SFL Corporation Ltd. (SFL) Q2 2013 Earnings Report, Transcript and Summary

Good day, and welcome to the Q2 2013 Ship Finance International Ltd. Earnings Conference Call. Today's conference is being recorded. And at this time, I would like to turn the conference over to your host today, Ole Hjertaker. Please go ahead, sir.

Thank you, and welcome, everyone, to Ship Finance International on our second quarter conference call. With me here today, I also have our CFO, Harald Gurvin, who will take us through the financials; and also 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 $25 million or $0.29 per share. Aggregate charter revenues recorded in the quarter, including 100%-owned subsidiaries accounted for as investment in associate, was $153 million, which is in line with the previous quarter. This is excluding any cash sweep from the Frontline vessels in the quarter. For comparison, in 2012, the average cash sweep was $0.16 per share per quarter. The EBITDA equivalent cash flow in the second quarter was approximately $121 million. And last 12 months, the EBITDA equivalent was $523 million. The Board of Directors declared a cash dividend of $0.39 per share, which is in line with the previous quarter. The $0.39 dividend represents $1.56 per share on an annualized basis or nearly 10% dividend yield based on the closing price yesterday. We have now declared dividends for 38 consecutive quarters, totaling…

Thank you, Ole. On this slide, we are showing our pro forma illustration of cash flows for the second quarter compared to the first quarter of 2013. 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 second quarter, total charter revenues were $153.7 million or $1.78 per share, slightly up from $152.8 million in the first quarter of 2013. Suezmax and OBO earnings were down in the second quarter due to the sale of a Suezmax and the loss of our OBOs in the first quarter, while offshore earnings were up due to an extra day of earnings under the bareboat charters in the second quarter compared to the first quarter. Vessel operating expenses and G&A were $34.8 million, slightly up from $33.6 million in the previous quarter, mainly due to the amendment from bareboat charters to time charters for 2 of the vessels in May 2013. We also had income of $2.5 million on financial investments during the first quarter, in line with the previous quarter. There was no cash sweep from Frontline in the second quarter, but we recorded a profit share of $100,000 relating to 1 of the Handysize drybulk carriers. Overall, this summarizes to an EBITDA of $121.5 million for the quarter or $1.41 per share, in line with the $121.6 million in the previous quarter. We then move onto the profit and loss statement as reported under U.S. GAAP. As we have described in previous earnings calls, our accounting statements are slightly different than 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…

[Operator Instructions] And we will take our first question from Fotis Giannakoulis from Morgan Stanley.

I want to ask you about the potential deals that you see in the market right now. We have seen, the last couple of months, asset price is, for most shipping segments, moving higher. For most of the traditional ship owners, that means the assets are more expensive, it's more difficult to acquire vessels. What does it mean for you, given the fact that you are looking at transactions that has come with secured cash flows? Are the cash flows that you see -- the charters that you see more attractive right now? And in which sectors do you see more opportunities in acquiring vessels?

Yes. Hello, Fotis, and thanks for calling in. We still see good opportunities in several sectors. And while we have seen prices, at least, stabilized, I wouldn't say that we've seen any dramatic movements upwards. And we're talking from historic low levels in many segments. I think part of that is that we saw the shipyards taking in a lot of orders in the first half of the year. Maybe they are now a little bit more relaxed, as they have covered more of their more pressing and immediate positions and therefore not so aggressively selling yard positions where they may actually take a loss on building vessels. Overall, I think it's still a very interesting time to invest in shipping assets. And we have, as also demonstrated by our -- by where we have put our money, we still think both the offshore space and the container space, at least for us, are the segments where we more easily can see the mix of attractive asset acquisitions and also cash flow characteristics matching our expectations. With that said, I mean, we definitely also look at other segments, and there are also opportunities there. I think between the 4 main segments, in addition to rigs and containers, we also think there could be deals to be done in the tanker space and also in the drybulk space. But we see more long-term charter prospects in the 2 first mentioned segments.

Can you be a little bit more specific about the chartering of the container ship vessels? You mentioned that you are in active discussions about these vessels. When do you think that these discussions will bring some results? And at what levels do you see the cash flow yields for these vessels being developing?

Yes. I mean, we, of course -- as we have not finalized anything, we cannot be too specific on commenting on those vessels other than that we are in discussions with some potential charterers. These vessels are not delivered. The first vessel's delivery is in October next year, so we have more than a year until delivery. We know that the yards are basically full. We hear yards now quoting potential deliveries towards the end of '15 and into 2016 for new ordering in certain sizes and particularly this size. So if that is the case, we believe there could be a value in holding these positions because we believe these vessels are very, very efficient for container lines. And therefore, we can -- we hopefully can get some nice charter rates on them. So therefore, also, as we are in -- some have some discussions, I don't want to be specific on charter rates either -- other than that we, of course, hope that these vessels will be accretive and also that we may, over time, also develop our investments in the sector.

Can you also give us a little bit of the positioning of this sector? I understand that the offshore sector is pretty robust, and the growth there looks positive and it's a pretty stable market. But there is a lot of focus in the recovery of the traditional shipping markets, particularly the drybulk sector. What is your view -- at which point of the recovery are we right now? How quickly do you think that this recovery is going to come? And also, it was -- for most of the people, it was a little bit strange that your focus is still on the -- is on the container ship market. Can you explain to us how do you view the container ship market vis-à-vis the drybulk market and also the tanker markets?

Yes. When we make investments -- and particularly, when we make investments where we hope to charter these assets at long term, we have to look beyond, call it, the near-term cycles. So when we make an investment, we focus on several factors. One is, of course, where is the entry point, i.e. what's the level we're buying the assets at. Two is the counterparty. Are they speculative players, or are they industrial players in terms of their -- the use of these assets? And of course, also, what kind of residual do we think we can expect at the end of the charter period. And the interesting thing with both shipping and offshore assets is that these are assets that typically built in Korea, China, Singapore and -- while they are quoted in U.S. dollars. So you have an interesting dynamics there where we buy and invest in U.S. dollars, but they're really built with local input factor, with most of the input factor being local currency. And we have, in some of these areas, seen very significant inflation, which, of course, could -- if that continues, it will have an impact on replacement costs over time. And in terms of the charter coverage, what we see is that, typically, on the drybulk side, you see more spot-oriented players, shorter-term charters and you don't see that many long-term charters to industrial players. So while we, of course, always look for interesting opportunities and can also take market positions from time to time, our core business is really long-term charter coverage. And then, there are not as many opportunities on the dry side for us as it is in some of the other segments. And in terms of where the -- when and to what extent the market will recover short term, I would leave the question over to you because you are probably more better positioned to answer that. We have a more long-term view on our investments and are not so focused on the near-term movements in charter rates.

I was counting on some help for my work, but thank you for your answer. My last question is a usual topic. I think you've been -- you've answered this question many times about the risk of Frontline. Gensan [ph] just earlier at the conference call was not very optimistic about, at least, the near-term prospects of the crude tanker market. I understand that the company has sufficient cash for the next couple of quarters. What will happen if Frontline is not able to serve the capital lease obligations to you? What will be the impact to your bottom line, both revenue and operating expenses? And is there a mechanism in place to take over these assets and operate them yourself?

Yes. To answer this last question first, absolutely, we can very easily -- if they should default, we can -- I mean, we own the vessels, and we have them on time chartered Frontline, so we can easily charter them out in the market ourselves. But I just want to stress that Frontline is paying the charter hire on time, and they do have other assets. It's had more than $80 million of cash as of second quarter, and they have some other assets there as well. And our key focus over the last 1.5 years after we restructured in 2011 has been to delever this asset quite rapidly. Before the restructuring, we're talking November 2011, we had approximately $750 million of debt associated with these vessels. We are now down to -- around $420 million if all loans were fully drawn. But as we have $220 million nearly undrawn, only 1/2 of that is drawn. And that compares to a scrap value, which, depending on the market quotation and your expectations for scrap value, could be in the region of the $300 million to $330 million perhaps, gives us a relatively good caution also -- just also just comparing that to call it scrap values if that was what it came to. But we believe these vessels do still have a commercial life, and we started off with a full interdependency between us and Frontline. We had all our vessels are chartered to Frontline. That was 100% of our cash flow. In the second quarter, only 18% of our EBITDA came from the Frontline vessels. And as we expand our business with the new rig, we hopefully -- with the new container ships that are coming onstream that the percentage hopefully will continue to be marginalized. So the short answer is that, of course, we monitor the situation. Of course, we will take care of our interests in -- if the market could -- should continue as weak as it is right now. But we have a lot of other assets and a lot of cash flow coming from elsewhere, and we are not so dependent on Frontline as we used to be.

And we will take our next question from John Reardon from Crowell, Weedon.

Just to address the prior questioner's concerns, in addition to the other assets that Frontline has, they also have a relatively recently announced equity funding mechanism with Morgan Stanley. So I think there's plenty of coverage. Ole, when I look around the world, it seems like with the exception of a few land shale plays, all the big oil exploration is offshore, the Deep Gulf, the Gulf of Guinea, Angola, Madagascar. And now, of course, the Barents Sea and the Arctic is looming. Do you -- could you just give us an overview of what you think of the offshore drilling environment and, in particular, the harsh drilling environment going forward, given your recent investment?

Yes, absolutely. I mean, first of all, I'm not an oil market expert. So, call it, detailed analysis on the oil market and expectations, I would leave to the professionals who do that for a living. But of course, we have a view on the oil market when we invest in drilling rigs. What we've seen is that the offshore oil production has been relatively stable over a long period, but we've seen a very significant increase in assets deployed in the exploration. And what we've seen is that the vessels are becoming more and more complex, and we see -- and of course, we see a lot of -- and we see more expensive equipment going into production from offshore. For the most recent investments, of course, part of our analysis was linked to who are going to use this rig. Is it a, call it -- is it a what we call a standardized-type asset, where the oil companies have -- will be attracted to it. And we see there is a sister rig, West Elara, that's been operating for Statoil for a long period very successfully. This rig here will go on charter, a 5-year charter, to ConocoPhillips. But that's not only ConocoPhillips, they're only fronting it for the license. You have several other oil companies who are fully committed to pay the charter higher to North Atlantic during that charter period. And the charter can be extended to 9 years. So there's a lot of cash flow there that we see coming from -- for this rig from production drilling. So what we see is that it's an interesting market. The oil companies, they want the newest, most efficient equipment. And another factor here is also the supply side. You have relatively few yards who can build these highly sophisticated units. And therefore, you have some dynamics there that is also interesting from a commercial perspective. So we do think it's still a very interesting area to invest in and, particularly, when we combine it with long-term charters to good quality counterparts.

So given that outlook, do you see, on a going forward basis, Ship Finance getting more involved in the offshore drilling and harsh environment drilling area on a -- of course, on a price opportunity basis?

Yes, I can confirm that. It's -- I mean, we have the 3 deepwater harsh environment, call it, deepwater drilling units in our portfolio already. We have this jack-up -- harsh environment jack-up, and then we also have a more standard benign water jack-up drilling rig built 2007, and we have some PSVs and anchor handlers. But it's definitely an important part of our portfolio.

We'll now take our next question from Eirik Haavaldsen from Pareto Securities.

I actually have my question answered previously. But how are you thinking in terms of your cash position now at $41 million? How comfortable are you with that going forward?

Well, the way we manage our liquidity is to -- we think it's more efficient for us to reduce drawn amounts on revolving credit instead of necessarily holding it them on deposit accounts earning virtually nothing. So the combined, call it, available liquidity at quarter end was around $260 million or so. And we can draw on that any day if we like to. So we are quite comfortable with our liquidity position.

[Operator Instructions] So it appears that we have no further questions.

Okay. So thank you. And then, I would like to thank everyone for participating in our second quarter conference call. And if you have any follow-up questions, there are contact details in the press release. Have a nice day.

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