SFL - SFL Corporation Q1 Results Hit By One-Off Items But Cash Generation Is Still Strong

2023-05-16 08:38:19 ET

Summary

• Net profit dropped by 87% Q-o-Q to just $6.3 million.
• Large One-Off items such as cost of Special Survey on drilling rig made a big dent.
• The dividend remains unchanged and is well covered by cash generation.
• So far, container ships are performing well even with liner companies earning less.

Investment thesis

SFL Corporation Ltd.’s ( SFL ) share price is down almost 16% over the last year.

The fear of a recession is building momentum, and ocean transportation stocks are not a good place to be in that period. As a result, SFL’s share price is also pulled down.

That is despite the fact that they have a fixed rate backlog of $3.7 billion with a weighted average duration of approximately 6 years, which should easily carry them over a recession.

SFL just published the 1st quarter 2023 unaudited financial results , so it is a good time to check how they are doing and the general business environment they operate in.

1st Quarter 2023 Financial Results

• Profit & loss

The company generated gross charter hire of approximately $182.5 million in Q1, including $4.9 million in profit sharing.

SFL achieved a much lower net income of only $6.3 million in the quarter or $0.05 per share. From this, they have decided to maintain their dividend of $0.24 per share.

The large drop in earnings of $42.2 million q-o-q was the result of several one-off items. Especially the cost of the scheduled special survey and improvements required for the Harsh-Environment drilling rig “Hercules”

The rig earned no money during the quarter, as it is in Norway to do the scheduled special periodic survey and the necessary upgrade work.

The estimated total cost of this work is about $100 million. Once this is completed in June. The rig will move to Canada where it will work for Exxon Mobil ( XOM ) for approximately 135 days including mobilization. The contract value is about $50 million. Thereafter the rig will move to Namibia in West Africa for work for another client for approximately 115 days including mobilization. The contract value for this work is similar to the one with XOM. “Hercules” is then open for new contracts from Q2 next year, and will be cash-generating.

There was also a $7.2 million net negative mark-to-market of equity investments and swaps relating to repurchased bonds. SFL also booked a gain from the sale of vessels of $10.1 million and took an impairment of vessels of $7.4 million.

SFL decided to maintain the dividend at the same level as the previous quarter.

Based on a share price of $ 8.71, as of closing on Friday 12th May, it gives investors a good TTM dividend yield of 10.8%

In terms of the safety of the dividend, their net cash from operating activities was $81.1 million. In the last quarter, they paid out $30.4 million in dividends. That is a dividend coverage of x 2.67

We were pleased that management has decided to put in place a share buyback program of up to $ 100 million. Should SFL continue to trade at the levels we now see, it is a good allocation of capital.

• Balance sheet

Regarding their balance sheet, long-term interest-bearing debt increased by $217.9 million and stood at $1.50 billion at the end of Q1.

Cash, and cash equivalent, reduced from $188.4 million to $185.2 million on a Q-o-Q basis.

SFL does incur higher interest expenses in the new rate environment.

Earlier, in Q3 of last year, they stated that they had about 70% of their financing on fixed rate or swap to fixed by financial hedging instruments. At that time, they estimated that a 1% increase in interest rates from their current levels would equal about $0.02 per share in lower distributable cash flow per quarter.

We also noted from Q1 that they have issued$150 million sustainability-linked bonds with a coupon of 8.875% maturing in 2027. That is certainly higher than what we were used to seeing.

In total, SFL has secured new financing arrangements so far in 2023 totaling more than $1 billion.

Business Prospects

Drybulk rates are not what they used to be. Hence, profit sharing here is unlikely in the short term but fundamentals look good for a recovery. The 5 Supramax vessels are trading in the spot market. Fortunately, this market is even better than the larger vessels, so profit generation here is still attractive.

With the sale of the older Suezmax vessels and chemical tankers, no tankers rely on the spot market.

A very positive event took place in Q1 when SFL managed to extend the charter with Volkswagen for the two older Pure Car Carries “SFL Conductor” and “SFL Composer for 3 more years.

These vessels will generate an additional EBIDTA of 38 million with higher rates. These extra earnings from higher rates add US cents 7.5 each quarter to cash that could potentially be returned to shareholders in the form of a higher dividend or their new share buyback.

How does SFL stack up against some of its competitors?

We chose to measure it up against Global Ship Lease ( GSL ).

GSL is somewhat different as they only own containerships, so they are not diversified in terms of segments within the maritime shipping industry. We like SFL's diversification.

Furthermore, SFL seems to focus mainly on large vessels and is, in our opinion, very selective in choosing their counterparts. GSL's focus is on medium and smaller-size ships, often referred to as feeder ships. For smaller ships, you have smaller liner companies too.

To get a better idea of what GSL is doing, we recommend that you read Nikolaos Sismanis's recent article here.

SFL is twice as big as GSL in terms of market capitalization. It is interesting to note that there is a much higher short interest in GSL.

What is going to happen in the containership space is crucially important to GSL as all of their vessels are in that segment. It is also very important, but not as much, to SFL which is quite well diversified with a fleet of tankers, dry-bulk, pure car carriers, and some offshore drilling assets. Only 52% of SFL’s revenue comes from the container fleet.

We have in a recent article about A.P. Møller - Mærsk A/S (AMKBY) shared our bearish view of that company in the next few quarters. They will weather the storm, but our bearish thesis for them is that we believe lower earnings will precipitate a lower share price. AMKBY is down 35% over the last twelve months.

SFL, and GSL, are more fortunate as they are less dependent upon the spot market.

Risks to the Thesis and Conclusion

There is a risk that we could get a recession that turns out to become deeper and longer than anticipated.

That could put pressure on the liner companies’ earnings. In such an environment, it is possible that some of SFL’s customers may try to renegotiate lower rates is possible. If we are to draw some parallels from what happened to their offshore drilling assets a few years back, such renegotiations could include charterers accepting to lengthen the duration of the charters in exchange for lower rates.

A recession is not a certainty at all. We may muddle through with lower growth and see a normalization to lower interest rates. Nobody knows for sure.

On a positive note, we noticed that their small container feeder vessel “Green Ace” of 1,700 TEU which is operating on short charters managed to get a very respectable $16,000 per day up to Q2 next year. That is even higher than our estimate of $14,500 per day. As such, there is no panic among shipowners yet. At the day rate that SFL has fixed the vessel is making a good contribution to cash generation and it must be a very high ROE.

All in all, we are of the opinion that SFL’s share price is very attractive at the present level.

When the market is giving you opportunities to buy shares at discounted prices, it is usually a good idea to buy.

We keep our Buy stance on SFL stock.

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