Ship Finance International Ltd. (SFL) has released its first quarter results and the big news for income investors is the restoration of the quarterly dividend rate to previous levels following a one quarter decrease. The shipping sector has been a train wreck - ship wreck? - since 2008 when an oversupply of new ships purchased by aggressive shipping companies sent charter rates to below breakeven for many companies. Ship Finance is one of the few companies to have made it out through the bad times with the current ability to pay a decent dividend and provide the potential for share appreciation returns to investors.
Ship Finance works as a leasing company in the shipping industry. It buys ships and leases them out on long-term bare boat contracts. The customer companies typically pay a minimum per day lease rate with a profit-sharing clause if the shipper is able to earn above a certain threshold. Ship Finance was spun out of Frontline Ltd (FRO) in 2004 and initially just owned crude oil tankers. Over the years, Ship Finance has expanded away from tankers and the Frontline leased vessels now account for one-third of the fleet. Offshore drilling and support ships are now the largest portion of the fleet accounting for 46% of the assets. Ship Finance also owns container and drybulk ships, accounting for 13% and 8%, respectively, of the fleet.
Historically, Ship Finance has paid out the majority of net income as dividends. In late 2008, the formerly steadily increasing quarterly payout was cut in half to 30 cents per share. The company resumed a path of increasing dividends in the first quarter of 2010 and the payout was up to 39 cents in the 2011 third quarter. Late in 2011, Frontline was in trouble with its loan covenants and was challenged to just stay profitable. Frontline made some moves to reduce its daily operating cost, including adjusting its lease terms, with Ship Finance. The result is a reduced debt load for Frontline and reduced daily lease rates on the tankers owned by Ship Finance. In return, Ship Finance received a $105 million up front payment and 100% profit share up the old lease rates. The new agreement runs through 2015.
Ship Finance reduced the dividend to 30 cents for the 2011 fourth quarter and now has re-raised the quarterly distribution to 39 cents for the 2012 first quarter dividend to be paid in June. The new dividend rate puts the yield at 9.8%, after the 6% share price increase following the announcement of the new dividend rate. A 10% yield is a reasonable return from Ship Finance based on the current soft tanker rates market. With some firming of tanker rates and better forward visibility on Frontline's earnings, Ship Finance's yield should slide to around 8%, which would result in a 20% share price increase. Ship Finance's shares should be viewed as over-priced anytime the yield slips below 8%.