Ship Finance International Limited Q4 2007 Earnings Call Transcript

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Ship Finance International Limited (NYSE:SFL) Q4 2007 Earnings Call February 14, 2008 10:00 AM ET


Ole Hjertaker – Chief Financial officer

Lars Solbakken – Chief Executive Officer


Jonathan Chappell – J.P. Morgan

John Kartsonas – Citigroup

John Parker – Jefferies

Justine Fisher – Goldman Sachs

Ole Hjertaker

Thank you very much and welcome to all participants to Ship Finance International’s fourth quarter conference call. From the Company here today, we have the Chief Executive Officer Lars Solbakken, my name is Ole Hjertaker, and I am Chief Financial Officer.

We will turn to page number two in the presentation that is available on our website.

Before we begin our presentation, I would like to note that this conference call will contain forward-looking statements within the meaning of the U.S. Privates Securities Litigation Reform Act of 1995. Words such as expects, anticipates, intends, estimates or similar expressions are intended to identify these forward-looking statements. These statements are based on our current plans and expectations and involve risks and uncertainties that could cause future activities and results of operation to be materially different from those set forth in the forward-looking statements.

Important factors that could cause actual results to differ include conditions in the shipping, offshore and credit markets. For further information, please refer to Ship Finance’s reports and filings with the Securities and Exchange Commission.

Page number three, today we will cover the fourth quarter of 2007 and we will discuss highlights and subsequent events. We are also going to discuss the financial results for the quarter. At the end, there will be a question and answer session.

In addition, we have also included more information on Ship Finance and our charter overview and we will also enclose some information relating to our accounting and specifically the breakdown of our finance leases and our deferred equity.

The board of directors has cleared a divided of $0.55 per share. Over the last four quarters, this represents $2.20 and a divided yield of 8% based on the closing price yesterday.

The net income for the quarter was $52 million or $0.72 per share. Year-end to quarter, $16 million or $0.22 per share of profit share accumulated, which is an increase from the $6 million or $0.08 per share accumulated in the third quarter.

In addition, in this quarterly result there is also $15.2 million of profit share that accumulated in the first quarter but has not been recognized until this quarter.

This quarter there was also a $6 million or $0.08 per share non-cash negative adjustment in mark to market of derivatives relating to our interest rate swaps and this is due to lower interest rates compared to third quarter.

We have an increased fixed rate, the charter higher backlog and if we exclude profit share, our net fixed rate contributions from operations was $108 million or $1.49 per share this is up 2.6% over the third quarter. If we include profit share and also a vessel that is not consolidated into our accounts, based on U.S. GAAP, the fixed rate contribution is $125 million or $1.72 per share. We will go into more details on that later in the presentation.

We have continued to reduce our non-double hull tankers and in the fourth quarter, we announced sale of three additional. Following these sales, we will only have six un-double hull vessels remaining and all of these vessels are chartered out medium to long term by Frontline.

We will have an operating fleet of 57 vessels and we also have 12 vessels in new-buildings that we have ordered.

We now have six offshore supply vessels in operation as of January 2008. Four vessels were delivered prior to the fourth quarter and were therefore in full operation during the quarter. One vessel was delivered in mid-October and then we took delivery of two vessels in January while we also sold one vessel so we net have six vessels in operation.

We have also recently announced a new twelve-year variable charter for two container vessels. These are chartered to an Asia based regional liner company and are fixed rate charter backload has been increased by $170 million over this period.

We have also initiated a share repurchase program and 692,000 shares have been accumulated so far of which 349,000 shares were accumulated by the end of the fourth quarter.

We have utilized equity total return swaps to finance this program and in our accounts for the fourth quarter; we had $900,000 gain in mark to market of derivatives relating to these shares.

The concept of the share repurchase program is for us an instrument in the toolbox where we have a very opportunistic approach to how we use that. We see that we have a higher yield on our equity and our funding rate under the total return swap; therefore, there is a margin of which we can take advantage.

Using that these total return swaps require us to reserve 20% cash deposits and this is reflected in our balance sheet as restricted cash. Our key focus going forward is to focus on new investments primarily and of course take advantage of opportunities as we see them also relating to our own stocks.

The board has also approved a divided reinvestment plan and direct stock purchase plan, which we expect to be announced in a separate press release very shortly. This is due to the fact that we have a larger number of retail shareholders in the U.S. and we have received a lot of requests for investing on this basis from our shareholder base.

In our profit and loss statement this quarter, we have for the benefit of our analysts and investors have disclosed more details in our total operating revenues. We have this quarter illustrated and showed that revenue lines, both from the operating leases, the finance leases and then subtracted out the revenues, which are classified as repayment of investment in finance lease.

Finance has most of the assets classified as finance lease based on U.S. GAAP; therefore, a very significant portion of the charter hire does not appear normally in the income statement. This is illustrated by the negative amount, which was $46.2 million for the quarter and $173.2 million for the full year.

We have also recorded $52.5 million in profit share for the year, which will be paid to us by Frontline in March, this year.

If you look at other financial items, there is a negative $6.2 million. This consists primarily of a negative $6 million mark to market on our interest rate swaps and approximately $1 million of positive mark to market relating to our equity total returns swaps.

If you look at the negative impact on our mark to market of interest rate swaps, our reduction in interest rates is in reality a very positive effect for Ship Finance plus we have covered 70% of our financing exposure; but we still have 30% open. But, our reduction in interest rates actually reduces the interest cost going forward. On a mark to market basis, we get this non-cash effect.

In our balance sheet, we have most of our assets classified as investments in finance lease. There is also a $226 million of deferred equity, which is not recorded in our balance sheet. This relates to the initial transaction and some subsequent transactions when we acquired vessels from Frontline and we were required due to the related party nature at the time to record these assets based on Frontline’s book value at the time and not on the acquisition price. This deferred equity is amortized back to our equity in line with the lease schedule we have on the specific vessels.

In the cash flow statement, I just want to point your attention to the first line under investment activities. This is where the repayment in investment finance lease appears. This is the same amount as we showed on top of income statement as the deduction from the charter rates received. This is a part of our cash charter rates but due to our accounting basis, where we have lease accounting, this flows through the cash flow statement only and does not appear on our net income.

Ship Finance’s operating performance is what the management focuses more on and we generate a significant cash flow per charter; this is based on our large performing fleet and we generated from our charters $138 million this quarter compared to $133 million in the previous quarter. If you deduct vessel operating expenses and general administrative costs, we have a contribution before interest, taxes, depreciation or administration or effectively the EBITDA before profit share of $109 million this quarter compared to $106 million the previous quarter.

If you also add in the profit share accumulated in the quarter, not as booked over P&L, but accumulated in this specific quarter, the contribution EITDA or EBITDA increased from $111 million in the third quarter to $125 million in the fourth quarter, which is a 30% increase.

A couple of measures for dividend payout companies is contribution after interest. We paid $34 million of net interest for the quarter or $0.47 per share.

Ship Finance started as a pure tanking company in 2004. For all the OBOES or oil boat ore vessels, combination vessels that can trade both in wet and dry are all trading in the tanker market.

The growth in the Company has been executed without issuing equity and this has primarily been fueled by the profit share from Frontline, which has been very substantial over this period.

The growth into bulk container in offshore has only been over the last two years. Over time, we expect to see a further balancing of all these segments and particularly container and offshore are viewed as very interesting growth areas for us, currently.

As we can target several segments, we don’t need to only focus on one segment and we can look to do the best deals available across these segments and across the market cycles in these segments.

What we see in the current market environment where financing is becoming more challenging to put together for many companies, you see an increased deal flow and also very good access to transactions.

We are well funded to grow as we still have surplus capital for investments and we think we can generate very interesting new projects going forward.

We have a unique order backlog and companies with large charter backlogs typically have five to seven years coverage. We are in a different league with 13.5 weighted average charter coverage. This is $5.6 billion or $77 per share while the EBITDA from this charter backlog is around $61 per share. These numbers are, of course, before profit share and does not include any REIT-chartering after the end of the current charters.

We have a history of paying stable quarterly dividends. The dividend announced today is $0.55 per share, which equals an 8% dividend yield based on yesterday’s close price.

We have invested significant amounts in 2007; but have also received significant net proceeds from sale of single-hull tankers, which we have reinvested to support a longer-term dividend capacity. We expect that new transactions will increase the dividend capacity going forward.

The profit share agreement with Frontline has been very favorable for the Company. The original charters were structured much lower in the tanker cycle and therefore, have a low profit share threshold. On average, we have received $84 million per year over the base charters over a four-year period. This represents more that $330 million over this period.

Our dividends are based on distribution capacity exclusive of this profit share contribution and therefore, this can help the Company grow even faster than they would otherwise have been able.

We have a close slide with the sensitivity relating to the profit share agreement with Frontline. Due to Frontline’s third party charter coverage, the profit share is a very robust even in a very slow market. Frontline has sub chartered out all the remaining single-hull tankers and also all the OBOES are chartered out essentially long term.

This illustration shows the sensitivity versus market earnings while the final profit share will depend on actual earnings on a vessel-by-vessel basis. As we can see, based on EMERX forward rates quoted currently, which are in excess of $60,000 per day, for the last three quarters of the year, that this could illustrate that we would get the profit share this year inline with the average. Bauctions have reported average (inaudible) to sea earnings in the regions of $100,000 per day so far the year for modern vessels.

But, of course, we will only know what the profit share will be after the vessels have generated their revenues for the year. Also, this illustration shows that even when the average rate is below $15,000 per day or more than $11,000 below our base charter rate with Frontline there will be a profit share contribution in 2008. We see the same picture also in 2009.

We currently have $2.3 billion of interest bearing debt as of December 31. This is a combination of $1.8 billion of bank loans and approximately half a billion dollars of bond notes. We have approximately 70% of our interest rate exposure fixed for a combination of fixed interest rate swaps or interest compensation courses with charters.

We have several new projects, which have been financed from stand-alone basis but no over limited recourse to Ship Finance. This improves our investor position and of course the risk for Ship Finance. Our focus is to continue diversifying our fleet and customer base on this basis.

We do have significant capital available as equity in new projects reported $79 million of net cash per year-end, which included $1.1 million of cash and a 100% owned subsidiary, which is not consolidated based on U.S. GAAP.

We will also receive $52.5 million of profit share from Frontline for the year 2007, which is payable in March of this year.

We have announced the sale of single-hull vessels and the two vessels that are scheduled to be delivered in the first quarter of 2008 is estimated to give us a net proceeds of $40 million after paying compensation to Frontline and paying down the debt associated with these vessels. We also have $84 million available under revolving credit facility. On top of this, we have several vessels without any loans attached and we estimate that we could borrow the region of 150 to $200 million against these assets if we would like.

As a summary, the net income for the fourth quarter was $52.4 million or $0.72 per share. Our profit share increased significantly up from $5.5 million in the third quarter to $16.1 million in the fourth quarter. The fourth quarter also includes $15.2 million of profit share with respect to the first quarter of ’07.

We have improved operational performance in the quarter where the cash contribution from operations after vessel operating expenses and G&A costs effectively EBITDA from operations increased 13% to $125 million.

We see significant growth opportunities in large diverse markets and we have announced approximately $1.1 billion of new transactions in 2007.

Twelve non-double hull vessels have been sold and effectively replaced by new projects with a longer term predictable cash flow. We have a strong liquidity position to fund equity portions in new investments and several projects are in the pipeline.

Finally, quarterly dividend is maintained at the high level of $0.55 per shares, which gives an 8% dividend yield based on the closing price yesterday. New projects are expected to grow the dividend capacity going forward.

We hand over to the operator for questions.

Question-and-Answer Session


Thank you. (Operator Instructions)

Your first call is from the line of Jonathan Chappell from J.P. Morgan please proceed.

Jonathan Chappell – J.P. Morgan

Good afternoon, I have three questions regarding the current environment and your growth trajectory. The first surrounds banks and the credit environment. We have heard a lot of stories about certain European banks that are “closed” for lending because they have taken on more than they could chew. What are you hearing from your banking sources, are they open to people like Ship Finance and are they willing to lend to projects in what we could call an uncertain macro environment right now?

Lars Solbakken

We see a very good financing market for us and I think what we have seen is in a way be polarization of the market where the strong companies, where the strong balance sheets and still have good access to capital while other less strong companies and maybe more project related companies are struggling a lot finding capital. With our balance sheet and the leverage against our assets, I think it is fair to say that the banks view Ship Finance as a very strong credit.

Just as an illustration, the fleet on charter to Frontline, the asset value representing those vessels is in the region of $3.5 billion. While we have outstanding secure debt against those vessel in the region of $1.3 billion and there is significant buffer there and this is exactly what the bank are looking for, strong companies that can survive a potential downturn in the market.

With respect to your question on European banks, there has been a lot of turbulence in the market and what we have seen is that most of the banks, even the banks who apparently shut their door a little bit in the Fall, have started opening their door a little but on a very selective basis. For us, not such a challenge, because this was only a few banks and we have more than twenty banks in our banking syndicate. While some banks are reluctant to do new business, other banks were very eager to do business. As long as we maintain a very active relationship with our banks, we see that we have access to capital and we are not relying on just one or two.

Jonathan Chappell – J.P. Morgan

The second question relates to opportunities. Are you seeing more owners who may have built assets on a speculative basis back when times were a little better, having problems finding the financing and are there more projects coming across your desk that you think may have better return criteria?

Ole Hjertaker

We clearly see that; we are seeing projects with better returns than we did last year. These are good opportunities to invest now with the higher returns and project logistics that we like. We expect it to be quite active year for us with volumes we did 1.1 billion last year; we were looking at a large number of projects that many of them did not cash meet our return requirements and we turned them down. Now we see many more projects kind of meeting our requirements.

Jonathan Chappell – J.P. Morgan

Okay and the last thing is just balancing new investments and new projects with the dividend, your backlog just continues to increase and the charter tenures longer as well; but, the acceleration of the dividend increases have kind of slowed of late as you have been more in investment mode. When do you see more of a return to the distribution rather than the reinvestment of cash as far as the profit share that is generated and other excess cash is concerned?

Lars Solbakken

Our target, of course, is to increase our dividend distribution over time and we will do that through identifying and doing investments. It is fair to say, we did a significant volume in 2007 but we also sold twelve single-hull vessels and effectively reinvested capital that came open relating to those.

For us, what is important is to build a very long-term predictable dividend base to insure that we are not in a position where we may have to reduce our dividends in the future.

We are also very concerned or focused on making sure that we continue to reinvest deals on our dividend base. As you know, any vessels has a finite life and have to make sure that we do this on a ongoing basis that is also why we have a fairly steep repayment profile on our debt even though, as I mentioned earlier, we have a relatively moderate leverage in manner of our assets. Either way, that is a way to preserve capital and facilitate future growth in a very slow environment. This creates reserves where we can act when others probably cannot.

Jonathan Chappell – J.P. Morgan

Is there a targeted pay down for 2008?

Lars Solbakken

We don’t have a disclosed targeted pay down; we have debt repayment profile essentially on most of our debt and we believe that we may re-borrow some of that but we see that as having a conservative long time profile to afford the divided capacity. Not just in the near term, in the next few quarters, but on a very long-term basis.

Jonathan Chappell – J.P. Morgan

Okay, thank you Ole and Lars.


We have our next question from John Kartsonas from Citigroup please proceed.

John Kartsonas – Citigroup

Hi, two questions here, first your CapEx, there was some shift between the years and two four was below what you guided in your previous quarter, what is going on there? Is there some new deliveries that move into 2008?

Ole Hjertaker

There is possibly deliveries of the supply vessels that move into 2008.

John Kartsonas – Citigroup

Then why is there then the increase in 2009?

Lars Solbakken

Also on the aspect vessels, I think we included more of them in 2008 and we have moved them into 2009.

John Kartsonas – Citigroup

That increasing 2009 CapEx and then on the depreciation, should we assume going forward all these vessels will be operating leases so that there won’t be any more depreciation? Secondly, is there anyway you can give us some guidance for ’08, for the depreciation line?

Lars Solbakken

I don’t have the depreciation line in front of me but in the fourth quarter we had most of our assets that in operating lease in operation. You should get a relatively good guiding from our P&L Statement, fourth quarter, and what will come on top of that is that we took delivery of a net increase of one also early in the first quarter 2008.

John Kartsonas – Citigroup

Okay, so you take the fourth quarter as a run rate, less than one in Q1 that would get me there, right?

Lars Solbakken

Yes, that should be on a good rough estimate.

John Kartsonas – Citigroup

Okay, that is all I had, thanks.


Your next call is from the line of John Parker from Jefferies please proceed.

John Parker – Jefferies

I just wanted to clarify in the profit share payments, are those always going to be in March even though you are now accounting for them on a quarterly basis?

Lars Solbakken

Yes, the profit share payment will continue to be in March the following year. The change we did in the profit share agreement was more related to how we can accumulate that and project those in our P&L statement. The cash effect of it will be the same in March the full year.

John Parker – Jefferies

I think the recent spike in tanker rates exceeded a lot of expectations and I am wondering if you had a view on why the spike was so large?

Lars Solbakken

We don’t operate directly in the tanker market, so that is probably a question that others may answer better than me, why that happened. It is usually a combination of factors. What we saw was that the tanker rate went up much faster than anyone anticipated. The winter market was a bit slow coming and then when it first entered the market was much tighter and therefore the rates went through the roof go in late December. We have also seen a very healthy market going into 2008; although, it has slowed down a little from the peak. The forward rate, we see good expectations in the market for a strong year in 2008.

We cannot explain exactly why the spike happened.

Ole Hjertaker

A weak market is ultimately is that a lot of shipments were delayed. It is also related to pricing, how that moves.

John Parker – Jefferies

Okay, you just closed you charter backlog, your cash flow backlog and your tenure, assuming that there are no call options exercised on person or vessels, could you comment on what might drive people actually call the vessels away from you and what plans you might have, if a lot of vessels are called away, to replenish your backlog.

Lars Solbakken

We have a charter backlog currently of $5.6 billion and EBITDA of $4.5 billion assuming no call options are exercised. If all call options are exercised, this backlog will be reduced by approximately $1 billion.

We are not so concerned about that because we have a big broader backlog as it is even if they are called at the earliest possible time. We have staggered maturities on these call options and if they are exercised, we get a better return on the projects for early termination than if the projects run through the end of the life. We will then get a lot of cash to reinvest. The question is then really, if we see a deal flow or will we be able to reinvest this capital on top of the growth that we need to build into the Company to raise the dividends beyond that.

I think we are quite comfortable with the situation as it is.

Ole Hjertaker

The thing that is important is that there is no purchase option on the Frontline fleet, which is a very large portion of our total fleet and there is no purchase options related to that part of the fleet.

John Parker – Jefferies

What do you think might drive people to exercise the first option would it just be an increase in asset values, would it be (inaudible).

Ole Hjertaker

If they want to access those values and they want to exit, it certainly could be that they could refinance at better terms. It is structured that the early purchase are typically more expensive than later. We do not expect to count on any rush of purchase options and many of these are bought into the future.

John Parker – Jefferies

I realize that most of your assets are fixed long-term charters. If you look forward and if you were of the view that we are going into a global economic slow or even a U.S. economic slow down, which of the sectors that you are invested in or that you might invest in would you think would be most impacted by that and which ones would you perhaps steer clear of and which ones would you be more likely to invest in if that were your view?

Ole Hjertaker

I think that at least, if you look at the market in total, the tanker market looks reasonably healthy, supply and demand, and we are not that concerned about the anchor market. Your offshore market looks reasonably healthy going forward with a good balance. Those factors, we are not that concerned about. Of course, the dry boat market where we are (inaudible) that we have a few vessels, it could be exposed, if there is a slow down in the world economy. Of course, all of our vessels are more the long-term charters and a lot of our vessels have been entering into charters when values and rates are much lower than today.

For example, if you take the Frontline fleet even if you had substantial reduction in values, we could be hurt on the profit share; but it wouldn’t be a problem even if there were substantial reduction in values.

John Parker – Jefferies

Thanks very much for your help, good quarter.

Ole Hjertaker

We are pleased with the position we are in and even if there is a slow down, we don’t expect any strong impact on ship Finance. There will be some impact if there is lower profit share; but the tanker market looks reasonably healthy.

John Parker – Jefferies

Okay that is all for me, thank you very much.


Our next question comes from Justine Fisher from Goldman Sachs. Please proceed.

Justine Fisher – Goldman Sachs

Good morning, the first question that I have is about the business that you are seeing from various segments of the shipping market; are you seeing any more increase for your business as a counter party in any particular segment that you are in or are you seeing business opportunities across the board?

Lars Solbakken

We see a general increase across the board, which has to do with the access to capital in the market typically also for what some of the project focus companies were able to do before but where they don’t have that kind of access to funding, currently. We see it across the board and we see the currently characteristics higher now than we thought last year for instance.

Justine Fisher – Goldman Sachs

You actually touched what my second question was going to be. I was going to ask whether you are seeing increased business from people who may have gone straight to the banks for borrowing previously like a Nordair, DBD or something like that and they didn’t get financing from the banks because either they didn’t have a longer relationship with banks or their credit ratings weren’t necessarily what they needed to be. Today they said, oh well, we can’t get money from the banks, we will go to Ship Financing because you are a middle man with a better relationship with the bank; they will sort of do the borrowing through you. Are you seeing increase inquiries from counter parties like that?

Lars Solbakken

We do that also; but, as a general note, doing a transaction, which you finance for companies, we can deliver in a way much better cost of capital than most companies can do themselves.

That has to do with our very long term nature of our business, predictable and our investors expect a lower total return on equity year over year than they do when they invest in more, say a sport tanker company for instance. If you combine the cost of our equity with our focus on structuring the right debt structure in each and every project, the combination of that gives a very competitive cost of capital.

We continue to be competitive in all market environments. If the interest rates are high and total return expectations for investors are higher, we still are competitive on a relative basis.

We think we are positioned to do business in all market cycles.

Justine Fisher – Goldman Sachs

Are you getting more questions from the banks about your kind of party risks. I am looking at Friday and obviously Frontline and Secural and Golden Osha, all of those are companies that the bank would be familiar with; but, are they saying to you, are you seeing an increase from people who are knocking on our door last week and we didn’t give them any money so now they are coming to you? Are they questioning you more about your counter parties?

Lars Solbakken

In a way, we take care of that also through the fact that we structure our new projects in projects effectively where we finance the with lower or very limited guarantees from Ship Finance, which means that the bank will actually have to take an active view on the risk profile in this specific project itself. For us, in addition of course, we have to do our own risk assessment relating to different counter parts. We also get a second opinion in a way from the bank, who do their credit evaluation of the chartering counter part.

Justine Fisher – Goldman Sachs

Okay, the last question I have is about bond repurchases. I know your bonds are still trading pretty close to par but would you look to buy those back. Buy back additional amounts of bonds this year and is there a price at which you think that would be attractive?

Lars Solbakken

We are very happy with the bond as it is. As you know, the bond was an integral part of establishing the Company back in 2003, based at an eight and a half coupon and it has different call options in 2011, it is a C, if you recall, option. Our net exposure to the bond has been reduced substantially as we hold $130 million approximately of bonds, ourselves. Of the 449 bonds, we control $130 million. If you compare that to our overall, that portfolio in excess of $2 billion, you see that they call it the relative cost of the bond is not very large. We have increased by acquiring some bonds; but we have a very opportunistic approach to this. As we do with the share repurchase program, which is on a similar type financing type basis. We view this as an investment and we put our capital to use where we think we get the best returns at any given time.

If we see other projects that give us a better return, we do that instead. But, there is no need for us to do anything with bond loan currently.

Justine Fisher – Goldman Sachs

Okay, thank you very much.


As there are no further questions, I would like to hand the call back to you for any additional or closing remarks.

Lars Solbakken

Thank you and thank you very much for all listeners to this call. The presentation is also posted on our website and we look forward to build the Company for you, thank you.

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