SFL Corporation Ltd

Welcome to SFL's third quarter 2023 conference call. My name is Sande Borgli and I'm an analyst in SFL. Our CEO Ole Gjertakke will start the call by briefly going through the highlights of the quarter. Following that, our Chief Operating Officer Trym Kjøli will comment on vessel performance matters before our CFO Aksel Olusen will take us through the financials. The call will be concluded by opening up for questions, and I will explain the procedure to do so before the Q&A session. Before we begin our presentation, I would like to note that this conference call will contain forward-looking statements within the meaning of the US 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. Forward-looking statements are not guarantees of future performance. These statements are based on our current plans and expectations and are inherently subject to risk and uncertainties that could cause future activities and results of operations to be materially different from those set forth in the forward-looking statements. Important factors that could cause actual results to differ include, but are not limited to, conditions in the shipping, offshore, and credit markets. You should therefore not place undue reliance on these forward-looking statements. Please refer to our filings within the Securities and Exchange Commission for a more detailed discussion of risks and uncertainties, which may have a direct bearing on our operating results and our financial condition. Then I will leave the word over to our CEO, Ole Hjertake, with highlights for the third quarter.

Thank you, Sondre. The charter revenues were $214 million in the quarter, which is up 23% from the previous quarter, primarily due to the drilling rig Hercules' no back-end service. The EBITDA equivalent cash flow in the quarter was approximately $130 million, which was also higher than the second quarter. And over the last 12 months, the EBITDA equivalent cash flow has been $485 million in total. The net income came in at around $29 million in the quarter, or 23 cents per share. The net income was impacted by some one-off items in the quarter, including gains on a vessel sale in the third quarter and some mark-to-market effects. This was offset by two tankers that were dry docked in the quarter and an unscheduled off-fire of around 14 days on the Jack of Brick Liners due to repair works on the top drive with associated higher upticks in the quarter. In line with the improved results and commitment to return value to our shareholders, we're also increasing our quarterly dividend to 25 cents per share. We have not paid dividends every quarter since our inception in 2004, and this has accumulated to $30 per share or more than $2.6 billion in total. And we have a robust charter backlog supporting continued dividend capacity going forward. Our fixed rate backlog stands at approximately $3.4 billion. And importantly, the backlog is concentrated around long-term charters to very strong end users. This transition has been gradual as we have changed the business model from a maritime leasing company to maritime infrastructure provider over the last 10 years. This includes switching from primarily bearable charters or financing arrangements to long-term time charters to end users. And I would note that the backlog figure excludes revenues from the vessels traded in the short-term market and also excludes future profit share optionality, which we have seen can contribute significantly to our net income. In September, we took delivery of the first of our four dual fuel car carrier new builds. The vessel named Emden will go on charter to Volkswagen Group for 10 years together with a sister vessel, and we will deliver the vessels to Volkswagen in Europe. The short-term market is red piping hot right now, and we have secured a very attractive interim charter from the shipyard in Asia to Europe, generating around $8.5 million in EBDA per vessel over a period of only two months. In addition to the new bills, we also have two existing vessels on charter to Volkswagen that have been extended for approximately three years, firm plus extension options, generating approximately $23.5 million in EBITDA per vessel per year. We have a very close business relationship with Maersk Line with 17 vessels and long-term charters. Maersk Line recently exercised an option to extend the time charter for a 9500 TEU vessel until mid 2025. This is at a higher rate than the current charter rate, adding $13 million to the charter backlog. In addition, we have a profit share relating to scrubber benefits on that vessel, where our share currently is 70%. In the third quarter, we also fully repaid a Norwegian Kroner denominated bond loan issued in 2018, where there was $48 million remaining at maturity. This was paid down from our cash balance. This loan was originally the equivalent of approximately $85 million, and the rest had already been repurchased opportunistically in the market. We have recently raised significant amounts in the new debt funding at very attractive terms in Asia and don't see a need to refinance the recently repaid bond loan with new financing in the near term. And after the extensive SPS and upgrade works to our harsh environment semi-submersible Hercules in the first half of 2023, the rig has been in Canada and drilled a well for ExxonMobil. This was finalized in September, and since then, the rig has mobilized to Namibia with a stopover in Las Palmas, and it's scheduled to start drilling for Gulf Energia in Namibia next week. This is for two wells plus an optional well testing, estimated to take around four months, including mobilization. When we calculate average day rates, we include mobilization of the rig from Las Palmas and back again, and this is compensated by the customer. This started in early October, and the estimated contract value is approximately $50 million, implying a day rate of approximately $435,000 per day for the period. After Namibia, the rig will move back to Canada to commence a contract with Equinor. The contract is for one well plus one optional well. And the duration for the firm contract period is six to seven months, including transit to and from Canada, implying a day rate of approximately $520,000 per day for the period. The rig will then be open for new contracts from the fourth quarter 2024 onwards. This rig is one of only a handful harsh environment ultra deep water semi-submersible rigs available, and market analysts are positive to long-term market prospects based on recent tender activity and a tighter supply-demand balance. And with that, I will give the word over to our Chief Operating Officer, Trum Sjöle.

Thank you, Ola. Over the years, we have changed both our fleet composition and structure, and we are now a maritime infrastructure company with 73 maritime assets in our portfolio. And our backlog from owned and managed shipping assets stands at $3.4 billion. The current fleet is made up of 15 dry bulk vessels, 36 container ships, 13 tankers, two drilling rigs, and seven car carriers, where four are on the water and three are under construction in China. The remaining new buildings are scheduled for delivery over the next seven months, starting in November. We have evolved from having a single asset class chartered to one single customer to a diversified fleet and multiple counterparties. And the fleet composition has varied from originally 100% tankers via majority offshore assets 10 years ago to container vessels now being the largest segment with just under 50% of the backbone. Most of our vessels are in long-term charters, but we have over the last 10 years completely transformed the company's operating model and have moved away from financing type bare boat charters and instead assumed full operating exposure. This makes us relevant for large industrial end users like Volkswagen, Maersk, Hapag-Lloyd and others. In the third quarter, 94% of charter revenues from all assets came from time charter contracts and only 6% from bare boats or dry leases. In addition to fixed rate charter revenues, we've had significant contribution to cash flow from profit share arrangements over time, both relating to charter rates and cost savings on fuel. Last 12 months, the aggregate profit share has been more than $16 million. Out of the current 73 vessels, we have 13 on bare boat type contracts and 60 on time charter and spots. Our operation is quite complex with vessels across multiple sectors and we have our own commercial operation out of Oslo as well as operational management out of Singapore and Stavanger. Our OPEX philosophy is to continuously invest in our fleet to optimize the vessel's performance and maintain a high level of service to our customers. This includes investing to minimize off-fire as well as investments to increase cargo carrying capacity and reducing energy consumption. This has become increasingly important with the implementation of IMO carbon intensity indicator, which will impact vessels operational profile, including routing and speed. EU ETS is also another hot issue becoming live from next year. In Q3, we had a total of over 6,300 operating days defined as calendar days less technical or fire and dry dockings. Three vessels have been dry docked in the quarter and our overall utilization across the shipping fleet was 99% in Q3 and 80.5% for the drilling rigs. For the rigs, as Ole explained, operating days are days on rate or in transit covered by mobilization fees, less days off hire and days spent in port, not on drilling rate. One of the key ESG targets for SFL is the reduction of carbon emissions on our fleet. Such reduction can either be met by fleet renewal in more efficient ships and with greener fuels, increased efficiency of existing fleet, or a combination of both. And as part of our fleet renewal program, we have four LNG dual fuel carriers under construction in China, of which one was delivered during the quarter, so three left. These vessels are among the most modern and efficient ships in the car carrier market. The hull has been improved and optimized with the new hull form with an S-BAU, as can be seen in the picture. And the LNG fuel system is of a high pressure type and the vessels are adapted for both ship-to-ship and port-to-ship LNG bunkering. In LNG mode, we expect a 25% lower carbon footprint per vehicle carried compared to a standard 6500 CEU conventional PCTC. The vessels are also fitted with the shore connection for zero emissions operation in port. And in addition to being able to carry EVs, the ships will also be able to carry hydrogen fuel cell vehicles. The first ship, Emden, is on her first voyage from Asia to Europe under Hyundai Glovis, and she will be delivered to Volkswagen in about one week's time. And with that, I will give the word over to our CFO, Axel Olsson, who will take us through the financial highlights of the quarter.

Thank you, Trim. On this slide, we have shown our performer illustration of cash flows for the third 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 214 million in the third quarter, including approximately 2.6 million of profit share, with approximately 94% of the revenue coming from a fixed charter rate backlog, which currently stands at 3.4 billion, providing us with strong visibility on the cash flows going forward. In the third quarter, the container fleet generated gross charter hire of approximately 91 million, including approximately 2.6 million in profit share related to fuel savings on seven of our large container vessels. During the quarter, we took delivery of the first of our four dual-fuel LNG car carriers. With four car carriers on charter at the end of the quarter, our gross charter hire increased to approximately 9 million in the third quarter compared to approximately 6 million in the second quarter. Our tanker fleet generated approximately 30 million in gross charter hire during the third quarter compared to approximately 35 million in the previous quarter. During the quarter, two Susmax tankers were off fire for a total of 46 days in connection with scheduled periodic dry dockings. These costs are expense directly for a shipping fleet, and OPEX for the tankers in the quarters was therefore higher than normal. The company has 15 drivable car carriers, which eight were employed on long-term charters during the quarter. The vessels generated approximately 20 million in gross charter hire in the third quarter. Seven of these vessels were employed in the spot and short-term market and contributed approximately 6.2 million in net charter hire during the quarter compared to approximately 7.2 million in the previous quarter. SFL owns two harsh environment-driven rigs, the Jacob Rig Linus and the semi-submersible rig Hercules. During the third quarter, the rigs generated approximately 64 million in contract revenues compared to approximately 19 million in the second quarter. The Linus is currently under long-term contract to ConocoPhillips Scandinavia until the end of 2028. In the third quarter, the rig generated approximately 16.6 million in contract revenues, which is down from the approximately 19 million in the second quarter, as the rig was off-hire for approximately 16 days, relating to an unscheduled repair of the top drive. Due to the repair works, the OPEX for the rig was also 2 million higher than budgeted for during the quarter. Hercules completed the drilling contract for ExxonMobil in Canada in September and has now been mobilized to Namibia, where it is expected to commence a contract with GALP Energia shortly. During the quarter, the rig recorded approximately $48 million in contract revenues, as the mobilization fees paid by ExxonMobil and associated costs is recognized over the actual drilling period pursuant to US GAAP. The same principle has been applied for demobilization fees due after the drilling contract was completed. Our operating and DNA expenses for the quarter was 86 million compared to 68 million in the previous quarter, primarily due to Hercules being back in operation, scheduled dry dockings and downtown and repair on the lines. This summarizes to an adjusted EBITDA for approximately 130 million in the third quarter compared to 109 million in the previous quarter. Then 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. And 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 CAP operating revenues. This includes repayment of investment in sales type, direct financing leases and leaseback assets, and revenues from entities classified as investment in associates for accounting purposes. The third quarter report total operating revenues according to US GAAP for approximately 205 million, which is less than approximately 214 million of charter hire actually received for reasons just mentioned. During the quarter, the company recorded profit share income of approximately 2.6 million from fuel savings on some of the large container vessels and the car carrier. As previously mentioned, the Hercules was back in operation during the third quarter and contributed with 48 million in contract revenue. Furthermore, this net result was impacted by non-recurring and non-cash items, including a gain from the sale of the VLCC Landridge Wisdom for approximately 2 million. A net positive mark-to-mark effect from stops of approximately 2.3 million, a positive mark-to-mark effect from equity investments of 300,000, and a decrease of 300,000 on credit loss provisions. Due to corporate taxes and withholding taxes in Canada, the company also recorded approximately 2.3 million of taxes in the third quarter related to the Hercules. As well, it also expects to pay similar types of customer taxes in Namibia. So overall, and according to US GAAP, the company reported a net profit of approximately 29.3 million, or 23 cents per share, compared to approximately 17 million, or 13 cents per share in the previous quarter. In terms of near-term outlook, we expect lower revenues for Hercules in the fourth quarter due to a long mobilization period from Canada to Namibia, where the rig is due to commence the contract to GALP Energia shortly. As mentioned previously, revenue from the Hercules will due to US GAAP accounting standards be recognized only from the drilling commencement date, and hence mobilization fees will be allocated throughout the respective quarters of gridding operations. For car carriers, revenues are set to increase as we have three new buildings delivering from Q4 to Q2, with the second vessel being delivered from DR in China second half of November. Following the handover to Volkswagen of the first and second new building during Q4 and Q2, the SFL conductor and SFL composer will continue the charters to Volkswagen for another two years plus optional years with an estimated EBITDA contribution of 23.5 million per vessel per year. Moving on to the balance sheet. At quarter end, SFL had approximately 118 million of cash and cash equivalents. Furthermore, the company and the market lost securities for approximately 6.2 million based on market prices at the end of the quarter. During the quarter, the company fully redeemed a NOC bond for which 49 million was outstanding with cash on balance sheet. The outstanding capital expenditure of approximately 136 million on our three car carriers under construction has been fully financed by 194 million of NetSea New Yorker financing yet to be drawn. During the quarter, the company re-delivered David Cecil and Bush Wisdom, following a declaration of a purchase option. The sale had a 10 million positive cash effect after repayment of secured debt relating to the vessel, and the corresponding book gain of approximately 2 million has been recorded in the third quarter. Based on Q3 numbers, the company had a book equity ratio of approximately 28.4%. Then to conclude, the company has delivered another strong quarter with growth in both revenues and EBITDA. The board has declared a 79 consecutive cash dividend to increase the dividend to 25 cents per share. This represents a dividend yield of approximately 9% based on the closing share price last Friday. The company has a strong balance sheet and liquidity position. So far in 2023, the company has secured new financing arrangements of more than a billion dollars, and we recently repaid our NOC bond with cash on balance sheet. Furthermore, our three new buildings are fully financed with attractive long-term financing, which will free up additional liquidity upon delivery. Our fixed chart rate backlog currently stands at 3.4 billion, which provides us with strong visibility on our cash flow going forward. And finally, with the Hercules now back in operation and delivery of new building car carriers together with new contracts for existing vessels, it's a strong revenue generation in the quarters to come as vessels are delivered and new charters commencing. And with that, I will conclude the presentation and move on to the Q&A session.

Thank you. We will now open up for our Q&A session. For those of you who are following this presentation through Zoom, please use the raise hand function to ask a question. When your name is called out, please unmute your speaker to ask your question. Thank you.

Hey, guys. Can you hear me?

Absolutely.

Thank you. I couldn't find the raised hand function, so I figured I'd just hop in. This is Greg from Greg Lewis. Hey, all. How are you? Yeah. Hi, Greg. I had a few questions I was hoping we could walk through. You know, it was good to see the. the the the dividend increase um you know and you know i i guess two things one is as you think about managing the trajectory of the dividend over the next i don't know one to two years how should we think about balancing you know potential dividend growth and and the and the drilling rigs just because you know it it seems you know it's it's clearly a very cyclical industry we're clearly in a strong part of the cycle and those assets look like they're gonna probably the Hercules looks like it's going to be able to generate a lot of cash here you know over the next two to three years um but maybe not as you know it's definitely a more volatile asset than say your car carriers or container ships so just trying to understand how you think about you know uses of cash from the hercules as we recontract this over the next couple of years

Yeah, I appreciate that. I mean, the Hercules, as you mentioned, you know, we just spent quite a bit of money on that rig in the first and second quarter of the year when it was out of service. And now it's really only got started. So the charter rate in Canada, you know, that was fixed, you know, more than a year ago. So it was at a lower rate. So that the charter rate should be mounting now as it is expected to start drilling in Namibia already next week. And the charter rate in Namibia is based on the, if we include both mobilization to and from Namibia and the drilling rate, should be well above the drilling rate we had or the rate we had in Canada. And then it's going back to Canada later next year for an even higher rate. And in fact, the drilling rate we have on Hercules, it's the highest drilling rate, I would say, in this cycle to date. So this rig is a very capable unit and customers are clearly willing to pay for the services. Of nature, you know, that market is a shorter term charter market. So it's not, this is not a market where you normally get sort of 10, you know, 8, 10, you know, 15 year charters. It's typically shorter charters and we have deliberately not been so keen on fixing it long-term because we see this market really building and you don't really want to fix something at the low end of the cycle. We think this is a cycle that has legs and therefore we're holding back a little bit before we want to, what we say, look for really long-term charters on that unit. I think if we were to look at long-term charters for the unit, you would have to accept lower rates than what we are fixing it at currently. So that's one asset. Of course, it's a big asset. But also, if you look at the history of that drilling rig, I mean, this is a drilling that used to be uncharted to CEDRIL. CEDRIL ended up in two Chapter 11s. We were offered in the last round, in our minds, a very positive, or call it treatment in the restructuring, we decided to take it back. And I think we can be honest and say it's been a really good decision from the company side to do that because returns we've had on this rate now with the rates we see is spectacularly better than the alternative would have been. But that is the history and the setting around that rate. If you look at some of the other assets, look at the card carriers. That, I think, is sort of a segment. We used to have two vessels. Then we ordered the four vessels. Then we bought another vessel. And then we have these quite spectacular, both the transportation, if you could call it that, on two of these vessels, where we make more than 10% of construction costs just moving the vessel from Asia to Europe. So you have a lot of other bits and pieces here that's also generating a lot of cash flow. And then we have the rechartering of the two older vessels to Volkswagen, where we increased the dividend by times five compared to where it was originally, simply because we own those assets and we negotiated it. And Volkswagen seemed to be quite happy with the service we provide them. The rig is one piece, but there are also other elements in our portfolio that is also adding. And of course, our mindset is, yes, our principal objective in SFL is to return cash to shareholders. I mean, that's why we're here. Otherwise, there wouldn't be any point in having a company like SFL if we don't really do that over time. And, you know, It's been 79 quarters now, and we've always made money operationally every single quarter based on our distribution. So I think, yes, I think that we are really just at the starting point in our minds in terms of cash flow from some of these assets. So hopefully there is more dividend potential also going forward.

Yeah, super helpful. Thank you for that. I did want to ask kind of a bigger picture question. Clearly across the more conventional shipping space where it's definitely a market that you continue to look at and have assets in, as SOFR has gone up, spreads have gone up, How has that changed the potential opportunities for SFL, i.e., I'm talking to some ship owners and they're looking at 8%, 9% or even higher borrowing costs. Has that created more opportunities for SFL, i.e., is the transactions team better? a bit busy here as we sit here in November relative to maybe where they were earlier this year? Or is it, hey, the market's been good for a couple of years and it's kind of steady as she goes?

Yeah, it's a good question. I mean, if you go back to 22, we screened or did really work on more than $20 billion of potential deal flow. And we ended up doing one in the end, you know, for various reasons. I think this year the volume has been lower, you know, in aggregate. And I think with the rising interest rate market, it's also, I would say, the way we see it, it's a time lag from where the underlying metrics and interest rates is one, asset replacement cost is another. Maybe to a certain degree, operating expenses, to the extent there has been, call it a little inflation in those metrics. It takes a little time for that to filter through in a customer's willingness to pay off for those services. So that's why I think 23 has been, I would say, the more interesting deal flow opportunities has been, I would say, on a gross number a little lower than 22. But I think this is going to pick up again. But I think the ones, I mean, if you look at the ones who offer more of financing structures, know maybe maybe for them there is more deal flow opportunity right now simply because uh you know funding cost is higher and therefore the alternative cost of of doing like a beer boat type lease you know is is relatively smaller but um we have you know we have strategically you know moved a little away from the beer boat type offering. Because what we have seen is that for those kind of deals, you typically do that with intermediaries. You don't do a beer boat deal with an end user. And therefore, there is a risk element here that I think is underappreciated. Right now, most of the shipping segments are booming, strong markets, nobody talks about it. But we've been through this over 20 years now. We've seen some cycles over the years. So our focus is do deals with strong counterparties and users. Focus on getting the right deals done. And don't be nervous if there is a quarter when you do that many deals. The deal flow is out there. There is a continued need for transportation assets and logistic solutions on the water. But just don't be desperate to do a deal because that's when you do the wrong deals. Maybe that's the short answer to that. We are constantly screening deal opportunities. We are looking at opportunities. We cannot communicate specifically what we look at. But there are deals that could potentially be done. But we try to be disciplined. It's got to be the right type of asset. We have to focus on the right, as we call it, residual value exposure, i.e. what kind of residual risk are we willing to take on after a deal? What's the financing structure? And maybe importantly, who's the counterparty? Is this counterparty strong enough? And in an underlying volatile market, Is this counterparty someone who can honor their obligation also in a down cycle? Because that's what we've seen over the years is that anybody can do a deal in an up cycle market. You just pay a little more than the next guy. The problem is how do you manage the down cycles? And that's, I think, that's something that... we hope our history brings along is that, yes, markets are volatile, but we managed through some pretty rough cycles and hopefully we're set up to deal even better with cycles going forward.

Okay, great. And then I did just have one other question on the balance sheet. I noticed we saw, I guess sequentially, some of the long-term lease liability went into... short-term lease liability is is that is that um is that just going to unwind or should we think about that being um either renewed or extended um you know over the next call I don't I don't know a couple yeah thanks for it's Axel here so I think you should look at that as all our like like our ordinary

traditional debt on the vessels, that there are opportunities to basically roll this going forward as well. We haven't finally concluded if we kind of do a new Yolko or do that bit traditional bank financing, but both options are likely. So I could just assume rolling that on on the same level.

Okay, perfect. Thank you for that. Thanks, everybody. Yes, thank you. Thank you.

But also you're following this presentation pursue the race and function can be found on the reactions in the toolbar. And the next question will come from Richard diamond, please unmute your speaker yeah.

Great quarter, great job building cash flow. Ole, you and the team have incredible deal flow at SFL. What do you think are the most interesting areas looking out to the fourth quarter and next year?

Yeah, thanks for that, Richard. And thanks for the kind words. You know, we are focusing across the board. Our preference are for deals that are, I would say, logistics sort of oriented, i.e. where we go into a logistics chain with counterparties. So car carriers, for instance, is a segment that we've been spending quite a bit of time on. We've grown a lot in that segment. We still think there could be interesting opportunities on the container side. Yes, the market is volatile, and yes, it's not the super cycle we saw a year or two ago, but there's still underlying demand for transportation capacity, and certainly with the modern high-end assets, the more fuel efficient that is reducing both the energy footprint or emissions footprint per loaded box, where that matters. And that's also where we have concentrated our investments. We've also seen some opportunities on the tanker side. So I would say there are opportunities across the board here. The only segment you could say we don't have in our portfolio that would be natural would be LNG in particular. But our dilemma there has been, one, it's sort of the investment level in that segment and the charter rates where you don't really amortize down so much of the investment, which means that we have been a little conservative in our willingness to take on residual exposure in that segment. But otherwise, we are active across the board and looking at opportunities, and I think we have quite good access to deal flow.

Thank you.

Yes, thank you. Thank you.

As there are no further questions from the audience, I would like to thank everyone for participating in this conference call. If you have any follow-up questions to management, 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 very much.