SFL - Earnings Call - Q1 2019

Transcript

Speaker 0

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to today's First Quarter twenty nineteen Ship Financials International Limited Earnings Conference Call. At this time, all participants are in a listen only mode. There will be a presentation followed by a question and answer session. I must advise you that this conference is being recorded today, Tuesday, May 21.

And now I would like to hand the conference over to one of your speakers today, Ulle Gestache. Please go ahead.

Speaker 1

Thank you, and welcome, everyone, to Ship Finance International and our first quarter conference call. With me here today, I have our CFO, Axel Olesen and Senior Vice President, Andre Ratbe. I will start by briefly going through the highlights for the quarter. And following that, Mr. Wollison will run us through the financials.

And as the operator indicated, the call will be concluded by opening up for questions. Before we begin our presentation, I would like to note that this 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.

These statements are based on our current plans and expectations and involve 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 conditions in the shipping, offshore and credit markets. For further information, please refer to Ship Finance's reports and filings with the Securities and Exchange Commission. The Board has declared a quarterly dividend of $0.35 per share. This is our first quarter with profits and dividends, and the dividend represents $1.4 per share on an annualized basis or nearly 11% dividend yield based on the closing price yesterday.

Over the years, we have now paid more than $25 per share in dividends or more than $2,100,000,000 in total, and we have a fixed rate charter backlog of $3,800,000,000 which should support continued dividend capacity going forward. The reported net income for the quarter was approximately $34,000,000 or $0.31 per share. This is from total charter revenues of around $160,000,000 primarily from vessels employed on time charter and includes a small profit split on the tankers. The EBITDA equivalent cash flow in the quarter was approximately $125,000,000 and last twelve months, the EBITDA equivalent has been approximately $480,000,000 The last twelve months have been very active in multiple transactions. We have grown our backlog by more than $1,300,000,000 and seen a major change in the fleet mix.

As a consequence of this, the EBITDA is up 25% compared to the same period last year. During the first quarter, we have agreed to extend the charters for two five thousand eight hundred TEU container vessels by five years, but added a purchase obligation at the end. In addition, four four thousand one hundred TEU vessels were extended by two years. All these vessels are chartered on bareboat basis to MSC. Subsequent to quarter end, we have also agreed to extend the charters for four eight thousand seven hundred TEU container vessels chartered on time charter basis to Maersk, and these charters will now expire in 2024 and 2025.

Combined, these adjustments added more than $170,000,000 to a fixed rate backlog and our aggregate backlog stands on the same level as at the end of the previous quarter. Following the high deal flow in the fourth quarter, the first quarter was more of a housekeeping quarter for us where several of the near term debt maturities were addressed. We paid down a Norwegian kroner denominated bond loan, as Mr. Olesen will discuss later, and we have virtually no further refinancings due until mid-twenty twenty. I would also like to highlight the position relating to the new maritime regulations focused on reducing pollution at sea to be implemented in 2020.

In order to be able to continue using lower cost high sulfur fuel oil or so called HSFO from 2020, vessels will have to be upgraded with exhaust gas scrubbers. The alternative is to use more expensive low sulfur fuel. And based on the forward curve we see today, price difference is currently priced at around $200 per ton next year. Depending on vessel size and scrubber configuration, a scrubber installation may cost around 2,500,000.0 to $7,000,000 per vessel, which which is a significant expense, particularly for smaller vessels. But payback could be short at the current spread levels, particularly for the larger vessels.

For vessels on bareboat and time charter, our customers pay for the fuel and will therefore benefit from the savings in fuel cost by installing a scrubber unless we agree to a profit share arrangement. For vessels in the spot market, the benefit will go to us. Given the added revenue potential for vessels with this equipment, we also expect that it will positively impact vessel valuations. Currently, 25 vessels in the fleet are scheduled to be upgraded with scrubbers, primarily in the container sector, but also larger crude oil tankers and dry bulk vessels. Based on discussions with our customers, this number may increase going forward.

For the vessels on long term charters, most of these investments will be covered by our charters, but in some instances, we may look at funding such investments against an adjustment to the charter rate, generating a proper return on our capital or alternatively a profit sharing model where we fund all or a part of the installation in exchange for an appropriate share of the gains of using lower cost fuel. We have also agreed to install scrubbers on for around cost and benefit on our two Suezmax crude oil tankers. From our side, upgrading vessels with scrubbers is as much a defensive move than an offensive. Worst case, if price difference should be smaller than analysts project and what is priced in the current forward curve, it may not be as profitable as one could hope for. But if there is a real market disruption as some think there will be, the gains could be formidable with very short payback time on equipment and a corresponding increase in asset values.

And an added benefit is the expected higher number of vessels out of service due to these upgrades, which should lead to a firmer market in most segments, everything else equal. Analysts estimate up to 3,000 vessels to be operated with scrubbers over the next twelve months, and it could take three to four weeks out of service to do the job. Currently, our capital commitments are limited to $26,000,000 but could increase over the next few months. Given the increased expected charter hire, we believe a significant portion of such investments can be financed and thereby limit our own net investments. Following the recent charter extensions, our charter backlog now stands at approximately $3,800,000,000 The bulk of transactions last year was related to container vessels, so the liner segment now represents more than 50% of our backlog, up from around thirty eight percent twelve months ago.

Our focus in the liner segment has primarily been on new design container vessels between 9,019 TEU, and we continue to see opportunities in the segment as illustrated by the acquisition in 2018, adding $1,300,000,000 to the backlog. In addition to the charter extensions mentioned earlier, we also recently chartered out two car carriers to Globus for a twelve month period. Due to the relative shorter nature of this charter, it is not included in the backlog figures. Up until 2017, the Offshore segment was our largest segment for a long period, but is now down to 26% of our charter backlog, down from 34% only one year ago. And as we can see from the slide on Page five, the backlog is only half of the backlog from the liner segment.

SFL received full charter hire on the drilling rigs on charter to Seadrill during the restructuring in that company, which enabled us to significantly reduce our financial exposure to the rigs in that period. We have agreed to temporarily reduce charter hire by 30% until 2022 with a catch up thereafter. And in the meantime, we will continue to generate strong net cash flow from these assets due to significantly reduced leverage and corresponding lower debt service costs. Seadrill has sub chartered the harsh environment jack up rig West Linus to ConocoPhillips until the end of twenty twenty eight. The harsh environment semisubmersible rig West Hercules has recently been awarded multiple consecutive sub charters in the North Sea and is now working for Equinor.

And including the West Linus, we have reduced the debt from $1,900,000,000 initially on the Seadrill rigs to less than $650,000,000 currently, And of this aggregate outstanding loan balance, only $266,000,000 is currently guaranteed by SFM. On the dry bulk side, we have 22 vessels in the fleet with 13 larger vessels chartered out on a long term basis and seven Handysize vessels and two Supramax bulkers traded in the spot market. One of our long term objectives is to combine stability and predictability in cash flows with operational agility, and we have seen over time that market volatility can generate super returns from time to time. We have a 33% profit split on top of the base rate of $17,600 plus interest adjustment or around $18,600 currently. This is above current market levels and we did not earn a profit split this quarter, but there are still many quarters left on the charter and there could be good opportunities to earn profit splits down the road.

The Kamsarmaxes and most of the Supramaxes are all on long term fixed rate time charters, while the seven Handysize dry bulk carriers continue to trade in the spot market as do two of the Supramax porters. The rates achieved this quarter for the Handysize vessels were approximately $5,900 per trading day, which was down from approximately $8,500 per day in the previous quarter. For the tankers, in the first quarter, the crude oil tanker markets benefited from high fourth quarter rate levels and good charter coverage going into the quarter. Rates across the segment fell slightly through the quarter, and part of the reason for that was a number of newbuildings that were delivered in the period. Rates did pick up again towards the end of the quarter, but softened again subsequent to quarter end.

But despite the relatively soft market, the share price of many tanker companies have surged lately. We believe that is partly due to the expectations effects of the implementation of the IMO 2020 regulations, which is expected to drive both increased demand and tightening supply in the segment. And market analysts expect a positive sentiment going into the third and the fourth quarter of the year. In the first quarter, the remaining VLCCs on charter from Frontline Shipping Limited generated around $27,600 on average per day, which was above the base rate, so a profit split of approximately $1,000,000 was accumulated. In addition to the VLCCs, we also have exposure to the crude oil tanker market through our two modern Suezmax tankers, which are traded in a pool with sister vessels owned by Frontline.

For these vessels, the average charter rate in the quarter was approximately $25,700 per day, which was up from the $17,500 in the previous quarter. And lastly, I would like to highlight that in the first quarter, 62% of revenues derived from time chartered vessels, while only 38% derived from bareboat chartered vessels and rigs, which may be a surprise to many. We believe we can offer superior service and flexibility to our customers, giving our access to more deal flow than if you focused on one operating mode only. And with that, I will give the word over to our CFO, Akce Olesen, who will take us through the numbers for the quarter.

Speaker 2

Thank you, Mr. Jakarty. On this slide, we have shown the pro form a illustration of cash flows for the first quarter compared to 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 work expenses, extraordinary and noncash items. Total charter hire for the first quarter was 155,000,000 up from $154,000,000 in the previous quarter. On the tanker side, SSL has nine crude oil, products and chemical tankers, most of which are employed on long term charters. The vessels generated approximately $18,100,000 in charter hire in the first half quarter, including approximately $1,000,000 profit share contribution from our VLCCs on charter to Frontline. The charter hire from our tankers was up despite the investment of two VLCCs in the previous quarter as crude tanker rates benefited from solid Q4 rate levels and good charter coverage going into Q1.

On the liner side, SSL has a fleet of 45 container vessels and two car carriers. All of our container vessels are employed on long term fixed rate charters. The liner fleet generated approximately $81,400,000 in charter hire compared to $75,500,000 in the previous quarter. The increase in charter hire for the liner segment is firstly due to the two nineteen thousand four hundred TEU container vessels delivered in December 2018 to have the first full quarter of charter hire in the first quarter and generated an EBITDA of approximately 7,800,000.0 The vessels are chartered out for a period of fifteen years to MSC, the world's second largest container line. And secondly, a full quarter of charter hire from all of our three ten thousand six hundred TEU container vessels on long term charters to Maersk Drive.

These vessels generated an EBITDA of approximately $300,000 in the quarter and are chartered out for a minimum period of six years. The company owns 22 dry bulk carriers, of which 14 are employed on long term charters and nine of which are trading in the spot market. All of the charter revenues for SFL's drybulk carriage is derived from time and voyage charters, and SFL generated approximately $23,400,000 in charter hire from the drybulk vessels in the first quarter compared to approximately $28,400,000 in the previous quarter. The reduction in dry bulk revenues was due to lower revenues on the seven smaller Handysize vessels and two Supramax vessels trading in the spot market. As a consequence of the soft market sentiment in the first quarter, there was no profit share from our eight Capesize vessels on long term charters to Golden Ocean.

SFL owns three driven rigs and five offshore support vessels. All these assets are employed on bareboat charters and generated $33,200,000 in charter hire in the first quarter compared to approximately $35,300,000 in the previous quarter. The reduction is due to reduced revenues from our drilling rigs after the sale of our Jackal Bricks of Alma in the fourth quarter and scheduled reduction in charter rates on one of the serial rigs. This summarizes adjusted EBITDA of $124,400,000 for the quarter to $1.16 per share, which is in line with the previous quarter. We then move on to the profit and loss statement as reported under U.

S. GAAP. As we have described in previous earnings calls, our accounting statements are different from those of a traditional shipping company. 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 reflect revenues classified as repayment of investment in finance leases, results in associates and long term investments and interest income from associates. Overall for the quarter, we report total operating revenue according to U. S. GAAP of $116,500,000 which is a lower number than the $160,000,000 charter hire actually received we have now mentioned recently.

The reduction in U. S. GAAP operating lease charter revenues is mainly due to reclassification of the income of two container vessels where the charters have been extended with the purchase obligation and consequently been reclassified to finance leases. This is also reflected in the increase in charter revenue and the finance leases. Furthermore, SSL recorded a 10,500,000 gain on mark to market movement on our equity securities investments and a $2,000,000 loss related to mark to market movement on interest and currency hedging derivatives.

In addition, there were other noncash expenses of approximately $4,200,000 in the quarter, including amortization of deferred charges. So overall and according to U. S. GAAP, the company reported net income of $33,600,000 or $0.31 per share. Moving on to the balance sheet.

We showed approximately $164,000,000 of cash and cash equivalents, including $10,000,000 freely available cash in our subsidiaries accounted for as investments in associates. In addition, the company had marketable securities of approximately $96,000,000 based on market prices at the end of the quarter. This includes 11,000,000 shares in Frontline and financial investments in secured bonds and other securities. The change in investments in marketable securities is mainly related to the increase of the value of the Frontline shares. In March 2019, SFL paid approximately €124,000,000 to settle a unsecured NOK denominated bond issued back in 2014, including related cross currency and interest rate swaps.

This was funded from the company's available liquidity. During Q1 twenty nineteen, new bank financing for existing vessels in a total amount of €104,000,000 was arranged, increasing the cash position by $73,000,000 net. These vessels include three VLCCs, three supermax dry bulk carriers and two car carriers. In January 2019, the company repurchased $3,400,000 of its $164,000,000 convertible notes due 2023 at a discount, as we do from time to time. Net outstanding amount under note after repurchase is $148,000,000 Stockholders' equity was approximately $1,200,000,000 giving a book equity ratio of approximately 30% at the end of the quarter.

Then looking at our liquidity and financing status. As mentioned, we have total available liquidity of €164,000,000 at the end of the quarter, including $10,000,000 in our subsidiaries accounted for as investment in associates. In addition, we had available marketable securities, including 11,000,000 shares in Frontline. At quarter end, the Frontline shares had a value of approximately $70,000,000 However, based on Frontline's closing price yesterday, the shares had a value of approximately $102,000,000 Furthermore, had five debt pre aired vessels at the end of Q1 with a combined short charter revalue of approximately $6,000,000 based on average broker appraisals. At quarter end, SFL had a gross interest bearing debt of approximately $3,200,000,000 This includes approximately $1,600,000,000 in senior secured bank debt, approximately $128,000,000 in unsecured note bonds and approximately $360,000,000 in convertible notes.

In addition, we have approximately $1,100,000,000 of capital lease financing. As illustrated on this slide, we have a staggered debt maturity profile and fixed amortization of approximately €125,000,000 per year, including €110,000,000 in scheduled debt amortization and €65,000,000 in repayment of the debt element of lease payments. Our senior bank and leasing debt is secured in assets and upcoming maturities are to a large extent covered by high quality assets with moderate leverage based on asset age and contract backlog, enabling us to roll over the bank debt or alternatively, the balloon is covered by purchase obligation, thus reducing the overall refinancing risk. Our bonds and common work on us are senior unsecured, and SFL is a frequent issuer in the market and may tap this market if terms are deemed to be attractive. In this quarter, we have been proactive on the financing side and have virtually no refinancing requirements before June 2020.

Then to summarize. The Board has declared a cash dividend of $0.35 per share for the quarter. This represents a dividend yield of 10.8% based on the chosen price share price yesterday. Net income for the quarter was $33,600,000 or $0.31 per share. We have recently added approximately $170,000,000 in backlog increase to charter extensions and have a very robust liquidity position, which gives us substantial investment capacity as well as flexibility to act quickly on opportunities in the market.

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

Speaker 0

Thank you so much. Now ladies and gentlemen, we will begin the question and answer session. And the first question comes from the line of Chris sorry, if I didn't pronounce it correctly, Wetherbee from Citi. Please go ahead.

Speaker 3

Yes, that sounded good operator. Thank you very much. Thanks, guys. I guess I wanted to start a little bit on your thoughts on the container market and in particular, sort of the impact of some of the preparations for IMO twenty twenty that could be occurring over the course of the next couple of quarters. Do you get a sense that or can you give us a sense of what you think the sort of impact to capacity might be as some vessels are going to be fitted for scrubbers, but other vessels are going through sort of a tank cleaning process to get new lower sulfur fuel on board kind of in late 3Q or 4Q.

Will that have an appreciable impact? Do you think it has a benefit to rates?

Speaker 1

Yes. I think you have two levels, I would say, to that question. If you're a liner operator, you have your, call it, running expenses, think your vessels, which is either renting them, owning them yourself, running them and paying for the fuel. And the other is how can they get effectively a fuel surcharge from their customers. And I think generally most of the liner companies have positioned themselves to be quite to get a significant compensation for the expected increase in fuel costs come 2020.

But of course, as we all know, it's every dollar saved on the cost side goes straight to the bottom line. So therefore, several of the large container lines have focused on installing scrubbers. And most of the scrubbers that are committed on the vessels we own are containerships on long term charters to liner operators. Due to confidentiality clauses, we cannot specifically disclose which vessel it is. But I would say generally, it's the larger vessels where you see most of the, call it, fuel oil, COVID consumption.

And just to give you some sort of some feel for the numbers, with a forward rate currently of around $200 per tonne, you can see an annual saving for larger containerships, and this is by that, I'd say sort of around 9,000 TEU and up. You can see a payback time effectively of less than one year. A large container ships, say, 20,000 TEU, would consume around 35,000 tonnes per day on, I would say, normalized speed adjusted for days at sea, while sort of 9,000 to 10,000 would have a consumption of around 22,000, 23,000 tonnes per year. So matching that up with the savings, again, at these levels, we're talking, say, around $7,000,000 savings for a very large containership and maybe $4.5 ish saving on a 9,000 to $10,000 TEU share. So this can be very significant for the liner companies.

So the question is instead of course, if you are a liner company, how much of the fuel surcharge will you be able to keep for yourself? And how much of that will you have to share with your customers? And that is, of course, down to the competitive landscape. What I think we will see also is an added effect also in this segment because of the number of vessels that is expected to go in force for retrofitting and the time that it will take both during the actual job, but also the rotation effect of taking it out of service before it's started into service, you could see a significant utilization impact of this, which should also benefit, hopefully, on the cost side for these liner operators.

Speaker 3

Okay. That's helpful. And that last part kind of answers the question I was thinking about. And then in terms of your exposure in the SFL fleet on the container side through the rest of the year, can you give us a sense of what's available, what's open for re chartering? And do you think you have the opportunity to maybe take advantage or maybe extend duration on some vessels as you go through the end of twenty nineteen?

Speaker 1

Yes. The only vessels we have coming off in at the end of this year are two small feeders vessels, 1,700 TEU vessels that are coming off 12 charters. And while all the other vessels are chartered much longer, I would say all the bigger vessels are chartered well beyond 2019 and 2020, call it, period where we do expect to see most of the volatility or potential volatility in fuel oil prices. I would add that we are currently discussing also on vessels, call it, scrubber installations. And we can get scrubbers from, call it, what I would say, call it the premium makers.

We can get them ready installed in about six months' time. So the lead time here get this equipment installed may be shorter than at least some thought that would be if you go back around six months.

Speaker 3

Okay. Okay. That's very helpful. Thanks very much for the time. I appreciate it.

Speaker 1

Yes. Thanks.

Speaker 0

Thank you so much. And the next question comes from the line of Randy Yeviens. Please go ahead.

Speaker 4

Hello. This is Chris Robertson on for Randy. Thanks for taking our call. Just to clarify on the scrubbers, will any of the

Speaker 1

25 vessels have exposure

Speaker 4

to the spot market at any point during 2020?

Speaker 1

Yes. Of that, I mean, two of the vessels we are installing scrubbers for our own account on two Suezmax tankers. So they will be exposed to the spot market. And of course, fingers crossed, there will be, let me call it, sort of there will be some positive effects there relating to the fuel oil. Also, there will be also on two VLCCs, we have also doing some upgrades there, which we are doing in conjunction with Frontline on two vessels where we will benefit from the profit split above $20,000 per day with our proportionate share.

So but all the others are tied in on long term charters. And then it's really more a question of how do you share the costs and what's the return on capital if we are going to pay for it. Or as we have indicated, we are also open to discuss a profit sharing arrangement if we think that we can get a very good and, of course, a significantly higher return on our invested capital if the market the price volatility on fuel oil will develop as we think it will into next year.

Speaker 4

Okay. That's really good color. And then in terms of the cadence of the installations, are any being completed during the second quarter? Will all 25 be complete by January 2020? And kind of what's the pacing of the installations for the rest of the year?

Speaker 1

Well, I think right now, it's relatively few. I think on the vessels we have, the bulk of it will be in the second half of this year. And based on, what you say, our intelligence from the various shipyards, of course, is ramping up. You only have relatively few scrubbers installed generally in the market now. And there is an expectation for 2,000 installations during the year.

So it would be very interesting to follow and see what kind of efficiencies sort of these yards have and whether or not there will be delays in the installation. The equipment itself is not super sophisticated, I would say. It's a big shower system. Of course, you need to put the piping in right, and it needs to be configured right, so it does what it's supposed to. But of course, given the huge volume of these, there could be logistical issues in getting these scrubbers ready at the various yards that where they're going to install it.

And there could also potentially be a lack of, I would say, workers to do the job because the water in particular the wash water in particular is very acidous. So you have to be very careful with your with the material you use and also the craftsmanship of putting it in to ensure that you will it will not malfunction after a short time. So we are definitely going through very interesting times for and for engineers, this is it's the time of their life.

Speaker 4

Got you. Last question for me. On those charter extensions that you completed, were the charters extended kind of at a similar rate? Or were they readjusted based on the current market?

Speaker 1

Well, I think it's a combination of some at current rate and some at a slightly lower rate but for a longer period. So I would say not not really material sort of downward adjustments, but it's really more a reflection of vessel age and the length and the structure of the charters. I cannot give you specific details on each of them, but we will we are sharing, as always, our full charter backlog vessel by vessel, which you can get by e mailing us or either directly or through our web page, www.sflcorp.com.

Speaker 4

Okay. I'm going try to sneak in one last question, if you don't mind. You guys are largely insulated from the rate volatility associated with this U. S.-China trade War tensions going on. But in your opinion, kind of what does the containership market look like if a deal is reached this year versus no deal reached this year?

Speaker 1

Well, of course, it's a big question, isn't it? Because it is affecting, obviously, trade in general. And we don't have our own independent analysis on the detailed effects of that, call it, trade dispute. I do hope that it is relatively shorter in nature. When we make our investments, of course, we have a very long term view.

And hopefully, this is what I this is will end up being what I would call market noise more than a long term fundamental shift in world trade. But of course, all container lines will be affected if it is a very lasting effect, where you would expect to see lower utilization on vessels. And then as a consequence, most likely higher level of vessels taken out of service. But I do think that the vessels that we have concentrated our capital, which is sort of what we call new design vessels from around 9,000 TEU and upwards with a more optimal engine and hull configuration and with better fuel consumption parameters, will be the preferred units also through and after such, call it, market disruption, you can call it that. But so far, we are watching it, and it looks like it's something that's being played out over Twitter.

So we'll see how this goes.

Speaker 4

Got it. Appreciate the time. Thank you.

Speaker 1

Thank you.

Speaker 0

Thank you so much. And there are no further questions at this time, so please go ahead.

Speaker 1

Thank you. Then I would like to thank everyone for participating in our first quarter conference call and also thank the SFL team for their great efforts. We are committed to continue building the company, and we believe there will be good investment opportunities for us going forward with attractive riskreward profiles. 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 contract pages on our webpage, which is www.sflcorp.com. Thank you.

Speaker 0

Thank you so much. And that does conclude our conference for today. Thank you for participating. You may all disconnect.