SFL - SFL Corporation Continues To Increase Its Dividend: Expect More To Come

2023-03-21 06:04:50 ET

Summary

• SFL recently raised its quarterly dividend by 4.3%. However, the share price has sold off recently due to general market turbulence, falling by more than 10% over the past month.
• The share price drop, in combination with an increased dividend, has led to an elevated, but sustainable, dividend yield of 10.3%.
• SFL generated an operating cash flow of $355M for FY 2023, compared to $111.5M in dividends paid. In other words, the operating cash flow is approximately 3x higher than the dividend.
• The fixed-rate charter backlog has increased to ~$3.6 billion with a weighted remaining charter term of 6.6 years. This ensures tremendous cash flow visibility and a stable model for many years to come.
• High-quality, diversified business models will eventually be rewarded. SFL has found the sweet spot in terms of capital allocation, adopting more of a blue-chip type of model.

SFL Corporation Ltd. ( SFL ) continues to deliver and offers a great place for income-oriented investors to achieve a high yield in a stable shipping platform, and at the same time, weather the global storm of bad news. It is no secret that the markets are in turmoil. Lots of things are happening simultaneously. High inflation, high-interest rates, and, sadly, the War in Ukraine continues alongside turmoil in the energy and commodity markets. The latest addition is a banking crisis. Regional banks in the US are failing. Silicon Valley Bank and Signature Bank have already collapsed, and First Republic ( FRC ) received emergency assistance by way of $30 billion in deposits from major banks, including JPMorgan Chase ( JPM ) and Bank of America (BAC), as a show of confidence in the regional banking system. In Europe, UBS ( UBS ) just announced it is acquiring Credit Suisse ( CS ) in a deal engineered to prevent a collapse in the banking sector, in which the Swiss National Bank has agreed to lend up to 100 billion Swiss franc in emergency liquidity in an effort to shore up confidence.

While all of this drama is unfolding, SFL is continuing to deliver stable cash flows and an ever-increasing dividend. The company recently raised its quarterly dividend by 4.3% to $0.24 per share, translating to an annualized amount of $0.96. That said, the share price has sold off recently, falling by more than 10% over the past month.

The share price drop, in combination with an increased dividend, has led to a dividend yield of 10.3%. This is very attractive income to lock in, especially when taking into account the following two factors:

1. The dividend is very well covered, in other words, it is sustainable.
2. The dividend is set to increase going forward, which translates into an ever-increasing yield on cost.

In this article, we will delve deeper into these factors. On February 15, SFL released Q4 2022 and full-year 2022 results. Throughout 2022, SFL was very active in building its portfolio through a combination of new long-term charters on existing vessels and new acquisitions. As a result, SFL added $1.5 billion to its fixed-rate charter backlog in 2022, increasing it to approximately $3.6 billion. Importantly, the weighted remaining charter term of 6.6 years adds tremendous cash flow visibility and ensures a stable model for many years to come.

This backlog has been secured with several investment-grade customers, including Volkswagen, Koch, and Exxon. No single customer represents more than 15% of contracted revenue, with the largest customers being Maersk (Rated Baa2 / BBB+), Hapag-Lloyd (Rated Ba2 / BB+), and Conoco Phillips (Rated A2 / A-). Also, the backlog is highly diversified, split between tankers, dry bulk carriers, containerships, car carriers, and energy assets. The composition of SFL's asset portfolio stands out when compared to other shipping companies, which have typically adopted a more focused, single-segment approach. Regarding the energy assets (offshore drilling rigs), it is worth noting that we have also put legacy issues behind us. The offshore drilling segment has been a drag on financials for many years following the 2014-16 oil crash as a result of fears around China back then. SFL has found employment for its rigs, including the Hercules contract with ExxonMobil Canada Ltd. for ~4.5 months, with start-up expected in Q2 2023. At least things are heading in the right direction.

Moreover, it is important to note that SFL's balance sheet is strong, ending the year with cash of $188 million versus very manageable debt payment obligations. Adjusted full-year adjusted EBITDA came in at around $500 million, comfortably covering the annual interest expense of $110 million. As such, even if SFL's interest payments rise in the future, there is a strong margin of safety. This financial strength positions SFL for further growth. In simple words, SFL is a cash flow machine. It generated operating cash flow of $355 million for the full year 2023, compared to $111.5 million in cash dividends paid. In other words, operating cash flow was approximately three times higher than the dividend. This leaves ample cash on the side for growth purposes, deleveraging, as well as to continue rewarding shareholders with dividend increases, as evidenced by the latest increase of 4.3%. Not only is SFL a cash flow machine today, but it is also a sustainable one, since, as discussed above, the backlog is secured for almost seven years, providing tremendous cash flow visibility.

Dividends will be the primary method for rewarding shareholders, as has been the case in the past. Since inception almost 20 years ago, more than $2.5 billion has been returned to our shareholders through 76 consecutive cash dividends. The good news, as discussed above, is that the payout ratio is very conservative, which not only allows a sustainable dividend but also the ability to renew and diversify the portfolio of assets and charters, which in turn further reinforces a sustainable long-term distribution capacity. The current market turmoil is a blessing in disguise for investors who can lock in a sustainable, sky-high yield of more than 10% with a growing dividend, which essentially means an even higher yield on cost. And one needs to also take into account that once the macro environment stabilizes, there will also be yield compression, meaning capital gains.

There are always risks involved, and SFL is not immune. For instance, prior to COVID-19, the quarterly dividend was $0.35 per share, or $1.4 on an annualized basis. In response to the pandemic, management adopted a conservative approach by slashing the annual dividend to $0.6 per share. The "savings" from this dividend reduction were invested in an aggressive growth program, resulting in the addition of approximately $1.5 billion to the revenue backlog over the past 12 months. SFL also made a significant push into the niche car carrier market, capitalized on the booming container ship market of the past couple of years (which has since softened), locking in lucrative long-term charters, and also enjoyed a resurgence of its energy assets, due to the increase in energy prices.

One could go as far as saying that COVID-19 was a blessing in disguise. The reduced dividend enabled the company to retain cash and grow its asset base and backlog, which in turn has allowed it to restart the mechanism of dividend increases from a position of strength. Given the long-term fixed backlog secured by high-quality charterers, I do not see any material risks to SFL for years to come. In short, SFL has generated a substantial surplus of operating cash flow that exceeds three times the dividends paid, providing a robust margin of safety for reinvesting internally generated cash flow. The company can also leverage appropriate debt financing to replenish any lost income by acquiring additional assets over time, generating additional cash flows, and so on. This approach has enabled SFL to adopt a blue-chip model of capital allocation, with a conservative and diversified business model.

For further details see: