SFL Corporation Ltd. (NYSE:SFL) Q2 2023 Earnings Call Transcript

SFL Corporation Ltd. (NYSE:SFL) Q2 2023 Earnings Call Transcript August 18, 2023

Marius Furuly: Welcome to SFL’s Second Quarter 2023 Conference Call. My name is Marius Furuly, and I’m Vice President for Investor Relations in SFL. We have a new format for the conference call this time using Zoom. And I hope this will be both as informative as usual and easier to navigate afterwards for you. Our CEO, Ole Hjertaker, will start the call by briefly going through the highlights of the quarter. Following that, our Chief Operating Officer, Trym Sjølie, will comment on vessel performance matters before our CFO, Aksel Olesen, will take us through the financials. The call will be concluded by opening up for questions and I will explain the procedure to do this before the Q&A session. Before we begin our presentation, I would like to note that this conference call will contain forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995.

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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 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 within the Securities and Exchange Commission for a more detailed discussion of risks and uncertainties, which may have a direct bearing on our operating results and our financial condition.

Then I will leave the word over to our CEO, Ole Hjertaker, with highlights for the second quarter.

Ole Hjertaker: Thank you, Marius. The total charter revenues were $174 million in the quarter, which were down from the previous quarter, primarily due to the sale of 4 spot traded tankers earlier this year. Over the last 10 years, we have changed the business model from a maritime leasing company to maritime infrastructure with long-term time charters to end users. Only around 9% of our charter revenues were from 7 bulkers and the container vessels employed on short-term charters and in the spot market. The EBITDA equivalent cash flow for the quarter was approximately $109 million [sic] [$100.9 million], in line with the previous quarter. And over the last 12 months, the EBITDA equivalent has been $480 million. The net income came in at around $17 million in the quarter or $0.13 per share.

The net income continues to be impacted by the drilling rig Hercules, which had no revenues in the second quarter, but with full operating expenses, while finalizing its comprehensive special survey or SPS and upgrades. The SPS was finalized in mid-June, and we then started the mobilization to Canada. We have been paid the mobilization fee from Exxon for the transit, but due to U.S. GAAP accounting rules, all of this will be recognized in the third quarter, together with the mobilization costs. There was also a $6 million gain in the quarter relating to sale of the last spot traded Suezmax tanker. This is our 78th quarterly dividend. And over the years, we have paid more than $2.6 billion in total and closing in on $30 per share. And we have a robust charter backlog supporting continued dividend capacity going forward.

The announced dividend of $0.24 per share is in line with the previous quarter and represents a very strong dividend yield at current share price levels. Our fixed rate backlog continued to increase and stands at approximately $3.6 billion from owned and managed vessels after recent charters. This provides continued cash flow visibility going forward with significant additional cash flow from the drilling rig, Hercules and the new build car carriers from the third quarter onwards. And importantly, the back book figure excludes revenues from the vessels traded in the short-term market and also excludes future profit share optionality, which we have seen, can contribute significantly to our net income. The SPS and upgrade work on a harsh environment semisubmersible, Hercules was completed in mid-June, and the rig then moved under its own power to Canada to commence a contract with ExxonMobil Canada to drill 1 well, which started mid-July.

The duration is estimated to approximately 135 days, including mobilization to and from Canada and the contract has an estimated value of $50 million implying a day rate of approximately $375,000 per day for the period. Thereafter, the rig will move to Namibia and commence a contract with a subsidiary of Galp Energia for two wells plus an optional well testing. Excluding optional days, the duration will be approximately 115 days, including mobilization with an estimated contract value of another $50 million, implying a day rate of approximately $435,000 per day for that period. After Namibia, the rig will move back to Canada to commence the recently announced contract with a subsidiary of Equinor. The contract is from 1 well plus 1 optional well.

The duration for the firm contract period is approximately 200 days, including transit 2 and from Canada, implying a day rate of approximately $520,000 per day for the period. The rig will then be open for new contracts from the fourth quarter 2024 onwards. The secured backlog on the Hercules is now in excess of $200 million, and we estimate approximately $100 million EBITDA from the rig over the next 12 months. This rig is only – one of only a handful harsh environment ultra-deepwater semisubmersible rigs available and market analysts are positive to market prospects based on recent tender activity and the tight supply-demand balance. The harsh market prospects into 2025 is particularly promising. And we now see day rates in excess of $500,000 per day as evidenced by our recently announced contract with Equinor for next year.

This is up 50% from last year, and most of that goes straight to the bottom line. And we continue to renew our fleet and divest the world or tankers. We sold 4 tankers traded in the spot market earlier this year, and we have now sold the Landbridge Wisdom, which is the only remaining bareboat charter tanker in our fleet. This is a VLCC on a relatively low bareboat charter rate and the charter exercised the fixed price purchase option a short while ago where we will sell the vessel back to them later in August. The net cash proceeds is estimated to approximately $10 million, and book gain in the third quarter is estimated to around $2 million. In May, the Board of Directors has authorized the repurchase of up to an aggregate of $100 million of SFL shares.

So far, around 1.1 million shares have been repurchased at an average cost of $9.27 per share or just over 10% of the authorized amount, and there is $90 million remaining. Further purchases may be made at our discretion in the form of open market repurchase programs, privately negotiated transactions, accelerated share repurchase programs or a combination of these methods. The timing and amount of any repurchases will depend on legal requirements, market conditions, stock price, alternative uses of capital, capital availability and the company’s determination that share repurchases are in the best interest of our shareholders and other factors. We see this as a tool in the shareholder value toolbox and would note that the company is not obligated under the terms of the program to repurchase any of our common shares.

This fiber program is valid until June 30, 2024. And with that, I will give the word over to our Chief Operating Officer, Trym Sjølie.

Trym Otto Sjølie: Thank you, Ole. Over the years, we have changed both fleet composition and structure, and we now have 73 maritime assets in our portfolio and our backlog from owned and managed shipping assets stands at $3.6 billion. The current fleet is made up of 15 dry bulk vessels, 36 container ships, 13 tankers, 2 drilling rigs and 7 car carriers with 3 around the water and 4 are under construction in China. The new buildings are scheduled for delivery over the next 10 months starting in September. We are involved from having a single asset class charter to 1 single customer to a diversified fleet and multiple counterparties. And the fleet composition has varied from originally 100% tankers via majority offshore assets 10 years ago, 2 container vessels now being the largest segment with just under 50% of the backlog.

We are now a maritime infrastructure company. Most of our vessels are on long-term charters, but we have over the last 8, 10 years, completely transform the company’s operating model and have moved away from financing type bareboat charters and instead assume full operating exposure, which makes us relevant for large industrial end users like, for example, Volkswagen, Maersk, Exxon and others. In the second quarter, 92% of charter revenues from all assets came from time charter contracts and only 8% from bareboats or dry leases. In addition to fixed rate charter revenues, we have had significant contribution to cash flow from profit share arrangements over time, both relating to charter rates and cost savings on fuel. Last 12 months, the aggregate profit share has been more than $25 million.

Out of the current 73 vessels, we have 13 on bareboats contracts and 60 on charter and spot trading. Our operation is quite complex with vessels across multiple sectors. We have our own commercial operation out of Oslo and operational management out of Singapore and Stavanger. Our OpEx philosophy is to continuously invest in our fleet to optimize the vessel’s performance and maintain a high level of service to our customers. This includes investing to minimize off hire as well as investments to increase cargo carrying capacity and reducing energy consumption. This has become increasingly important with the implementation of IMO carbon intensity indicators, which will impact vessels’ operational profile, including routing and speed. In Q2, we had a total of over 6,000 operating days defined as calendar days less technical off-hire or off-hire for drydocking.

Our overall utilization across the fleet is 99.4% in Q2, a number we are continuously striving to maintain as high as possible. Net charter revenue from our fleet was $174 million in Q2, and our OpEx in the quarter was $38 million. One of the key metrics for SFL is the reduction of carbon emissions by improving our fleet weighted average AER or Annual Efficiency Ratio. AER as a carbon intensity indicator is a measure of how carbon-intensive our fleet is by calculating the emissions per actual capacity and distance sales. While the MARPOL Convention, IMO have implemented requirements for reducing carbon intensity of all ships larger than 5,000 gross tonnes from 2023 onwards. The requirement to obtain an acceptable CII rating will be gradually stricter each year towards 2030.

Such requirements can either be met by fleet renewal, increased efficiency of existing fleet or a combination of both. Although CII compliance is certainly challenging, SFL is well positioned to manage IMO’s trajectory towards 2030. As part of our fleet renewal program, we have 4 LNG dual-fuel car carriers under construction in China that when entering into service will be among the most modern and efficient ships in the car carrier market. On the energy efficiency front, we have carried out an investment program for all vessels in our fleet, including energy-saving devices and technology to capture and analyze data from onboard sensors for real-time performance management and voyage optimization. Furthermore, we are cooperating closely with several of our key charterers on further vessel upgrades.

The scope includes exhaust gas scrubbers, cargo intake boost, all modifications, new propellers and propeller fixtures as well as enhanced antifouling systems. We also collaborate with key charters on data integration for more optimal weather routing and performance management. In addition to reducing carbon emissions, we believe these investments will make our vessels more attractive in the market when the vessels are either up for redelivery of potential charter extensions. And with that, I will give the word over to our CFO, Aksel Olesen, who will take us through the financial highlights of the quarter.

Aksel Olesen: Thank you, Trym. On this slide, we have shown a pro forma illustration of cash flows for the second quarter. Please note that this is only a guideline to set the company’s performance and is not in accordance with U.S. GAAP and also net of extraordinary and noncash items. The company generated cash flow gross charter hire of approximately $174 million in the second quarter, including approximately $2.2 million of profit share, with approximately 92% of the revenue coming from our fixed charter rate backlog, which currently stands at $3.6 billion, providing us with strong visibility on the cash flow going forward. In the second quarter, the container fleet generated gross charter hire of approximately $90 million, including approximately $2 million in profit share related to fuel savings on 7 of our large containers.

Our tanker fleet generated approximately $35 million in gross charter hire during the second quarter, compared to approximately $47 million in the previous quarter. Charter hire from our vessels strain in the spot market in the second quarter was $2.2 million, compared to $10 million in the first quarter, following the sale and delivery of the 3 remaining spot vessels during the second quarter. Consequently, we do not expect any contribution from tankers trading in the spot market from Q3 onwards as well as remaining 13 tankers are employed on long-term contracts with high-quality charters. The company has 15 dry bulk carriers, of which 8 were employed on long-term charters during the quarter. The vessels generated approximately $24 million in gross charter higher in the second quarter.

Seven of these vessels were employed in the spot and short-term market and contributed approximately $7.2 million and charter hire during the quarter, compared to approximately $4.6 million in the previous quarter. SFL owns 2 harsh environment drilling rigs, the jack-up rig Linus and the semisubmersible rig Hercules. The Linus is current on a long-term contract with ConocoPhillips Skandinavia until the end of 2028. During the second quarter, the rig generated approximately $19 million in contract revenues, in line with the first quarter. As in the first quarter, we recorded operating expenses on Hercules, which were approximately $7 million. Furthermore, there has been no revenue from the Hercules during the quarter due to special periodic survey and upgrades, which were completed in mid-June before the rig mobilized to Canada to commence the drilling contract with Exxon Canada.

Although the Hercules commenced mobilization towards Canada in mid-June, we recorded no revenue in the second quarter due to U.S. GAAP accounting standards for drilling service contracts, which recognize revenue only from the drilling commencement date. Accordingly, mobilization and demobilization revenue and cost for Exxon contracts will therefore be amortized over a drilling base in the third quarter and recorded in the Q3 P&L. And finally, our 3 car carriers generated gross charter hire of approximately $6 million during the second quarter, including approximately $200,000 net profit share related to fuel savings on one of the vessels. Our operating and G&A expenses for the quarter was $68 million, compared to $75 million in the previous quarter.

This summarizes to an adjusted EBITDA of approximately $ 109 million [sic] [$100.9 million] in the second quarter, compared to $110 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. So 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 type, direct financing leases and leaseback assets and revenues from some entities classified as investment in associate for accounting purposes.

So the second quarter report total operating revenues according to U.S. GAAP of approximately $165 million, which is less than approximately $174 million of charter hire actually received for the reasons just mentioned. During the quarter, the company recorded profit share income of approximately $2.2 million from fuel savings from some of our large container vessels and a car carrier. And we recorded nearly a full quarter of operating expense on Hercules, we did not record any revenue on the rig duties temporary or state. And as just mentioned, revenue from the Hercules were due to U.S. GAAP accounting standards we recognized only from the drilling commencement date and has been reflected in our P&L in the third quarter. Furthermore, the net results were impacted by nonrecurring, noncash items, including a gain from the sale of the Suezmax tanker Everbright of approximately $6.4 million.

A net positive mark-to-market effect of $1.9 million, a negative mark-to-market effect from equity investments of $1 million and a decrease of $200,000 on credit loss provisions. So overall, and according to U.S. GAAP, the company reported a net profit of approximately $17 million or $0.13 per share. While reporting on the transitional quarter, it’s worthwhile to mention that we expect revenue to increase from Q3 onwards as we will record a first quarter of revenue from the Hercules rig following the commencement of the Exxon contract in July. Also, we expect revenue effect from our 4 car carriers newbuildings to be delivered during the next 3 quarters. In addition, the new 3-year charter for 2 car carriers, Composer and Conductor will commence in Q4 and Q1.

We estimate EBITDA from these to be approximately $47 million per year, significant increase on existing contracts, which was approximately $9 million per year. Moving on to the balance sheet. At quarter end, SFL had approximately $201 million of cash and cash equivalents. Furthermore, the company marketable securities of approximately $5.9 million based on market prices at the end of the quarter. In June, SFL has not filed about the purchase option on VLCC on bareboat charter, which the delivery is to take place at the end of August. A $10 million positive cash effect is expected after repayment of debt – secured debt relating to the vessel with a corresponding book gain of approximately $2 million to be recorded in the third quarter. In May, the company announced $100 million share back program.

So far, the company has acquired approximately 1.1 million shares at an average price of approximately $9.27 per share. During the quarter, SFL refinanced the drilling rigs Hercules and Linus in 2 separate loan facilities with $150 million per rig. The refinanced Hercules and Linus loans have matured in the fourth quarter of ‘25 and in the second quarter of ‘26, respectively. Furthermore, the company arranged 2 JOLCO for 2 existing vessels, the car carrier Arabian Sea and the container vessel Maersk Pelepas. The financings are secured at very attractive rates with matching maturities that match the long-term chartering contracts, another net positive cash flow effect of $180 million in the second quarter as the vessels are debt free. The outstanding capital expenditure of $194 million on our car carriers under construction, of which the first vessel is expected to be delivered during the third quarter has been secured to JOLCO arrangements.

And during the second quarter, we drew down $33 million on a predelivery facility with respect to the 2 last car carriers under construction. The remaining CapEx to be paid for a special periodic survey and upgrades on the Hercules, which now is completed, will be funded with cash on hand. And the same goes for the outstanding amount of approximately $48 million, maturing in September. So based on the Q2 numbers, the company has book equity ratio of approximately 27.6%. Then to conclude, the Board has declared a cash dividend of $0.24 per share for the quarter. This represents a dividend of approximately 9% based on the closing share price yesterday. In May, the company announced $100 million share buyback. And so far, the company’s acquired approximately 1.1 million shares for a price of approximately $9.27 per share.

Our fixed charter rate backlog currently stands at $3.6 billion, which provides us with strong visibility on the cash flow going forward. The latest financing facilities concluded the company’s new building and capital expenditure program is now fully financed materially all of the short-term debt is refinanced with new long-term loss. In summary, SFL has secured new financing arrangements so far in 2023 in excess of $1 billion. The amount is split across 12 different facilities and a wide array of products, securing a continued well diversified funding platform for the company going forward. Furthermore, with the recent contract awards for 2 car carriers in contract with Volkswagen with commencement in Q4 and Q1, the estimated EBITDA from these vessels is approximately $47 million per year, a significant increase from existing contracts, which was approximately $9 million per year.

Finally, we announced a new contract award for a harsh environment semisubmersible drilling rig, Hercules, confirming a tightening supply-demand balance and a strong market outlook, which is now materializing in attractive day rates and a strong cash flow generation. And with that, we conclude the presentation and move on to the Q&A session.

A – Marius Furuly: Thank you, Aksel. We will now open up for a question-and-answer session. For those of you who are following this presentation through Zoom, please use the raise hand function to ask a question. When your name is called out, please unmute your speaker to ask your question. Thank you. And we will have our first question from Richard Diamond. Please unmute your speaker to ask your question.

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Q&A Session

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

Ole Hjertaker: Well, yes, you can say with the newbuilding prices coming up, a very substantial, both on the back of full order book at the shipyards, where they now also start to actually make a little bit of profit instead of losing a lot of money as they used to do. You also have inflation in both the raw material cost that goes into building the ship and, of course, labor building it. Which means that when the ownership typically second-hand values over time will have – will be linked to newbuilding prices. So if we had sort of the old model where we were just sort of a financial leasing provider in the shipping space, we would typically have to give away purchase options in order to do deals. That’s what most people do when they are in that game.

And then, of course, there is a higher probability of those purchase options being exercised, and therefore, called away from us. So the good example here, we think is the existing car carriers we have if they have been on a more financial lease, the charterer would have exercised those purchase options because – but instead now, we can reach out of them at a much higher rate than we had in the first charters and that is, of course, goes straight to the shareholders. So I think rising newbuilding prices is definitely benefiting existing shareholders.

Richard Diamond: Thank you.

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

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

Aksel Olesen: So that is correct. So the line is on our contract with ConocoPhillips until the end of 2028 on the Ekofisk field on the northern side in the North Sea. As you correctly point out, the contract is adjusted semiannually, basically end of April and end of October. There is around just shy of $200,000 per day. For the time being in that market is still – is somewhat kind of neutral. So also going forward, at least we expect the day rate to stay in that region for the time being. But we also expect over time activity on Norwegian continental shelf to increase and that could potentially then reflect in a higher contribution from the rig.

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

Trym Otto Sjølie: So the cash contribution from new buildings is still – it’s considered substantial, I would say, especially for the first 2 vessels coming where we will have an initial voyage there. But I think…

Ole Hjertaker: Well, yes, I mean, we do not disclose sort of contribution per vessel on an individual basis. So as Trym was pointing out, first, as you delivered, first, we will have a voyage from Asia to Europe, where the vessels will then be delivered to Volkswagen. The spot market for car carriers right now is super hot. So we will have a very – hopefully, a very significant contribution on the voyage from Asia to Europe. Market is currently quoted well in excess of $100,000 per day. So with an OpEx of around $6,000 per day for similar vessels like this, needless to say, there’s a lot of cash flow coming there. And then they will commence the 10-year charters at the pre-agreed charter rates. And that’s also when the new charter rate will kick in on the existing vessels.

So we have several sort of elements coming in, but we haven’t provided full breakdown of that. But what we do have and give everyone access to once it is our full charter backlog where you can back out effectively the charter rates that are being generated by the vessels, also including the new builds.

Aksel Olesen: Exactly. So basically, if you look at I mean our strategies then to fix out these vessels on long-term charters with Conoco, call it, low teens returns on the equities, so the contribution will be accordingly. And for the financing, of course, that is fully financed, that will be drawn down on the 2 first ones in connection with 3 delivery, it is still – and the financing is form of Japanese operating leases at very attractive terms. I do not go into exact details on that. But of course, the margin provided is extremely attractive. So the blended financing is going then to be fixed up on delivery. And all in, considering kind of the long-dated financing, it’s far more competitive than the final traditional banking market.

Climent Molins: Makes sense. Final question from me. Looking at the second half of the year and into 2024, it’s clear that your cash flow will improve markedly. How should we think about potential dividend raises going forward? And secondly, how do you plan to balance that, so potential dividend raises with share repurchases?

Ole Hjertaker: Yes. So I mean we, of course, see both as shareholder – returning capital effectively to shareholders direct and indirect. Our aim is, of course, and what everything we do is focused around building the distribution capacity to shareholders. But we never communicate – we never give sort of guidance on what the dividend will be in the next quarter or quarters after that. But typically, when we have seen in the past, usually, when we increase dividends, we managed to stay there. and also the Board, an important piece of, call it, the Board deliberations around the dividend every quarter is the long-term sustainability of the dividend level sort of being discussed. You’re correct, third quarter onwards will have significantly more cash flow hopefully than first and second quarter.