SFL Corporation Ltd

Good day and thank you for standing by and welcome to the Q2 2021 SFL Corporation Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question and answer session. If you wish to ask a question, please press star 1 on your telephone keypad. For your information, this conference is being recorded. Now, I would like to hand the conference over to your speaker today, Ole Hjertaker. Please go ahead.

Thank you and welcome all to SFL's second quarter conference call. I will start the call by briefly going through the highlights of the quarter. Following that, our CFO, Aksel Olesen, will take us through the financials, and then the call will be concluded by opening up for questions. Before we begin our presentation, I would like to note that this conference call will contain probability statements within the meaning of the U.S. Private Securities Delegation Reform Act of 1995. Words such as expects, anticipates, intents, estimates and 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 with the Securities and Exchange Commission for more detailed discussion over risks and uncertainties, which may have a direct bearing on our operational results and our financial conditions. The announced dividend of 15 cents per share represents a dividend yield of around 8.5% based on closing price yesterday, and this is our 70th quarter with dividends, so it's a bit of a celebration from that perspective. Over the years, we have paid nearly $28 per share in dividends, or around $2.4 billion in total, and we have had an increasing fixed-rate charter backlog recently, supporting continued dividend capacity going forward. The total charter revenues was $141 million in the quarter, with more than 80% of this from vessels on long-term charters and less than 20% from vessels employed on short-term charters and in the sport market. The EBITDA equivalent cash flow in the quarter was approximately $103 million, and last 12 months the EBITDA equivalent has been approximately $424 million. The net income came in at around 20 million in the quarter or 16 cents per share. There were some one-offs in the quarter including a smaller impairment on a rig we are recycling and negative mark to market on interest hedging instruments. There was also a higher interest element in the quarter as we have already raised the capital to refinance the remaining 147 million dollars convertible note in October and have therefore around 2 million dollar extra interest charge in the second quarter and third quarter until it's paid down. There were also around $900,000 higher upgrading costs in the quarter due to additional crew rotation costs linked to COVID restrictions. Our fixed rate backlog has increased and stands at approximately $2.7 billion from owned and managed vessels after recent acquisitions and adjusted for the recent disposals. This has provided continued cash flow visibility going forward. The backlog excludes revenues from 16 vessels traded in the short-term market and also excludes future profit share optionality. In addition, we have excluded charter hire relating to the drilling rigs to be conservative in light of the ongoing financial restructuring in CEDRA. We are very pleased to continue to execute on our commitment to invest in assets and markets with a lower carbon footprint. We have spent a lot of time on evaluating various new technology initiatives that can improve performance of vessels, including our existing vessels on the water. In April, we agreed with the Volkswagen Group to build and charter out two new-built dual-fuel car carriers designed to use liquefied natural gas, or LNG, for propulsion, and today we announced an agreement to build two more vessels in the same series. The charter period for all these four vessels is 10 years from delivery in 2023 and 2024, and the transactions have added more than $400 million to the fixed-rate charter backlog, and importantly also added two very solid counterparties to our customer portfolio. We are not yet at liberty to disclose the name of the counterparty for the last two vessels, but we can say so much that it's a large investment-grade Asian-based shipping company, and we really look forward to working with them more closely and hopefully over time also develop more business opportunities with them. In addition to the car carriers, we have recently added two additional 14,000 TEU container vessels with charters to Evergreen. These are sister vessels to four vessels we already own and delivery is scheduled in just two to three weeks. In addition to the solid cash flow during the remaining two and a half years or so with Evergreen, a key attraction here is the rechartering position in 2023 and 2024 for fuel-efficient vessels we know are very attractive assets in the market. The purchase price is confidential, but I can confirm that it's significantly below current charter-free values reported by brokers. We have also agreed to acquire two modern 6,800 Tu vessels with long-term charters to Murskline. One of the vessels has been delivered to us already, and the second vessel is expected in a week's time, so we'll have good cash flow effect already this quarter. Total acquisition cost for these vessels is around $150 million, and with the rallying second-hand market, the chartery values are in fact already up 40-50% from the levels we required them at creating a nice buffer for us. With these vessels, we will have 15 vessels on charter to Maersk. All these vessels and also the Evergreen vessels and the car carriers are on time-charter terms where we are responsible for tactical management and vessels operation and therefore also have the direct interaction with the counterparties. Coincidentally, our customer MSC has exercised purchase options for 18 vintage feeder vessels. Due to the age of these vessels, the deal structure was bearable charters with no technical risk and MSC had purchase obligations at the end of the charter period. The vessels are now 25 years old on average and MSC has exercised for purchase options with some vessels delivering at the end of this month and the remaining in September. Net cash proceeds after repayment of associated debt is estimated to approximately 40 million dollars and we expect a neutral to marginally positive book effect from this transaction in the third quarter. Excluding the drilling rigs, the backlog from owned and managed shipping assets were 2.7 billion at the end of the quarter. Over the years, we have changed both fleet composition and structure and we now have more than 70 shipping assets in a portfolio and no vessels remaining from the initial fleet in 2004. In addition to the long-term chartered vessels, we have 16 vessels trading in the short-term market. We also had a significant contribution from profit share over time, both relating to charter rates and fuel savings. We do not have a set mix in this portfolio, focuses on evaluating deal opportunities across 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 and not just invest because money is burning in our pockets. The two drilling rigs are not included in the reported Charter Backlog figures, and with respect to seed drill and the ongoing financial restructuring, We cannot give more details than what we have disclosed in our press releases or is otherwise publicly available. We receive approximately 75% of the lease hire under the existing charter arrangements for West Linus and West Hercules during CEDROS Chapter 11 proceedings. Both rigs are active and working for all companies, and the charter rate is sufficient to cover our debt service relating to the rigs. and we are of course pleased to see a strengthening harsh environment market in the North Sea on the back of a firm oil price. A few weeks ago we entered into an amendment to the Charter Agreement relating to the semi-submersible drilling rig West Hercules. Under the amendment agreement with CEDRO, the West Hercules is contracted to be employed with oil major Equinor in Norway and Canada until the second half of 2022 and thereafter re-delivered to SFL in Norway. This agreement remains to be reconfirmed by the court in September, and if so, SFL will continue to receive a bare-foot hire of around $65,000 per day until CEDRIL emerges from Chapter 11, and thereafter approximately $60,000 per day while the rig is employed under a contract and generating revenues for Seadrill and approximately $40,000 per day in all other modes, including where the rig is idle and mobilized to and from Canada for the Equinor work. We continue to have a constructive dialogue with Seadrill regarding the rig Vestlinus, which is on a sub-chart of the ConocoPhillips in the North Sea until the end of 2028. Seadrill has filed a planned support agreement which is also supported by a majority of its secured creditors. Based on these filings, a potential emergent from Chapter 11 could be in early 2022 and we expect to have more clarity on Vestlinus well ahead of this. Over the years, we have gone from a single asset class chartered to one single customer to a diversified fleet and multiple counterparties. and over time the mix of the assets in Trotter backlog has varied from 100% tankers to nearly 60% offshore 10 years ago to container and car carriers now being the largest segment with 80% of the backlog. If we look at the counterparties, it is known mainly to end users and market leaders in their respective segments and relative few 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 to repeat business with Maersk, MSC and Evergreen, for example. Our strategy has therefore been to maintain a strong technical and commercial operating platform in cooperation with our sister companies and the SeaTankers Group. This gives us the ability to offer a wider range of services to our customers, from structured financing to full-time time charters. With full control over vessel maintenance and performance, including energy efficiency and emission-minimising efforts, we can impact improvements to our vessels through the life of the assets, and not only be passively owning vessels employed on beer boat charters where the customer 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, and in the current environment, with rising raw material costs driving replacement costs for vessels, this value is for the benefit of SFL and our stakeholders, while for bare-board charter deals, the value is usually retained by the charterers through fixed-price purchase options. And with that, I will leave the word over to our CFO, Aksel Olesen, who will take us through the financial highlights of the quarter.

Thank you, Mr. Hjertaker. On this slide, we have shown a performer illustration of cash flows for the second quarter. Please note that this is only a guideline to assess the company's performance, and it's not in accordance with U.S. GAAP, and also not of extraordinary and non-cash items. The company generated gross charter hire of approximately 142 million in the second quarter, with more than 80% of the revenue coming from our fixed charter rate backlog, which currently stands at 2.7 billion, providing us with strong visibility on our cash flow going forward. In the second quarter, the line of fleet generated gross charter hire of approximately 75 million, including approximately 2.4 million in profits with contributions related to fuel savings on some of our large container vessels. Of this amount, approximately 95% was derived from our vessels on long-term charters. Following the company's recent acquisitions, SFL's line of fleet backlog currently stands at approximately 2.2 billion with an average remaining charter term for approximately 4.7 years were approximately seven and a half years if weighted by charter hire. Our tanker fleet generated approximately 15 million in gross charter hire. Of this amount, more than 80% was derived from our vessels and long-term charters to, among others, Phillips 66 and Frontline. The net charter hire from the company's two Zeus Max tankers employed in the short-term market was approximately 1.8 million compared to 2.5 million in the previous quarter. A dry bulk fleet of 22 vessels generated approximately 39 million in gross charter hire, including approximately 1.2 million in profit share contribution from our cape-sized vessels on charter to Golden Ocean. Of this amount, approximately half was derived from our 12 vessels on long-term charters to Golden Ocean, Sino-France and Hyundai Glovis, while the other half was derived from our 10 supermax and hand-sized vessels employed in the short-term market. These vessels generated approximately 14.9 million in net charter hire, compared to 9.8 million in the previous quarter. Isabella owns two drilling rigs, which have been chartered out to subsidiaries of Sea Drill on bearable terms. In the second charter, we received charter hire of approximately 12.2 million from their rigs. This summarizes to an adjusted EBITDA of approximately 103 million per second quarter, compared to 98 million in the first quarter. We then 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. As a result, a significant portion of our charter revenues are excluded from US GAAP operating revenues and instead looked at as revenues classified as repayment of investment in finance leases and investor loans, resulting in associate and long-term investments and interest income from associates. For the second quarter, we report total operating revenues according to US GAAP of approximately 117 million, which is less than approximately 142 million of charter hire actually received for the reasons just mentioned. During the quarter, the company recorded profit split income of 3.6 million, mainly related to fuel savings on some of her large container vessels and the dry bulk vessels on long-term charters to Golden Ocean. Furthermore, the net result was impacted by a non-cash impairment of 1.9 million, reflecting the net proceeds from the recycling of West Taurus during the third quarter, in addition to approximately 1 million in additional OPEX related to challenging crude change logistics, and approximately 2 million in additional interest costs due to the issuance of the sustainability-linked bond in April, ahead of the maturity of the convertible bond in October. So overall, and according to US GAAP, the company reported a net profit of 19.5 million, or 16 cents per share. Moving on to the balance sheet. At quarter end, SFL had approximately 372 million of cash and cash equivalents, excluding approximately 8 million of cash held in a wholly owned, non-consolidated rig-owning subsidiary. Furthermore, the company had marketable securities of approximately 23 million, based on market prices at the end of the quarter. In April, the company successfully placed a 150 million senior secure sustainability-linked bond during 2026. The bond will have a coupon of 7.25 per annum, and the net proceeds will be used to refinance existing debt, including our convertible bond with maturity in October, which is included in the short-term debt with approximately 147 million outstanding at quarter end. The company has remaining capex of approximately 670 million relating to recent acquisitions. During the second quarter, the company issued approximately 10 million new shares to its ATM and DRIP programs who net proceeds of approximately 87 million to part-finance these acquisitions and to have additional investment capacity going forward. The remaining investment amounts are expected to be funded with senior debt, and there are no immediate plans to raise more new equity. As of today, we have obtained approximately 300 million of senior debt from international banks after attractive terms, addressing the funding of the vessels to be delivered during the third quarter. Based on the Q2 numbers, the company has a book equity ratio of approximately 28%. Then to summarize. The Board has declared a cash dividend of 15 cents per share for the quarter. This represents a dividend yield of approximately 8.5% based on the closing share price yesterday. This is the 70th consecutive quarterly dividend, and since inception of the company in 2004, Approximately $28 per share, or approximately $2.4 billion in aggregate, has been returned to shareholders through dividends. SFL has successfully committed close to $700 million towards accretive investments so far this year. And in the process, we have expanded our relationship with some of our key clients by investing in modern eco-designed container ships, and at the same time disposed of older, less efficient vessels, Demonstrating our commitment to further improve our carbon footprint pursuant to our ESG strategy. Following the recent investments, our backlog from our shipping assets now stands at 2.7 billion, providing strong visibility on future cash flow, debt service and continued distribution capacity. And with 372 million of cash at court rent, SFL is well positioned to execute on new accretive investments in the time to come. And with that, I give the word back to the operator, who will open the line for questions.

Thank you. If you wish to ask a question, please press star 1 and wait for your name to be announced. If you wish to cancel your request, please press the hash key. Once again, please press star 1 if you wish to ask a question. We're now taking the first question from the line of Randy Givens at Jefferies. Please go ahead.

Howdy, gentlemen. How's it going?

Hi there.

Hey, so I guess the first A couple of questions are around the new container ship acquisition. 14,000 TU vessels. Can you give the age of the ships? Are they scrubber equipped? Some more details. I know you're not going to give the purchase price, but just trying to get some other details around that. And then looking at kind of residual upside after the current charters end in 23 and 24.

Yeah, absolutely. The vessels are sister vessels to four 14,000 Tu vessels that we have today on charter to Evergreen. These are very fuel-efficient vessels. In fact, one of our vessels was the first vessel with 51-meter beam, i.e. the very biggest you can take through the Panama Canal. So our vessel was the first of that size to go through the Panal and actually use that corridor to serve the US East Coast market. So we know these are very versatile vessels with very good deadweight capacity and fuel efficient built in 2013 and into 2014. They don't have scrubbers. This is something we discussed with the current charterer Evergreen. In the end, you know, when you charter out a vessel, it's your customer who pays for the fuel. So if we were to make such investment, it would of course be if we got either a compensation for that investment through, you know, linked to their fuel savings or a profit share, like we've done with Maersk on several vessels, where we have a base increase for the investment, and then we get the cut of the profits that comes out of that. We have not made such agreements with Evergreen, and of course, therefore, we cannot justify making that investment now. Of course, when we look at the new charter position, this is something we would obviously discuss with, call it a new potential charterer for these vessels, if it makes commercial sense for us. Right now we know that the shipyards are all sold out for vessels of this size and category from quality shipyards. 24 is basically well sold out and we hear that even 25 may be challenging certainly for a series of vessels. We've also seen other operators out there forward fixing already vessels with chartering positions similar to ours. So we see that there is also good demand on potential on the customer side. But exact timing of this is something we would have to look at. And again, it's all about trying to create the best, call it economic outcome for us from a risk reward perspective, obviously.

Got it. Okay. And then looking at your dry bulk assets, clearly those are outperforming most of your others now, profit sharing, fully getting from Golden Ocean. The convertible maturity is handled, seed drills mostly in the past now. So all of those things together, how do you view the dividend current at 15 cents? Chances you re-up that back to the 25 cents it was before the recent cut. And then how do you view your dry bulk fleet from here as well?

Yeah, thanks. Very, very valid questions, of course. On the dry bulk side, we are, of course, very excited to see the dry bulk market being very robust and has been increasing over the last few months. Of course, If you look at the economic side of that, and certainly from a reporting side, because of the new accounting principles for shipping assets with the load-to-discharge principle, you have effectively a delay in the revenue recognition when the market is strengthening, and then the corresponding tail if the market is softening. So the 1.25 million dollars we got in profit share from Golden Ocean on top of the base rate. So this is just icing on the cake as we like to say it. We would of course like to see more icing on the cake. and based on the forward market it could be significantly more than was reported this quarter but it has a delay effect as I mentioned and of course the profit share is in the end actual you know performance for the vessels also if you look at our acquisitions you know recently we've done several deals Some vessels are already delivered. Several are to be delivered over the next very few weeks. So we will see more. We will see cash flow production from these assets already in the quarter. So I think, you know, as we come to the finalization of the third quarter and we look at the numbers at that time, that would be a more good time to look at also You know, the distribution at the time, and needless to say, you know, we were focused as always on distribution per share, long-term distributable capacity per share. So, of course, it's an objective to build dividend going forward, but exact timing and amounts, et cetera, it's something the board has always reserved, you know, the right. We have never in the history of SFL Thank you.

We are now taking our next question from the line of Greg Lewis at BTIG. Please go ahead.

Hey, thank you, and good afternoon, Ola and team, and I hope you're doing well.

You know, I guess, Ola, I would like to ask, you know, Randy is right, you know, big question around the dividend. I guess I'll ask it a different way. You know, if we were to kind of rewind the clock a little bit, You know, the first dividend, you know, moved down was from the, you know, it looked like it was driven by, you know, the ongoing issues around C-Drill. And then the second knockdown of the dividend was really around COVID. And so, you know, realizing that there's a lot more than just C-Drill and COVID that drive the decision around the dividend, are those two things kind of, like, Thank you very much.

It's difficult to be very specific on that. I mean, of course, when we made the adjustments, you know, one was due to general huge market uncertainty surrounding the whole COVID, which had a much wider sort of impact than just on the drilling side. And then you had the meltdown on the rig side, where Seadrill was in the process of, you know, We were filing for Chapter 11 when we felt that it was very prudent to take down the dividend given the heightened uncertainty around that. We have some more visibility now with Seedrill, given what we noted in the report with one rig where we have an agreement that we'll run through next year, but it's not entirely out of the woods. Hopefully over the next couple of months now, We will have more clarity there as well. But at the same time, we also see very good performance in some of the other asset classes like the dry book vessels that was mentioned. And we've been doing more business with these new transactions and of course hope to execute on additional deal opportunities going forward. So I think the best way to phrase it is probably that the board Will is assessing, call it the dividend, with the perspective of what they believe is long-term sustainable in a more normalized world. And this quarter the dividend was kept stable. Next quarter management can hope that there is good performance, continued good performance. and also better visibility and also cash flow coming in from these new assets that will build that long-term distribution capacity. But again, we cannot make specific comments on what the dividend could be because again, this is a right the board reserves to have the appropriate flexibility.

Well, 100%.

I'm also realizing that you are limited

and how you can talk about the relationship with C-Drill and the rigs. I guess I'll ask it this way. It's been reported in the news that a couple other drilling companies are potentially looking at acquiring C-Drill. Is it right to think that if Company A acquires Seadrill, they by default, even though Ship Finance is the owner of those rigs, or is that something where then Ship Finance... I'm really just looking for color around the relationship contract or agreement. How would something like that work if Seadrill were in fact to be acquired?

Just to clarify a question, I think your question is if there is some kind of that our rigs automatically are a part of the sale if seed is required? Yeah, that's exactly right. Exactly, yeah. So it's really up to the board or kind of the acquirer to make a separate proposal to have the failure in that respect and up to the board to evaluate that. We have two attractive harsh environment assets, which also seem to be the most desired As I think about that, I'm really interested in the Conoco contract with the jack-up. Is there any change of control?

Is that something where Conoco, as the customer of that rig, Is there any approval process through them, or is that something where, you know, I'm just kind of curious, do they have any input into the potential, you know, whatever, say, and potentially where that rig goes in the event that C-Drill decides to, you know, have its company be sold?

I cannot talk for the Vestelara, which is the sister rig of Linus River, that is also working for Conoco, but the concept on our rig and our relationship with Cedril and Conoco is that under the current agreement, SFL has basically a step-in right into that contract not to be unreasonable with help from Conoco. And I think if you look at the operations of the rig, it's more part of the infrastructure of the eco-fishing field, which has a long lifetime. So we believe there is interest from Koneko to keep that rig and that will have to be addressed if and when such situation occurs.

Thank you very much for that. Have a great day. Thank you.

And we are taking our next question from the line of Liam Berkey at Bradley.

Yes, thank you. On the press release, you have a capital requirement of $670 million on the acquired vessels plus new builds. Understanding you're taking delivery on third quarter on the existing vessels and then the new builds delivery is 2024. Could you give a sense of timing of how that outlay of $670 million would go?

Yes, absolutely. I mean, we have, I mean, the new buildings are the new buildings with that capex. I mean, there's some called pre-delivery funding and then the bulk maturity on delivery on kind of the five vessels that some have been delivered and some are in the process of being delivered. I mean, Financing has been secured basically with a combination of cash at hand and also senior bank financing at very attractive terms. So that's all secured. We experienced a tremendous interest from financing institutions based on the high quality of assets, but also You mentioned you've got additional deals that you're looking at. Would that be primarily in the container space or are you looking across the board to your entire fleet?

Now we are segment agnostic, so we look at opportunities across the board in several shipping call it sectors. We think this is a really important distinction from many other maritime companies who are focused on one single segment and therefore is looked into investing there. What we have seen over time is that Typically, it's at the peak of the markets that the equity market is open and when banks will lend you the most money. And therefore, if you are in one single segment, you're almost programmed to invest the bulk of your capital maybe at the suboptimal time. So what we try to look at, we look at multiple segments at a time and we evaluate risk rewards and market dynamics within the segments and we compare them to each other. So you could say it's a coincidence. We've done mainly over the last couple of months, we've done mainly container ships and car carriers, which both liner type assets, but still very different sort of market dynamics where one segment has boomed a lot and the other has strengthened, but differently than the container side. At the same time, we also see many opportunities in other sectors where There are no further questions on the line. Please continue. Thank you. Then I would like to thank everyone for participating in our second quarter conference call and also thank the SFL team on board the vessels and onshore for their continuing efforts in a time with continued operational disruption caused by the COVID-19 situation. If you 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 webpage, www.sflcorp.com. Thank you.

That concludes our conference for today. Thank you for participating. You may all disconnect.