SFL Corporation Ltd. (SFL) Q3 2012 Earnings Report, Transcript and Summary

Good day, and welcome to the Quarter 3 2012 Ship Finance International Limited Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Ole Hjertaker. Please go ahead, sir.

Thank you, and welcome, everyone, to Ship Finance International and our third quarter conference call. My name is Ole Hjertaker, and I am the CEO in Ship Finance Management. And with me here today, I also have our CFO, Harald Gurvin; and our Senior Vice President, Magnus Valeberg. Before we begin our presentation, I would like to note that this conference call will contain forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. Words such as expects, anticipates, intends, estimates or similar expressions are intended to identify these forward-looking statements. These statements are based on our current plans and expectations and involve risks and uncertainties that could cause future activities and results of operations to be materially different from those set forth in the forward-looking statements. Important factors that could cause actual results to differ include conditions in the shipping, offshore and credit markets. For further information, please refer to Ship Finance's reports and filings with the Securities and Exchange Commission. Net income for the quarter was $34 million or $0.44 per share. The aggregate charter revenues recorded in the quarter, including 100% owned subsidiaries accounted for as investments in associate, was $179 million. There was a full cash sweep effect on 22 out of 27 Frontline vessels in the quarter, but the number also includes negative adjustments of $2.8 million relating to 5 VLCCs. The net contribution recognized in our accounts in the quarter was therefore $10.2 million on the cash sweep. The EBITDA equivalent cash flow in the quarter was $145 million or $1.64 per share. The Board of Directors has declared a cash dividend of $0.39 per share for the third quarter. This represents $1.56 per share on an annualized basis or 10% dividend yield based on the closing price yesterday.…

Thank you, Ole. On this slide we have shown our pro forma illustration of cash flows for the third quarter compared to the second quarter of 2012. Please note that this is only a guideline to assess the company's performance and is not in accordance with U.S. GAAP. For the third quarter of 2012, total charter revenues were $166.2 million or $2.10 per share compared to $168.9 million or $2.13 per share in the second quarter of 2012. On the VLCCs, Suezmaxes and chemical tankers, revenues were in line with the previous quarter. The container vessels achieved revenues of $14.6 million in the third quarter compared to $17 million in the previous quarter. The reduction is due to lower earnings on the 5 vessels previously chartered to Horizon Lines. We have recently taken delivery of the 2 car carriers, which will have a positive effect on the fourth quarter revenues with income on average for half of the quarter. The drybulk vessels achieved revenues of $15.6 million in the third quarter compared to $17.6 million in the previous quarter. The reduction is due to the sale of 1 OBO during the third quarter and lower revenues for the 4 vessels previously chartered to Hong Xiang. We have sold 2 additional OBOs in the fourth quarter, which is expected to reduce drybulk earnings going forward, partially offset by the delivery of 1 Handysize drybulk carrier in the middle of November 2012. On the offshore side, charter hire came in at $93.9 million, in line with the previous quarter. We also generated cash sweep from Frontline of $13 million in the third quarter, in line with the second quarter. Please note that these numbers exclude the $2.8 million accumulated asset in the second quarter relating to 5 years, which was reversed in…

[Operator Instructions] We shall take our first question from Herman Hildan from RS Platou Markets.

My first question relates to, call it, your main sponsor. Over the last couple of years, you created a Seadrill MLP for Seadrill, Golar MLP for Golar LNG. It's also using Frontline 2012 to, call it, take advantage of the weakness in the commodity shipping market. So my first question is really, how does Ship Finance fit into, call it, these qualities portfolio companies? And are you getting the attention that you should get from your main shareholder?

Well, I think we get good support from our 40% shareholder and we also hope we get good support for -- from the other 60% shareholders we have. Ship Finance has been in operation now for nearly 9 years. We have demonstrated over time that, one, the company has been able to produce positive results, have been able to pay dividends and more importantly have been able to go from a structure position where we had only 1 type of vessels, only 1 client and a very close interdependence to a diversified portfolio where we now have more capital invested in the offshore sector than we have in the tanker and other traditional sectors. I think the fact that we have come through, first, the extreme financial turmoils in 2008 and then also in the market turmoil last year, where we saw tanker values, for example, dropping almost 50% from 2008 to 2009 and then dropping another almost 50% from that. This is again from a super peak in 2008, dropping another 50% or so say, 18 to 12 months ago. We came through that, no covenant issues and we stood firmly on our own feet. Mr. Fredriksen, of course, has many other investments, and we see that they do a lot of transactions. We are very happy with the deals that we do have with them, but I think it's worth noting that we have not done any deals with what we call related companies, i.e. companies where Mr. Fredriksen is also an influential shareholder since 2008. So everything we've done after that has been with totally unrelated third-party partners. And we think that we have a balanced portfolio and we'll look for growth opportunities going forward. I think maybe one of the key benefits of having a very…

Okay. Just one final question. You recently did, as you mentioned, the car carrier transaction, which has been I guess somewhere between 10% to 20% below transactions done both before and after -- sorry, other transactions has been done 10% to 20% above the deal that you did both before and after the deal. And, I mean you seem to be securing about 20% return on equity and the other 5-year deals, obviously, you're repaying the investments over -- from contracts. Is this the kind of return level that we should expect going forward in -- or for example, in the deals that you're going to do within the next 4 to 6 months?

No, we don't give specific guiding on return on the investments. I think we're looking at the investments both from, of course, you at our absolute return but also risk-adjusted return. So we think that investing in the low end of the cycle is generally more interesting than investing in the high-end. But we -- but if and when you do invest in the high end, you have to be very careful with, of course, the counterpart and also that you're able to take down your exposure to the asset to more of a mid to low level type exposure. That transaction, I think, is a good example of what we believe is our premium access to deal flow. It's a deal that was not sort of circulated in the market. We got hold of it and we thought it was a nice transaction. We bought -- we did not buy a vessel -- the vessels with contract. We bought the vessels from one party and then we secured the charter on the other side and matched the 2 together, which also, I would call, is part of the value creation that we see opportunities and combine them. So going forward, we will not give any indications on exactly which assets and how fast we necessarily will invest but generally, this is a much more interesting environment to invest in. We are on the lookout for interesting opportunities. Those car carriers is a good example, and hopefully, we will find other transactions down the road in not too many months.

We shall take our next question from Fotis Giannakoulis from Morgan Stanley.

Harald and Ole, I want to go back to Frontline. You gave a detailed presentation but I just want to make the assumption that the market returns back to what it was in the previous quarter and gives back the gains from the last few weeks. Do you see the potential of a new restructuring with Frontline? And will you consider that any new restructuring will have any impact on your dividend?

Well, first, I mean, we did a restructuring in 2011. We think that was an extensive exercise. Not -- and of course, there, if you know, our largest shareholder was mentioned. He put a lot of -- committed a lot of capital to make that transaction happen. We got $106 million cash up front. We prepaid a lot of debt, and we have a breakeven level on these vessels was actually gives us a margin even at the very low reduced base rates. We saw in the third quarter, market was very -- very, very soft, softer than we've seen for quite a long time. But still, Frontline, they had a cash position of $177 million at the end of the second quarter. It was only reduced to $165 million in that market. So the combination of a low-cash breakeven level for Frontline and the fact that we can service our debt and continue our steep amortization at the lower rate, I think, is a comforting factor. With respect of the cash, we -- there, I would say, volatility is a friend because we have -- the cash sweep is averaged over a full calendar year and, of course, recognized on a quarter-by-quarter on a -- which is the year-to-date number that is taken in. And of course then, if you see softness in one quarter, that will be balanced by the market with market recoveries in the next quarter. And as we -- as I illustrated on a graph on one of the slides that, there have been very few quarters over the last 15 years where we wouldn't have accumulated anything to the cash sweep. And even if we correct away what we call the super cycle between 2003 and 2008, it's still a reasonably healthy level. So we hope for continued volatility because we -- in that market, because we think that will benefit the cash sweep contribution.

I understand that this cash sweep mechanism gives you a way of an option to the tanker market, but how much of your dividend depends on this cash sweep mechanism? Let's say -- let's assume that you would decide the next few months to dispose all the vessels with Frontline, would that have any impact on your ability to pay your current dividend?

Well, we -- of course, it's a very hypothetical question, and we have our contracts with Frontline which are standing there. There is no termination option or purchase option, for that matter, for Frontline in the deal. When the board communicates the dividend level, it is not linked to any specific charter or any specific counterpart. And part of the board's deliberation, when they do decide dividend on a quarter-by-quarter basis, is on the long-term -- what was that, long-term expectations for the company. We have a very significant charter portfolio. And Frontline, going from being 100% of a backlog is now down to just around 25% or so. So that means that we have a lot of cash flow coming from other sources. We have a lot of cash flow coming from offshore assets. We do have capital that we hope to also to reinvest and generate that will hopefully, then, also generate a good positive cash flow. So I don't think you necessarily should make a direct link between the cash sweep, the contribution in any quarter and the dividends that the board decides on.

Okay. I just want to go back to your recent offering and your potential future acquisitions. If my estimates are correct, you have more than $250 million of liquid cash right now. How much of this cash is available for new acquisitions? And if you can give us an idea of whether you see more attractive opportunities. We saw an exotic transaction with 2-car carriers that generated very good returns. Are there more transactions right now in the market that they can have so attractive cash flow yields?

Well, on -- in terms of returns, so that -- we will have to wait and see. I mean, we try to be risk-focused and looking for risk-adjusted return. And of course, at the same time, we also try to be greedy for our shareholders and take the return we can get out of deals. We don't specifically communicate investment capacity as such. But what we have seen, I mean, we raised around $190 million or more than $190 million of capital last month, 1.5 month, and the equity we raised is earmarked for new investments, definitely. The bonds we raised was communicated to basically refinance and replace other debt financing and therefore wouldn't increase the absolute leverage in the company. That said, we also have a very steep prepayment profile on one or many of our projects. So potentially, there could also be some capacity there. So we just have to wait and see, but I'm reluctant to communicate or commit to a specific number. What we've seen before, like in 2008 when we did the 3D quarter rigs in very quick succession, we did not have that much -- I mean, we had basically the same sort of, call it, cash amount on our balance sheet as we have currently. I think, also, we demonstrated by -- through also both the bond rates and the equity rates that we can -- that we do have access to the market. We know that we have premium access to the banking market to put together financings. As Harald commented, we have -- we had significant competition for the car carrier deal and we also see very good interest from the bank side on the rig financing, which is not so strange. We try to put together sound transactions, good assets. We like cash flow. The banks like cash flow. And we typically have accelerated repayment profiles rather than, call it, bullet-style repayment profile because we think that builds a buffer, a long-term buffer in the company.

And jumping to the financing market. Harald, if you can comment, how do you see the ship financing market this quarter and if you can compare it with previous quarters. If you see any changes, obviously, you have a lot of banks competing for your deals, but do you see that the situation is more difficult for more of your competitors? And if you bring this today, what are the terms that you think they are feasible for a standard deal?

Well just commenting on the banks who are active, I mean, you've seen some banks announcing that they will be leaving the market. But as we said, for the car carriers, we have banks calling us, wanting to finance them and also for the refinancing there, we -- there's over 10 banks actually looking at the deal. And -- but on the terms we get, we don't comment on margins, except that we have attractive margins. And typically, you get, depending on the contract you have in place, you get 60% to 80% leverage and you get attractive repayment profiles from 10 to 15 years.

And my last question has to do with container ship vessels and the 4 Handysize bulkers that are available right now for chartering. What do you think about the redeployment of these vessels?

Yes. For some of these -- 5 of the containerships were vessels that were previously chartered to Horizon Lines. We renegotiated a transaction earlier this year where we took the vessels back in combination with a note and 10% of a $40 million note and 10% of the equity in Horizon Lines. And those vessels have been traded in the spot market. And the container market is relatively poor, and one of the vessels is, like, currently idle and looking for deployment. And -- so it's definitely not the time to lock in long-term charters. Typically, what we see is that, long-term charters very often is linked to shorter term -- the short-term market. So we expect to continue to trade those vessels in the short-term market until the longer-term market hopefully improves somewhere down the road. That said, it's -- they're relatively -- in our portfolio, we see them as a relatively small exposure. And also from a cash flow perspective, it's really not -- that's not really where the cash flow in our company is coming from. So what we think, that situation is definitely very manageable.

We shall take our next question from David Miso [ph], private investor.

Two questions. With the prepayment of the March 2013 dividend, is it safe to assume that the -- that they'll be no other source for a dividend until June of 2013?

Well, as a prominent ship owner once said, "You have to support your shareholders." We have noted and we have also had to had conversations with investors over the last couple of months...

I'm not -- I didn't mean it in a negative way. I'm just saying, is there any other source where there'd be -- that you might be able to come in with a special dividend or something unusual outside of your normal dividend policy? I wasn't being critical in any way about the prepayment.

Okay. So from the company's perspective, we also communicated and the board communicated that no additional dividend payment can be expected prior to the declaration of the first quarter dividend in 2013. So you could [indiscernible]

And then I [indiscernible] remind the question again, my ignorance. Your cash sweep with Frontline, is there a termination date on that?

It runs through 2015.

So there was prepaid the first couple of years and then -- is that correct? Or have they prepaid the entire cash sweep?

Well, they prepaid -- the entire cash sweep in aggregate for the remaining vessels in the region of $240 million to $250 million. They prepaid $106 million. So you can say that, if we get full cash sweep for a period of 2 years out of the 4 years, we would be equally well-off. And if we get more cash sweep, it would be a real -- it will be a net profit to us.

That, of course, is -- it accumulates on a quarterly basis. But it's -- the final calculation is done at year end for each year and then is payable in March.

[Operator Instructions] We shall take our next call from CJ Baldoni, Principal Global Investors.

The cash sweep, is that a restricted cash at Frontline?

You would have to refer that to them. We don't have the information on how they treat that in their accounts. My impression is that the restricted cash in Frontline is more linked to the ITCL vessels, but you would have to refer to Frontline.

So if the world changes dramatically between now and March when they're supposed to pay it, and March comes around and they can't pay it, what's your recourse?

Well, we own the vessels. So we can then take the vessels away from them if they don't perform on their charters and on their obligations. So that could be the first step. And then of course, we would have a significant claim with the company if something like that happen. But what we've seen -- we've seen the third quarter being a very poor market, we saw that they still have $165 million free cash, not restricted cash. And that was only down $12 million or so from the previous quarter. So even in a very depressed market, they are really not burning that much cash at the -- apparently, looking at their accounts.

Is that guaranteed by Frontline?

Well, yes. This is guaranteed by Frontline. Absolutely.

And then if you could just shed a little bit more light on -- I'm sure it just comes down to a financial calculation, so maybe the question is moot, but as far as the OBOs are concerned, I mean, if I remember correctly, those vessels have been generating good cash flow above the contracted rates for you. I'm just curious as to why sell them now?

Well, the OBOs that have been sold -- and we have sold the 6 out of, originally, 8 OBOs. All of those vessels have been sold after the contracts had ended. And the OBOs where they -- when we acquired them, they were all trading in the oil market because they can go both with oil and drybulk, but in the late -- in the last few years, they have been switched into drybulk and have been operated in the drybulk market. And in that market -- the charter rates in that market has been relatively poor, so that of course has an impact on -- also on Frontline's willingness to compensate us for terminating the charters. We, on our side, even if those vessels are now 20 years old, we don't -- typically, the tankers and bulkers are scrapped when they are somewhere between, I would say, 22 and 27 years. So we see that also as an opportunity to sell those assets and reduce leverage and take the cash out of that and reinvest that in other -- for other assets.

I didn't realize the contracts were at their expiration?

Well, the subcontracts -- our charters to Frontline, they run until 2015.

Okay. So it means -- so the contracts with Frontline was still valid which -- okay.

Yes.

And then did you say that the rate on the car carrier bank loan was the same as the rate on the deal that you did in the Norwegian bond market? Or did you not -- what's the rate there?

Well, the new -- the interest rate in the Norwegian bond market is, on a swap-to-dollar fixed basis, is 6.06%. While the back loan interest rate on the car carriers will be based on a floating LIBOR, plus a margin. We may or may not swap that out. We see 5-year interest rates now hovering about 70 -- or in the high 70 -- around 80 basis points. So we see a very interesting interest rates turf there.

Okay. So that's based on LIBOR plus a margin?

Yes. Exactly.

Okay. And then -- and there's no reason to think that margin is much different than the margin that you have on your other debt, right?

Exactly. Exactly. I think we have competitive margins in the bank market.

And then as far as the -- can you just touch again on the other rig refinance? Did you say that you're looking at just refinancing one of them now and you're not going to take out any incremental debt, although you could?

Well, if you look at the first one, the one that we're financing now is the West Polaris. And that's financed by Level 1 facility maturing in the early second half next year. We recently launched that transaction. The current outstanding is around $400 million, just above that. And we're refinancing approximately the same amount, just a slight increase, but still a leverage below 60%. So close to -- the market values there are quite good in the market. So it's basically a straight refinancing of that loan.

Okay. And what about the other second one? Why are you staggering it? I'm assuming the bank can [indiscernible]

We have 2 more rigs in one facility. Those mature -- don't mature until mid-November next year. And of course, the financings we have today, because they were down back in 2008, they are extremely attractive with a very low margin. So we want to hang on to those as long as possible to save interest costs.

But at the same time, of course, do that in a very prudent manner. So we are -- we have been actually asked by some of the banks, "Why on earth are you doing this early?" Because they were expecting us to sit out and wait until final maturity just because of that. But of course, it's always a matter of making sure that you're not in a squeeze in any way in terms of timing. And that's also how we can get the best terms out of the market, including out of the banks who are financing us.

Okay. And then lastly, real quick. In some of your charts, in the press release and in the presentation, so when you go back and revise the prior period like, for example, of the first page, the charter revenues and EBITDA are different. Is that because you're adjusting it for sales and purchases?

No. I think that adjustment, that's also noted in the notes. In order to make the periods comparable, the only adjustment made there is that the cash sweep accrual on 5 of the Frontline vessels. There was an accrual of $2.8 million that was in the second quarter numbers. As we see now on a year-to-date basis, it's 0. In the P&L, we -- the cash sweep contribution is reduced to $10 million. But in order to make the numbers more comparable, we have also then removed that contribution in the second quarter numbers for comparison purposes.

[Operator Instructions] We have no questions in the queue at this time.

Thank you. Then I would like to thank everyone for participating in our third quarter conference call and wish everyone a nice day.

That will conclude today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.