SFL Corporation: Results Surprisingly Strong For This Ship Lessor
Summary
- SFL Corporation showed a slight amount of growth compared to the previous quarter, although the dividend cut was disheartening.
- The shipping industry has been impacted much more by the COVID-19 pandemic than many others.
- The company's business model is better designed to weather the condition than that of many other companies in the industry.
- The majority of SFL Corporation's cash flow comes from solid, well-financed companies that should reduce counterparty risk in the current environment.
- The company appears to easily be generating sufficient cash flows to cover its dividend at the new level.
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On Wednesday, May 20, 2020, ship leasing firm SFL Corporation (NYSE:SFL) announced its first-quarter 2020 earnings results. At first glance, these results were mixed, as the company failed to meet the expectations of its analysts in terms of bottom line earnings but it did manage to beat their expectations in terms of its top line revenues. In addition, the company was forced to cut its long-standing dividend, which undoubtedly disappointed many investors. A closer look at the actual earnings report does indeed reveal that there was a great deal to like here, although there were reasons to be disappointed too, as the COVID-19 pandemic has impacted shipping much more than some other sectors.
As my long-time readers are no doubt well aware, it is my usual practice to share the highlights from a company's earnings report before delving into an analysis of its earnings results. This is because these highlights provide a background for the remainder of the article and serve as a framework for the resultant analysis. Therefore, here are the highlights from SFL Corporation's first-quarter 2020 earnings results:
- SFL Corporation brought in total operating revenues of $121.896 million in the first quarter of 2020. This represents a 1.68% increase over the $119.877 million that it brought in during the previous quarter.
- The company reported an operating loss of $27.415 million in the most recent quarter. This compares very unfavorably to the $20.216 million operating profit that it reported in the last quarter of 2019.
- SFL reduced its quarterly dividend by 28.57% to $0.25 per share.
- The company increased its charter backlog by an appealing $230 million in the period.
- SFL Corporation reported a net loss of $87.054 million in the first quarter of 2020. This compares very unfavorably to the $23.642 million net profit that it reported in the fourth quarter of 2019.
One of the most important factors affecting the shipping business during the quarter was the outbreak of the COVID-19 pandemic. This outbreak caused nations around the world to shut down their economies during the quarter and then leave them closed over most of the second quarter. This shutdown resulted in various nations halting or curtailing shipping traffic, which could have a markedly negative effect on the shipping industry. With that said, SFL Corporation states that the pandemic had no noticeable impact on its business activities despite this. All of its customers are currently current on charter hire payments, which appears to be one reason why revenues actually increased quarter over quarter in direct defiance of the outbreak.
With that said though, we can see that SFL Corporation swung to a loss compared to a net profit in the fourth quarter. The primary reason for this is that the company had to take a $113.5 million impairment charge, $80.5 million of which was from seven of its Handysize bulk carriers. What happened here is that the outbreak of the pandemic has reduced the opportunities for SFL to secure new charters for these vessels, and the company thinks that this may be a long-term problem. As a rule, the value of an asset is determined by the amount of cash flows that can be generated by it. This is known as the discounted cash flow valuation model. As the company expects that the forward earnings will be lower than the value as reflected on its balance sheet, it needs to reduce this value. Accounting rules require that a company in this situation take an equivalent charge against its earnings, as this is what this charge is. It is important to note that this is a non-cash charge, and the company did not actually see $80.3 million leave its bank account. Therefore, we can likely safely ignore this when trying to determine the performance of the underlying business. If we do that, the company would have been very close to profitable.
Another source of the impairment charge was an unrealized loss that the company had to take on its marketable securities. SFL Corporation owns a number of securities that it can sell quickly into the market just like some of its customers like Seadrill (SDRL). As is the case with any other asset, the company is required to use mark-to-market rules to account for it on the balance sheet so as to properly reflect the value of its assets as of the closing date of the quarter. As pretty much everything went down once the coronavirus broke out, the value of its portfolio went down. The amount of the loss was about $13.6 million in the quarter. This was also an unrealized loss, so we can also safely ignore it, especially it we assume that the market will recover. This is certainly possible. If we do this, then the company would have been profitable during the quarter. This is nice to see in the current environment.
One of the reasons for this strong performance is that SFL Corporation's business model generally consists of leasing out vessels to shipping companies on a long-term basis. This is a much better model than operating the ships itself, as it provides some insulation from the market cycles that the industry regularly suffers from. Rather, it acts somewhat like a bank or a car leasing company (or at least that is the closest analogy that I can think of) in that it should get paid regardless of the economic environment. While it is still subject to counterparty risk, it should overall have much more stable cash flows than other companies in the shipping industry.
One other nice thing about SFL Corporation is that the overwhelming majority of its revenues come from a few very well-financed companies. We can see this here:
Source: SFL Corporation
This is certainly a nice thing, because the companies are likely better able to withstand the current environment in the industry until conditions improve than weaker-financed companies. This theoretically reduces the counterparty risk, as it lessens the chance that any company that serves as a customer for SFL Corporation will go under or be otherwise forced to break a contract with it.
The overwhelming majority of SFL Corporation's current fleet consists of liners, which are mostly container ships, although the company does have two car carriers.
Source: SFL Corporation
This sector was obviously very significantly impacted by the COVID-19 pandemic as countries all over the world shut down their economies and severely curtailed shipping traffic in an effect to slow down the spread of the pandemic internationally. Fortunately though, the two largest shipping operators accounted for approximately 84% of the company's contract backlog of $1.9 billion. It is also nice to see such a large backlog in the current environment, as contract backlog is as close as we can get to guaranteed revenues in this industry. At the current level, the liner division alone represents 15.59 quarters of operation for the entire company, however, the average term weighted by charter revenue was about eight years. As these charters are with reasonable stable and well-financed companies, this is a good position to be in.
We can also see that SFL Corporation has a reasonably large fleet of twelve crude oil, product, and chemical tankers. Perhaps surprisingly, the dayrates that the company's leasing partners receive for these remained strong during the quarter, despite the collapse in oil prices at the end. While SFL does lease these out to companies like Frontline (FRO), much like the way that it charters out the rest of its vessels, it also has profit-sharing agreements on them, so it also directly benefits when dayrates remain high. The company generated $5.9 million in revenue from the profit-sharing agreement alone during the quarter, which is somewhat of a bonus.
Without a doubt, the most disappointing thing in these results was the fact that SFL Corporation decreased the quarterly dividend from $0.35 to $0.25 per share. Ostensibly, management took this action because it expects lower revenue from those vessels not currently under long-term contracts as the global economy slowly comes back on-line from the coronavirus-driven shutdown. This is a reasonable view to have. As is always the case though, we want to ensure that the company can actually afford the dividend that it pays out. The usual way to do this is by looking at the free cash flow, which is the amount of money left over from its ordinary operations after it pays all of its bills and covers all necessary capital expenditures. This is normally calculated by subtracting capital expenditures from operating cash flow. In the first quarter, SFL Corporation had an operating cash flow of $74.512 million and capital expenditures of $23.394 million, for a free cash flow of $51.118 million. When we consider the current 107,632,337 common shares outstanding, this new dividend would cost it $26.908 million. Clearly then, the company has sufficient free cash flow to cover its dividend, which is nice to see and should be a comfort to investors.
In conclusion, this was a surprisingly decent quarter for SFL Corporation, although the dividend cut was disappointing. There is a very real chance that the next few quarters will be somewhat weaker due to the economic shutdown and fears that the coronavirus will return. SFL Corporation appears well-positioned to weather the conditions though, and the company's overall business model is certainly better than what most other shipping industry players have.
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This article was written by
Power Hedge has been covering both traditional and renewable energy since 2010. He targets primarily international companies of all sizes that hold a competitive advantage and pay dividends with strong yields.
He is the leader of the investing group Energy Profits in Dividends where he focuses on generating income through energy stocks and CEFs while managing risk through options. He also provides micro and macro-analysis of both domestic and international energy companie. Learn more.Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.
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