 million versus a loss of $2.4 million last year. So, despite the rapid increase in interest rates, we see the positive effect of our hedging strategy where the not paid interest is only $10 million higher despite the rapid increase in the interest rate levels. Last quarter, we completed the balance sheet optimization program and therefore also booked the write-off of debt issuance costs of $10 million. So that’s no longer applicable this quarter.

So for the second quarter, we end up with a net income of $39 million or $0.73 per share, and adjusting for the unrealized gains on derivatives, we end up with an adjusted net income of $28.2 million and that results in adjusted earnings per share of $0.53. Looking at the balance sheet, it’s still robust and clean. There are two main components, it’s cash of $450 million and our vessels — the 13 vessels with an average age of 3.6 year with a book value of about $2.3 billion. That gives an equity of $870 million, solid equity ratio of 31%. If we look at cash flow statement for the quarter, we have $47.5 million in cash flow from operations and $9 million in change in working capital. We had $16 million in drydock expenses and amortized about $26 million.

We paid out last quarter the $0.75 per share in dividends, resulting in $40 million and we end up then with a solid cash position of $450 million. Having a deeper look into our interest rate portfolio. We have made no changes to the derivatives during the quarter. So, we maintain a high hedge ratio of 62% to 65% in the coming quarters. It’s a mix of SOFR-based interest rate swaps and LIBOR-based swaps. As LIBOR has exceeded to be — sees to be quoted, these LIBOR swaps will transition into SOFR swaps during the third quarter. If we look at the components here, we have $820 million of swaps, and then we also have $201 million of fixed rate leases in the portfolio. So, on the interest rate swaps, these are valued today at $58.7 million on our balance sheet and provides a solid hedge in the coming quarters and also cost visibility.

Looking at our funding portfolio, in Q1, we concluded the balance sheet optimization program. The funding portfolio is then consisting of about 50% of long-term leases and 50% of debt which is split in term loans and a $400 million non-amortizing revolving credit facilities. The revolver gives us flexibility on — for cash management when we have a cash position of $450 million, which means that we can repay the RCF at any point in time and therefore also reduce interest rate cost. The maturity profile is pushed out. First maturity is in 2028 and as you see here, it’s spread out with the last maturity in 2035, subjected if we exercise the two extension option on that financing. This portfolio is provided by a diverse and strong and supporting group of banks.

It’s split out in various regions. So, we have banks from the US, from Europe, and then also increased our exposure in Asia. So this gives us a rock solid foundation to support the company coming further. And with that, I hand it over to Oystein for an update on the markets.

Oystein Kalleklev: Okay. Thank you, Knut. So let’s have a look at the market, starting with the volumes. So these are the volumes from January to end of July. In that period we see that export growth is about 3%. U.S. was flat in Q1 due to the shutdown of Freeport but with Freeport up and running again, the U.S. volumes are increasing and are the main contributor to volume growth. We have also had shutdowns in Norway and Norway is back exporting. So they are also adding $1.6 million, same as Algeria. On the import side, we continue to see strong growth in Europe, adding 5 million tonnes in those seven months. We’ve seen less demand for Japan with nuclear restarts. But China bouncing back. China, after they loosened up the COVID restrictions, we did see Chinese demand rebounding from March.

And in the second quarter, Chinese import growth was about 20%. So then looking at the gas prices, they have been incredibly volatile like the last couple of years, driven mostly by supply events as well as of course COVID. So looking back the last 1.5 year or so, of course, we saw high gas prices coming out after the invasion of Ukraine and also the strong demand in the end of ’21. We had the Freeport shutdown middle of last year, which started to bring prices up. And then, of course, we had the Nord Stream explosion which cut off a lot of Russian pipeline gas to Europe and actually sending the price of gas as high as $100 per million BTU. For those who are not too familiar with million BTU, that’s 5.8 million BTU in a barrel of oil, so that means that we are talking here about gas prices equivalent to about $600 per barrel of oil and of course, when prices are going to these kind of levels, demand goes down because of the high prices and switching to coal or propane or oil products.

So with the spike in price, we’ve seen a lot of demand subversion in Europe, especially, which are more reliant on the spot market and we saw gas prices basically falling from a high of $100 per million BTU in August last winter to about $10. And we actually — then a level where natural gas actually where a competitive towards oil. You see the dotted line here, it’s LNG being sold at oil price with about 20% discount and of course when prices go down again, we can see more demand and now lately the last week or so, we have had a situation where Australian workers are contemplating strikes which could cut off almost 50% of Australian volumes or 10% of global volumes. So, these are really big numbers when we look at the Freeport explosion which cut off that plant.

We were talking about 3.5% of global volumes. So, these are almost 2.5 times bigger volumes and I will come back to the situation in Australia. And with that, of course, we have seen a rally in European gas prices in the last week or so. And we do expect gas prices to head upwards in line with the future course as there will be more demand when we are going into the winter. So look at — let’s have a look at the situation in Australia. There are several mega projects in Australia, as you can see here on the map. The uncertainty today is around three different projects which are — last year exported about 41 million tonnes, close to 50% of all Australian volumes. So there — here we are talking about industrial actions where workers are contemplating a strike which will affect the Northwest Shelf plant operated by Woodside, the Gorgon and Wheatstone projects operated by Chevron.

So, these projects are mostly selling all of the volumes to Asian buyers given the short distance to these big markets, with Japan, China, South Korea, taking the vast majorities of these cargoes. So if there is a shutdown, it will really create a supply crunch where Asian buyers will have to compete for Atlantic Basin cargoes mostly US, and drive prices up where we have seen already the fair of this happening are driving up prices. Of course, we don’t expect shutdowns at the similar period of time as we have seen when we had the Freeport explosion, which is a more technical issue. But that said, we have seen similar actions happening on the Prelude project in Australia last year where industrial action closed down exports from June the 10th to August 25 last year.

So, this is still unresolved but is something to keep an eye on. Another interesting topic is the supply of Russian Gas. So what we are putting in how – with Drake meme is, the — Europe has really said they don’t want to have Russian pipeline gas and also with Nord Stream pipeline exploded, it’s not feasible to move those volumes. So, the share of Russian pipeline gas in Europe — European Union’s natural gas demand has been on a sharp fall and of course, this gas have been replaced primarily by LNG. Europe has been incredibly lucky. First, we have had the COVID shutdowns in China and then we have seen the economic growth of China, probably being on the slower side of expectation, which has resulted in Europe being able to source a lot of volumes from the spot market and US cargoes, especially the flexible US cargos going to Europe.

But not only the US cargoes, actually when we look at Russian LNG, it’s very welcome in Europe, and actually Russian LNG into Europe has just kept on going. As we can see on this graph on the right-hand side, Russian LNG to EU, 37% of the cargoes went to EU in 2021. It actually grew to 47% last year. And so far this year, 51% of Russian LNG is going to European countries. And why? It’s because the European buyers can’t really afford to not take the Russian LNG given the tightness of the LNG market. So, looking at the European gas market which has been front and center the last couple of years. European gas inventories now are at a very high level. We are — where they are close to the 90% threshold that EU was targeting for November 1, already today, but again, there are — the winter is not started.

And of course, once you were getting into the winter, European consumers will start to utilize the storage level and depleted, as is the seasonal pattern. So, IEA had some scenario analysis of how vulnerable Europe is to supply crunches and we have four different scenarios here. So it might be a bit confusing here on the right hand side, but we look at, once the heating season start, which is 1st of October, what is the level of — inventory levels there. And you will see, as you get to November, December, January, February, March, these storage level will be declining as we are using from the storage levels. So, how much did they declining, it really depends on a couple of factors. It’s — the biggest factor is whether the winter will be called or not and then it will also be about how much gas will you be able to source from the LNG market and that’s why we have seen the rally in the gas prices last week or so.

Because, if in the event Asian buyers are competing for marginal spot cargoes, LNG supply will be more restrictive. And in such a situation where you have a cold winter and restrictive LNG supply, Europe could end up with very low level of gas coming out of the winter this season despite the high service level today. So looking at the market we are operating in, is the freight market. The spot market has been acting as usual. We have had the spot market cooling down as we’re getting out of the winter. And once we are getting closer to the winter, spot rates are going up and following the seasonal pattern today, we are already above $100,000 per day for modern tonnage. And if you look at the future curves on the left-hand side, which is the dotted blue line, we see that the future curves are pricing ships for the winter in excess of $200,000 per day, in line also with what we have seen in the past.

But keep in mind, there has been a lot of the — traders and the portfolio players, they have been taking ships on longer term charters. So, the numbers of fixtures in the spot market has gone down and also the spot fixtures being down today are primarily relets where charters are fixing ships to each other, not independent owners Looking at more term rates where we are more active. Of course, term rates are driven by, of course, supply and demand, but they’re also driven by newbuilding prices and interest rates level. So we have seen newbuilding prices picking up about 30% in the last two years and of course, when people are doing a tender for new buildings, those people investing these amount of money in a ship, they need a higher breakeven level in order to defend such investment also when interest rates are picking up.

So, today newbuilding prices are at around $265 million with a couple of more ships for — available for delivery at ’27 before we are starting to have only yard slots open for 2028. So today the ten-year rates as you can see here in the light blue line is hovering about — above $100,000 and then at about $150,000 for a five-year time charter rate. So this is one of the reasons why we are also very optimistic about re-contracting our ships. We have two ships open in ’27, competing with these ships. And then two ships also in ’28, where we do think that once we are re-contracting ships, we will be doing that at higher levels, which we have also done and evidenced in the past. Looking at the order book, we had a lot of contracting of newbuilds last year with these higher prices.

We have seen fewer contracting these days. But the order book is big and it’s also reflecting of the fact that we have a lot of new volumes coming to the market and it’s reflecting the fact that still we have a lot of steam propulsion on water with 35% of the fleet consisting of steamships and we do see more and more of these ships leaving the shipping market and have to be replaced by more modern fuel-efficient tonnage, driven by economics, driven by regulation, and also to — from next year, actually carbon taxation in European Union. If we look at the order book today, most of the ships are committed to long term charters. Only about 10% of the ships in order book ae uncommitted so far. Looking at what we could call the cargo market, the LNG supply, we’ve seen continued FID projects taking the final investment decision.

Latest one being Next Decade’s Rio Grande, which announced going ahead with the Rio Grande project. And we’ve also seen two other projects in US this year; Venture Global’s Plaquemines Phase 2 and Port Arthur, also earlier this year. So we have about 100 million tonnes of project in North America under construction or where they have taken the final investment decision and then 73 million rest of the world. And there are still a lot of projects chasing FID. The project we deemed probable or highly probable to do so, is about 85 million tonnes in North America, 68 million tonnes of the rest of the world. So we do see a very strong growth in the market. The nameplate capacity today is 465 million tonnes. We do expect LNG supply this year to be about 420 million tonnes.

We are not able to have 100% utilization on these projects. And then this — if you add all the projects under construction, you are getting to 634 million tonnes, but there are still projects trying to get FID. And if you put in all the highly probable, you are ending up at a very big number 788 million tonnes. So that is one of the driver for all these contracting of new LNG ships. So with that, I think we conclude today’s presentation. Just going to run through the highlights quickly. Revenues for the quarter, in line with our guidance. We have stronger earnings, $39 million or $28.2 million if you adjust out unrealized gains on derivatives giving our earnings per share of $0.73 or $0.53 respectively. We have completed our drydocking program of the four ships on time and budget.

We just recently had an extension of our Cheniere time charter for Flex Vigilant, bringing that ship into 2031. Revenues for the second half of the year will pick up as we have completed the dockings and as we do see a stronger spot market and we are confirming the guidance we already provided in February, $370 million of revenues for the year, adjusted EBITDA of $290 million to $295 million, driven by higher earnings in Q3 and Q4. So with that, we are happy to declare another dividend of $0.75, bringing the dividend the last 12 months to $3.25 giving, as I mentioned, 10% yield and then we can do that easily given our high backlog and strong financial position. So with that, I thank you for joining the presentation. We will then be gathering some questions and do a Q&A session.

Thank you.

A – Oystein Kalleklev: Okay. Let’s start the Q&A session, Knut. And I think we have received quite a lot of questions today as well. Even though I think most of the analyst reports coming out this morning was, this is boring stuff. No news. Everything as expected, but we rather be boring and profitable than funny and losing a lot of money. So let’s see. Okay.

Knut Traaholt: We have a good group of questions. So thank you for sending them in. Let’s start with the contracts. And Wolfsburn, he questions, if it’s a surprise that Cheniere declared the option on the Vigilant that early, and can we expect any other options to be declared by Cheniere any soon?

See also Goldman Sachs Dividend Stocks: Top 12 Stock Picks and 15 Smallest Stocks In Warren Buffett’s Portfolio.

Q&A Session

Oystein Kalleklev: Yeah. Well, he is a loyal shareholder. Now it’s not a surprise at all. Actually, if you read the press release we sent out last year when we did this deal with Cheniere for three ships which we extended then, we vowed the fact that the Vigilant had early option, due Q3 this year, it’s now Q3, even though we reporting Q2. So, it comes as no surprise. And they also have an early option to extend Endeavour in spring next year where the period is slightly bigger or longer, 500 days. So I would expect that to happen as well. So, no surprise, as planned.

Knut Traaholt: And then a follow-up on the contracts from Eirik Haavaldsen in Pareto Securities. In the fixed rate contracts, are there any inflation adjustments?

Oystein Kalleklev: No. We have them on a fixed rate level. Of course, there are some facts in those contracts. That’s why we’re making some money. However, we have hedged the risk in terms of inflation. Usually, there is the strong correlation between interest rates and inflation. So if inflation goes up, interest rates tend to go up as we have seen very much so the last couple of years. So, we — as Knut has shown, we hedged a lot of our interest rates, so we have covered the inflation risk in that sense. And actually, our cost of interest rates, interest rate per day is higher than OpEx per day. So it’s actually a more important risk to cover.

Knut Traaholt: Yeah. Then we have some questions around the contract portfolio. We today announced 54-year of firm backlog and 80 years including the options and then we talk about open vessels in 2027 and ’28. So the question is, what’s the likelihood of the options to be declared?

Oystein Kalleklev: Yeah, I would say, right now, given where term rates are for ships, ships have become a lot more expensive. I showed now the ships have been cost — newbuilding price has gone up 30% in two years, but keep in mind, we auto ships back in ’17 and ’18. So they’ve gone up from 180 to 65. So — and rates for newbuild, $100,000 or rates are lower. Although most of the options we have are typically at a higher rate than we have on the firm period. So, I think the likelihood of options being extended is very high. Whether all the options will be exercised, it’s hard to say, but I think most of the options will probably be called by the charters and all kind of backlog is then most probably longer than the 54 years, we have firm.

Knut Traaholt: Okay. Then moving on to drydock. We have a question from Haakon Lunder, who works in the offshore drilling industry. And they have a concept in the drilling industry about continuous class, there they do maintenance in class renewal, while in operation in order to reduce time at the yard and off-hire. Is that the concept that could work in the LNG for — and for FLEX when doing drydocks?

Oystein Kalleklev: I think it’s a bit different if you are on a semi-submersible drilling rig. And you can spend $50 million-$100 million doing the special survey on the ship. We — of course, we do have continued — continuous maintenance all the time. We do have cash inspections regularly and of course, prior to us going into our dock, we want to minimize the stay at dock. So what we are doing is to prepare everything in advance. So once we are doing the discharge, we use the ballast leg to prepare all the maintenance, starting to take down equipment, so they are ready to being maintained. And I think we evidenced that now, we guided 80 to 90 days docks day for those four ships we had planned this year. We managed to spend only 77 days on those four dockings, average 19 days. And I think if you compare that with most all other LNG owners, we are comparing very favorable, on time and also on cost, because staying in a dock is costly.

Knut Traaholt: And he follows up with another question on the new buildings. It’s been mentioned that there have some new gadgets slightly different from our vessels. So while we are in drydock, do you plan to do any upgrades of the vessels?

Oystein Kalleklev: It’s not major upgrades. Of course, we always do software upgrades, might be some new energy saving devices. So we are putting in some more sensors, but not major upgrades. We have the most efficient engines. That’s a two-stock. People oiling ships today is still the two stocks. Actually very few people are ordering the mega-ships, which we have nine out of 13 in our fleet is mega-ships, because they are quite expensive. Usually, they have one or two high pressure compressors running at 300 bar. People today are maybe often opting for cheaper engines with lower pressure, which resulting not as good combustion and more meet and slip. There are some other gadgets. You have the air lubrication system, but so far there are some mixed results on these systems.

I think if you are to order new ships today, of course, shaft generator is quite popular. It’s basically if you have a bicycle and you have a dynamo on the bicycle in order to make lights, so rather than running the auxiliary engines, you can use the dynamo. But of course, if you use the dynamo, you also create fiction. So it’s not like you get free electricity. You have to build more on the engine, but you can use less of the auxiliary engines. So, that’s a roundabout way of saying that we plan no big upgrades because the ships are state of the art, and we order them because we could get state of the ships at the right time, at the right price, compared to what it is today.