SFL - Q4 2022

Transcript

Operator (participant)

Good day and thank you for standing by. Welcome to the fourth quarter 2022 SFL Corporation earnings conference call. At this time, all participants are in listen only mode. After the speaker's presentation, there will be the question and answer session. To ask a question during the session, you will need to press star one one on your telephone keypad. You will then hear an automatic message advising your hand is raised. To withdraw your question, please press star one one again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to a speaker today, Ole Hjertaker. Please go ahead.

Ole Hjertaker (CEO)

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, would also be present in the question and answer session. Before we begin our presentation, I would like to note that the total charter revenues were, which was up 17% compared to the third quarter. The majority of the revenues were from vessels and long term charters, and around 16% for vessels employed on short term charters and in the spot market. The EBITDA equivalent cash flow in the quarter was approximately $135 million, which is up 7% from last quarter.

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 up from the third quarter, where it 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.

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 after recent acquisitions and charters, providing continued cash flow visibility. 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 original 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 costs 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 be available for new contracts from mid the 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. Market analysts are positive to market prospects 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. 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 built Suezmax tanker. This vessel has been trading in the spot market for a number of years now. We are taking advantage of a strong tanker market which is also reflected in the value. This is in line with our strategy of selling older vessels and reinvesting in newer and more fuel efficient vessels. Net cash proceeds has been estimated to approximately $23 million after repayment of associated debt. We expect a book gain of approximately $5 million this quarter. Over the years, we have changed both fleet composition and structure. 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. 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. In the fourth quarter, 93% of charter revenues from our shipping assets came from time charter contracts and only 7% from bareboat and 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 out, 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 a portfolio and quantify our contracted backlog. The list speaks for itself with market-leading operators like Maersk, Hapag-Lloyd, ConocoPhillips, P66, Volkswagen, and now 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 deal flow opportunities, such as the repeat business we've 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 end to full service time charter, which we are doing more of. With full control over vessel maintenance and performance, including energy efficiency and emission minimizing efforts, we can impact improvements to our vessels through the life of the assets and not only be passively owning vessels employed on bareboat where the customers may not always have an incentive to make such improvements.

In addition, we can retain more of the residual value in the assets when we charter out on time charter basis. 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. 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 (CFO)

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 US GAAP and also net of extraordinary and non-cash items. The company generated gross charter hire of approximately $208 million in the fourth quarter, including approximately $7 million of profit share, with 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 for 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 7.3 years if weighted by charter hire. Our charter backlog includes approximately half a 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 shorter 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 with total consideration of approximately $39 million. Net cash proceeds to SFL after repayment of associated debt is estimated to be approximately $23 million, and they expect to record an accounting gain of approximately $5 million in the first quarter. The company has 15 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 6 vessels in the previous quarter.

SFL owns two harsh environment drilling rigs, the 2014 built jackup rig, Linus, and the 2008 harsh environment semi-submersible rig, Hercules. The Linus is currently under long-term contract to ConocoPhillips Scandinavia until the end of year 2028. 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. The aforementioned 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 Linus.

In addition, we had higher than normal operating expenses for shipping fleet due to vessel deliveries during the quarter. Other income of approximately $2 million is primarily derived from interest income from financial investments. This summarizes an adjusted EBITDA of approximately $135 million in the fourth quarter compared to $126 million in the previous quarter. We move on to the profit and loss statement as reported on the US 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. Therefore, a significant portion of our charter revenues are excluded from US GAAP operating revenues.

This includes repayment of investment in sales-type, direct financing leases and lease back assets, and revenues from entities classified as investment in associates for accounting purposes. 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 catch-up payments for previously reduced charter hire from Seadrill during Chapter 11. Furthermore, the company 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.

The company recorded a $2.9 million gain related to positive mark-to-market effects related to equity and debt investments, a decrease of $400,000 in credit loss provisions. Finally, the company recorded a $1.4 million gain related to positive mark-to-market effects related to interest rate swaps. At quarter end, approximately 70% of our financing was fixed rate or swaps to fixed by financial hedging instruments. With the recent raise in interest rates, we now see the benefits of a conservative financing strategy. Similar to our charting 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% increase in interest rates from current levels equals approximately $0.02 per share in lower distributable cash flow per quarter and vice versa. When evaluating new investment opportunities with a conservative approach when assuming the interest rate cost during the life of the project, we generally seek to fix the interest rates back to back with the 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 shipping fleet due to many vessels deliveries during the quarter. Overall, according to US 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 markable securities of approximately $7 million based on market prices at the end of the quarter. In addition, the company had seven debt-free vessels at quarter end with a combined charter fee value of approximately $180 million based on average broker appraisals. During the fourth quarter, the company entered into long-term financing arrangements for two 14,000 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 Supramax 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 convertible notes due in May 2023, and approximately NOK 40 million equivalent in Norwegian kroner is current outstanding under bond due in September 2023. At the end of the quarter, SFL has four LNG dual-fuel car carriers under construction for delivery in 2023 and 2024. The remaining capital expenditures related to yard installments was approximately $210 million at quarter end. The majority of this is expected to be financed by debt facilities in due course. Based on the Q4 numbers, the company had a book equity ratio for approximately 28.3%. To conclude, the company has delivered another strong quarter with growth in both revenues and EBITDA.

The board has declared the 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. We recently raised a $150 million senior unsecured sustainability-linked bond, which, together with cash and balance sheet, addresses the upcoming maturities in the convertible note in May and a note bond due in September. Our fixed charter rate backlog currently stands at $3.6 billion. After adding $1.4 billion in 2022, it provides the strong stability on our cash flow going forward.

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

Operator (participant)

Thank you. As a reminder to ask a question, you need to slowly press star 1 1 on your telephone keypad and wait for a name to be announced. To withdraw your question, please press star 1 1 again. Please stand by while we compile the Q&A roster. This will take a few moments. Now we're going to take our first question. The first question comes from the line of Chris Wetherbee from Citi. Your line is open. Please ask your question. Excuse me, Chris, your line is open. We're going to take the next question. The question comes from line of Greg Lewis from BTIG. Your line is open. Please ask your question.

Greg Lewis (Managing Director)

Yes, thank you and good afternoon, everybody, and thanks for taking my questions. Ole, I did have a couple questions around, you know, the rigs you mentioned. You know, you mentioned the $80 million of rig CapEx ahead of the contract with ExxonMobil. You mentioned upgrades about potentially long-term work. As we, you know, as we think about the Hercules, it's, you know, it's a 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?

Aksel Olesen (CFO)

Absolutely. Thanks for calling in. You know, what can we say? 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 drilling functionality, and then you have the platform itself, or you can say the marine piece, which is really sort of stable, it sits stable in the water while under drilling operations. You have relatively few drilling rigs with a steel quality, and that needs to be built from the yard side.

It's gotta 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. It has been drilling, you know, 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, will have to be, you know, renewed, call it painted, you know, parts changed, you know, generators need to be overhauled. I mean, this is sort of normal procedure.

The difference with a drilling rig and a normal ship is that a ship is basically like a big bathtub with a small engine in the end, that you push through water, and a drilling rig has a lot more equipment and a lot more high value equipment on board.

Ole Hjertaker (CEO)

You know, as a consequence, as you go through your scheduled maintenance, there is more work to be done. You know, while, you know, we cannot give you a sort of a full breakdown on a, on element by element, but I would say that you have one piece which is just regular, you know, standard maintenance. You have, you know, some upgrades that are relating to, you know, as we've 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 drillings, where we can see more, you know, you know, no. Yeah. If you look at the, sort of the... Daniel, you also have some upgrades relating to specific contracts. For instance, you know, for this, you know, contract in Canada, there is around $6 million of upgrades that needs to be done. And really to qualify for call it requirements in Canadian waters for this specific drilling rig as an example. 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, you know, 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've been through a period where this whole segment has been under the weather, I would say, since 2014, 2015 when the market came down. That also, you know, that's not only for the drillers themselves, but also for anyone in, involved in that value chain, be it, you know, parts suppliers and equipment manufacturer and everyone.

Now when things are really revving back up, you know, you not only have a sort of a, you know, of course, costs to look to make sure you can manage, but also facilitating all the parts in time, for, you know, the drilling, you know, activities that you're going to do. That is also, you know, important piece here to actually get everything you need in time. What we are looking at, and this is with any drilling rig or any equipment over time, you know, as things, you know, with time, you know, you have to replace equipment. You know, sometimes you have equipment where the manufacturer cannot longer service it because of, from a timing perspective.

That is also something that is going into the overall cocktail.

Greg Lewis (Managing Director)

Yeah.

Ole Hjertaker (CEO)

The other side of this is cashflow potential on these drilling rigs. You know, 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 cashflow, you know, EBITDA cashflow per year, you know, relating to that contract. Yes, they are expensive to upgrade and maintain and take through special surveys, but there's also very significant cashflow potential when these rigs work in a recently hot market.

Greg Lewis (Managing Director)

Yeah. No doubt about it, especially where rates are. I, you know, not that I wanna spend all the time talking about the offshore rigs, but I think it is somewhat, you know, as people think about SFL and as we, you know, try to, you know, think about the dividend, that's obviously important to us and investors and obviously SFL as well. You know, I guess in previous years when the, you know, the rig market, like you mentioned, was in a 6-7 year downturn, it was. You know, the assets maybe weren't as viewed as core to the portfolio.

Really, you know, I guess what I'm trying to understand is, as we think about potential for the offshore rigs to be additive to the dividend, you know, maybe a six or 12-month contract on the Hercules doesn't make it additive to the dividend. Like is that a fair way to think about it? Where maybe if the rig is on a multi-year contract, generating cash flows, obviously paying back the, you know, 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? Should we be thinking about cashflow 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 (CFO)

Yes. Thanks for that. I'll make an attempt to answer that. I think as you see on both rigs, to start with the Linus, it has a long-term contract which is market linked. I think as you know, work ourselves through 2023, and we see the market expectations for 2024 and 2025, I think that's when should expect to come in to call it distributable cash flow from the rigs in terms of kind of contributing to the dividends. I think that's kind of the timeframe we're looking at. I think if the Linus is covered, it's reset every six months, that's positive. You basically have a interesting supply demand for that type of rigs in the North Sea, with many rigs leading as well.

Also same with the semis. We've seen many semis migrating out on the international market, where you actually see now higher day rates in than in the North Sea. You see, you have a lower OPEX. You have more term business. That's really when you can see, get visibility on that, you know, we can guide on more precise guidance on kind of the cash flow actionable to support the dividend. We think indeed it looks very interesting.

Ole Hjertaker (CEO)

Yeah.

Greg Lewis (Managing Director)

Okay, great.

Ole Hjertaker (CEO)

maybe also to add on that. I mean, if you look at the e-expense, of course it's an investment as you take it through this SBS. 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. 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. There may be actually be cash, you know, coming out of those.

From that perspective, you know, this is something that we have, I would say, been prepared for quite a while and, you know, 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. The distribution capacity long term.

Aksel Olesen (CFO)

Yeah.

Greg Lewis (Managing Director)

Yeah. No, 100%. Just kinda pivoting more to, you know, bigger picture how we should think about lease yields and, you know, and really, you know, your returns. I mean, clearly interest rates have gone higher. You know, is, you know, 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. It looks like we've seen some crackdowns, we'll just say it in Asia around some leasing companies deploying capital across the maritime space. Is there any shakeout where we could see, you know, returns for SFL, you know, 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? You know, should we be thinking about that as neutral at best?

Ole Hjertaker (CEO)

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 could say that those are becoming more competitive in a way because as we have seen it over time, you know, 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, you know, call it use those, call it financing services, you know, they could otherwise go to the bank and borrow at a floating rate, which was lower. That has not come up.

From our perspective, I mean, we focus more on time charter contracts because then we have more direct interaction with the end users. Also if you look at the way we have sort of managed interest rate risks over time, we have tried to hedge that out. When we do a deal, we structure the financing and then we hedge the interest rate generally. Which means that, you know, when they come up for rechartering, yes then we have, I would say, you could call it. Then we have an interest rate exposure, but charter rates also have an element of interest embedded in themselves because for anyone who wants to charter out a vessel, you know, they will have to take into account their financing costs at that time.

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. We're 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, you know, less than $1 billion, you know, 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.

We're screening a lot of deal opportunities and try to be disciplined and, but then selective when we do deals.

Aksel Olesen (CFO)

Yeah. 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 only improved over last year. I think with our name, track record, I think we're able to achieve extremely competitive financing. As Ole alluded to the kind of the limitations you see in the Chinese market is you could argue it's kind of a more bareboat type financial providers which we could just have been competitors to us, although we haven't done bareboats. I think kind of the financing market there has is now smaller and that potentially gives us more opportunities.

Greg Lewis (Managing Director)

Okay. Super helpful. Thanks for the color.

Ole Hjertaker (CEO)

Yeah. Thank you.

Operator (participant)

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 (CEO)

Thanks. I would like to thank everyone for participating in this conference call. 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 (participant)

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