On Tuesday, February 18, 2020, ship leasing firm SFL Corporation (SFL) announced its fourth quarter 2019 earnings results. At first glance, these results appeared to be very disappointing as the company failed to meet the expectations of its analysts on either top-line revenues or bottom-line earnings. A closer look at the actual earnings report, though, does tell something of a different story as there were certainly a few things that investors should appreciate here such as the company adding to its backlog in spite of some of the fears that have been plaguing the industry. Admittedly, though, SFL Corporation has always been somewhat insulated from near-term industry problems. This should also help the company weather the problems that the coronavirus has caused for the industry so far this year. Overall then, investors should be reasonably satisfied with these results and have a lot of reasons to continue to be optimistic in the company.
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 results. This is because these highlights provide a background for the remainder of the article as well as serve as a framework for the resultant analysis. Therefore, here are the highlights from SFL Corporation’s fourth quarter 2019 earnings results:
- SFL Corporation brought in total operating revenues of $119.877 million in the fourth quarter. This represents a 7.49% increase over the $111.527 million that the company brought in during the third quarter.
- The company reported an operating income of $20.216 million in the most recent quarter. This compares favorably to the $20.181 million that the company reported in the previous quarter.
- SFL Corporation added $224 million to its charter backlog due to receiving new vessels during the quarter.
- The company sold $100 million worth of stock that it owned of oil tanker operator Frontline Ltd. (FRO).
- SFL Corporation reported a net income of $23.642 million in the fourth quarter of 2019. This represents a substantial 518.58% increase over the $3.822 million that the company reported in the third quarter of 2019.
It seems essentially certain that the first thing anyone reviewing these highlights is likely to notice is that every measure of financial performance showed an improvement over the third quarter. With that said, though, at least in terms of revenues, the improvement was relatively small. This was not really unexpected, though, as the primary reason for this is that the company took delivery of two ships that were immediately chartered out to Hunter Group ASA under a five-year contract. I stated that this would be happening in my last report on the company. This does show that at least thus far, shipping companies continue to take delivery of vessels and honor their contracts in spite of the trade tensions between the United States and China. The coronavirus, however, was a non-factor during the fourth quarter, but it might have an impact later this year.
Unfortunately, though, some of the continued difficulties in the offshore drilling industry that we have been discussing in past articles had a negative impact on the company during the quarter. We see this in the fact that the company took a non-cash impairment charge related to five offshore support vessels. This is something that is required by accounting rules whenever a company determines that an asset is actually worth less than what it says on the balance sheet. As the value of a vessel is largely determined by its future earning potential, deterioration of economic fundamentals or dayrates in a sector can cause the value of a ship to decline. In this case, the value of the five offshore support ships went down by $34.1 million compared to the prior-year quarter so the company took a writedown of this size. It is important to note, though, that this was a non-cash charge and the company did not actually see $34.1 million leave its bank account so we can safely ignore the charge. If we do this, then the company’s increase in net income would have been even larger than what we saw.
One thing that is characteristic of SFL and some other companies that either are or once were associated with shipping tycoon John Fredrikssen is that they own stock in other companies. This benefited the company during the quarter as the strength in the market pushed up the value of these securities by $27.9 million. As was the case with the writedown on its ships, accounting rules require that the company record a mark-to-market gain on its income statement. While this does not necessarily represent new cash coming into the firm, it still has the effect of offsetting some of the impairment charge, which is one of the reasons why the company’s net income was not as low as it could have been considering the size of the writedown. With that said though, the company did sell some of these shares during the quarter and realized $13.7 million from this sale. This $13.7 million does represent money coming into the company’s accounts, unlike what the impairment charge represented.
One of the most important things for a company is to be able to maintain its income. This is of course also true for SFL Corporation. The company is fortunately decently well-positioned to accomplish exactly this. We can see this in the company’s charter backlog:
Source: SFL Corporation
The company’s contracted backlog is the total amount of revenue that it will bring in from its fleet going forward based on the contracts that it already has in place with its customers. As this revenue is backed by contracts, it is as close as we can get to guaranteed money in this industry. As we can see above, SFL currently has approximately $3.6 billion in revenue backlog, which represents thirty quarters at the fourth-quarter rate. Thus, the company can operate for roughly this long even if it fails to secure any more business for a while. This is the kind of thing that we like to see from a company that we are invested in.
Naturally though, this backlog will still run out eventually. That is why it was nice to see that SFL added to it during the quarter. I noted this in the highlights. As I stated there, SFL took delivery of two ships during the period and added $224 million to this figure. That is because these ships were already chartered to Hunter Group before it took delivery of the vessels. This is the core of the company’s business model. Basically, it purchases ships and then leases them to shipping companies under long-term contracts. As such, it operates almost like a bank to the shipping industry as opposed to an actual operator like Frontline or Golden Ocean Group (GOGL). This model gives the company an ability to weather problems in the industry that is far superior to other shipping firms. When we consider the problems that the Chinese coronavirus breakout has been causing for other companies, this will likely be appealing.
The company has certainly enjoyed success at executing this business model. As we can see here, the average remaining charter length on the company’s 88-ship fleet well surpasses five years:
Source: SFL Corporation
This positions it well to continue to deliver steady results for a while, despite the struggles in the industry. Thus, it can continue to be a source of income for us.
As is always the case though, we want to ensure that the company can actually afford the dividend that it pays out. This is because we do not want to suffer a dividend cut and the stock price decline that typically accompanies it. The best way to do this is by looking at a company’s free cash flow, which is the money left over from a company’s basic operations after it pays all of its bills and makes any necessary capital expenditures. It is usually calculated by subtracting capital expenditures from operating cash flow. In the fourth quarter, SFL Corporation had an operating cash flow of $58.396 million and had total capital expenditures of $10.287 million, which gives the company a free cash flow of $48.109 million. The company’s dividend only costs the firm $37.669 million based on the current rate and share count though. Thus, SFL Corporation appears to be generating more than enough cash to afford its dividend at present, although it is paying out a sizable portion of its money, which is frequently the case with this company.
In conclusion, this was a reasonably solid quarter for SFL Corporation and shows us the ability of the company to weather any problems in the shipping industry. These problems have unfortunately manifested themselves in a major way with the outbreak of the coronavirus in China that has caused the country to close off its ports and many of its businesses. This will only be a short-term thing, but it is still uncertain when it will end. In the meantime, SFL appears to be a way for investors in the sector to ride out these problems.
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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.