For long-term investors that have had the stomach to handle the wild share price swings, Ship Finance International Ltd. (NYSE:SFL) has been a steady and high rate dividend payer. Now after several years of repositioning the company's asset base, Ship Finance should be poised for the next round of dividend increases.
Strong Long-Term Results in a Difficult Industry
Ship Finance was spun-off out of Frontline, Ltd. (NYSE:FRO) in June of 2004. The initial share price was $14.75. Over the 9.5 years since the IPO, SFL has paid a total of $16.70 per share in dividends and the share price currently sits at about $16.50. However, the ride has not been smooth. The financial crisis coupled with a global recession hit the shipping industry hard. In early 2009, Ship Finance reduced the quarterly dividend by half to $0.30 and during the bear market the share price dropped from a high near $32 in May 2008 to a low of $5 in March 2009.
The Ship Finance results stack up very well when compared to other former high flyers in the shipping industry. Initially, Ship Finance generated the bulk of its revenue from the oil tanker sector of the shipping space. Here are charts comparing the share prices of SFL to its former parent Frontline and Nordic American Tankers (NYSE:NAT).
Diversify and Expand Markets To Stabilize Cash Flow
When it started out in business, Ship Finance owned up to 52 crude oil tankers that the company leased back to Frontline and those contracts produced the majority of the company's revenue. However, as of the 2013 third quarter, the remaining 20 Frontline contracted vessels bring in only 27% of revenue and less than 20% of EBITDA. The Ship Finance debt secured by the Frontline tankers has been reduced by 80% over the last 5 years and the remaining debt is less than the scrap value of the ships. Reducing the exposure to Frontline has been a smart move, since the tanker company has not been profitable since 2010 and the current level of revenues is down about 60% from five years ago. The crude tanker market has been very tough for an extended number of years without any meaningful rebound in sight.
To replace the charter crude tanker business, Ship Finance has shifted its investments to offshore drilling rigs and the company has been acquiring bulk and container freight vessels. The Ship Finance model is to purchase vessels with a combination of equity and debt financing and then charter out the ships on bare-boat, long-term contracts. With the type of deals the company likes to put together, Ship Finance ends up with very low financial risk, accretive cash flow, no or low operating expenses, and the potential to refinance in the future to improve the profit margin or generate extra profit on the sale of a vessel.
As of the 2013 third quarter, Ship Finance was generating 51% of revenue from offshore drill rigs, 27% from tankers, 9% from dry bulk carriers and 13% from container ships. On the new business front, a new-build $600 million harsh-environment jack-up drilling rig will go into service in early 2014 and 8 on-order container ships should start on lease contracts late this year with the last reaching construction completion in 2015.
Looking for A Distributable Cash Flow Reversal to Positive Growth
The diversification into different types of vessels did not completely offset the decline in revenue from the winding down of the Frontline tanker fleet and decline in rates in that shipping sector. Even though Ship Finance has increased the quarterly dividend to $0.39 from the $0.30 rate set during the financial crisis, the cash flow coverage of the dividend has tightened considerably. In fact, EBITDA minus the I-nterest and A-mortization for the four quarters ending with the Q3 of 2013 was $98 million and the dividends paid for the year totaled $131 million. With the new shares issued in the most recent quarter to pay for the equity stake in the new jack-up rig, the annual dividend payments going forward will be $145.5 million.
However, distributable cash flow will increase significantly starting in 2014. Ship Finance has accelerated paying down the Frontline linked debt and will no longer be making those amortization payments. Result, annual available cash flow jumps to $171 million. When the new offshore rig starts producing the full amount of contracted revenue, another $21 million net cash flow goes into the hopper. As the container ships are completed and put under contract, there will be additional positive cash flow streams. Also, over the past year, Ship Finance has refinanced $1.2 billion of debt on three existing drill rigs to more attractive terms. Finally, the Frontline contracts were restructured to make it easier for the tanker company to cover its minimum lease payments but will provide a serious cash flow bump to Ship Finance if tanker rates start to improve.
As a result, distributable cash should end up north of $50 million per quarter in the near future, handily covering the $36 million quarterly dividend payout. By the second or third quarter of 2014, I expect Ship Finance to announce its first dividend increase since the first quarter of 2011. Note: the payout was decreased $0.30 for one quarter at end of 2011.
While Ship Finance has a policy of putting together deals with steady cash flow, the SFL share price does not follow the same path. This is a volatile stock, swinging from under $10 to almost $23 over the last three years. Ship Finance is a very good buy under $15 with a 10% plus yield and I would be looking to reduce a position size at $25. The current $17 share price and 9.3% yield should also be attractive with a secure dividend for income investors.
Disclosure: I am long SFL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.