On Tuesday, August 20, 2019, ship owner and leasing firm Ship Finance International (SFL) announced its second-quarter 2019 earnings results. At first glance, these results appeared to be rather mixed, as the company did beat the earnings expectations of its analysts by quite a bit, but it also failed to meet their expectations in terms of top line revenues. A closer look at its results, meanwhile, does indeed reveal that there was quite a lot to like here, and perhaps more importantly, the company showed remarkable stability despite all of the volatility in the market and the increasing trade tensions between the United States and China. This is one of the things that we have come to like about this company, as it continues to provide a nice steady income to its investors via its dividend.
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 Ship Finance International’s second-quarter 2019 earnings results:
- Ship Finance International brought in total operating revenues of $110.902 million in the second quarter of 2019. This represents a somewhat disappointing 4.84% decrease over the $116.543 million that the company brought in during the first quarter of the year.
- The company reported an operating income of $46.093 million during the most recent quarter. This compares somewhat unfavorably to the $51.287 million that it reported during the previous quarter.
- Ship Finance International entered into new leases and time charter arrangements that added approximately $200 million to its backlog.
- The company issued NOK 800 million (approximately $90 million) worth of senior unsecured bonds during and immediately following the close of the quarter.
- Ship Finance International reported a net income of $28.121 million in the second quarter of 2019. This represents a 16.29% decline over the $33.592 million that the company reported during the first quarter of 2019.
It seems likely that the first thing that anyone reviewing these highlights is likely to notice is that Ship Finance’s revenues went down slightly compared to the previous quarter. This somewhat detracts from my earlier statement that the company is quite a stable entity. However, this is somewhat misleading, as accounting rules require the company to exclude some money coming in from its reported revenues. Most notably, the company brought in $10.4 million through charter hires that is not included in the $110.9 million figure, as it was considered a “repayment of investment in charter hires.” In the first quarter of the year, the company had $9.9 million worth of revenues that were excluded from the reported revenue figures for the same reason. After we add these revenues back in to the reported figures, we see that Ship Finance’s revenues did still decline on a quarter-over-quarter basis, but the decline was not as steep as it may otherwise appear. Ship Finance did not provide a reason for this decline, but it seems likely that it was caused by ordinary business fluctuations, such as the timing of the receipt of payments from its customers. The company’s revenues are up substantially from the $96.8 million (plus $9.5 million of unreported revenues) that it had a year ago, so for the most part it does not appear that we have anything to worry about here.
One of the most important metrics to watch for a company like this is its charter backlog. This is the total amount of money that the company can expect to receive over the terms of all of its leases. As these payments are backed by contracts, we can basically consider this as guaranteed future revenue. Inevitably, someone will point out in the comments that this revenue guarantee is dependent on the ability of the counterparty to actually make the charter payments, and while this is certainly true, the charter backlog is as close as we can get to guaranteed revenue in this industry. Thus, it was nice to see that the company added $200 million to its charter backlog during the quarter despite the fears of a reduction in global trade caused by the growing trade tensions between the United States and China. Of course, in reality, China has simply shifted its imports to come from other nations, and Ship Finance is a global company that does not have to worry that much about which nations are actually on either side of a trade deal. Its business model, likewise, is that of leasing the ships out to other companies that actually perform the transportation of cargo, which insulates it somewhat from a reduction in total global trade.
At the close of the quarter, Ship Finance International had a total charter backlog of $3.7 billion, which represents approximately 33 quarters’ worth of business at today’s revenue level. Thus, the company could continue to operate for more than eight years, even if it does not secure any new charters. With that said, the average remaining charter length is five years, so some of these charters must be promising higher future revenues than they are generating right now. This is certainly a good position for the company to be in, as it should ensure stability going forward, which is nice for those that are invested in the company for income, as well as should help it ride through a near-term recession or other economic shock.
More than any other, the story that dominated the financial media during the second quarter was the escalating tensions between the United States and China, particularly in the area of trade. This was also the cause of a great deal of volatility in the markets as investors worried about the impact that it would have on corporate profitability. As a result, it may come as something of a surprise that the demand for containerships increased during the quarter, as evidenced by rising charter prices for these vessels. Ship Finance notes that the rising demand was primarily in north-south trade and rising intra-regional trade. It does note, though, that forward demand remains uncertain due to the trade tensions.
Ship Finance International continues to move in directions meant to take advantage of this strength in the tanker ship market. While I am quite certain that readers are well aware of the company expanding its tanker fleet last year, it may not be as well known that it continued this expansion recently by buying three 2,400-4,400 TEU vessels following the end of the second quarter. These vessels are certainly smaller than most of the company’s fleet, but small ships can still turn a profit, and these should. This is because the vessels all came with a 5.5-year bareboat charter with a leading containership operator. This purchase of cash-flowing ships is something that we generally like to see, as it should have a positive impact on the company’s overall cash flows, and thus, investors should be reasonably happy with this development.
The company’s containership fleet was the biggest driver in the backlog growth that we saw during the quarter, although it came at a cost. Basically, in exchange for installing exhaust scrubbers on seven of its 8,700-10,600 TEU liners, the customer agreed to extend the charters. This resulted in $160 million being added to the backlog, which was 80% of the total backlog added in the quarter. The installation of these scrubbers does bring the liners into compliance with the 2020 low-sulfur emissions standards though, so it was a necessary investment for Ship Finance despite the upfront costs. It should be able to make its money back from the new backlog, fortunately.
As mentioned in the highlights, Ship Finance International recently floated approximately NOK 800 million in debt. This consisted of two issues – a NOK 700 million tranche issued in June and another NOK 100 million tranche issued following the end of the quarter – which is a good sign, as it indicates that the market is still welcoming to the company’s debt. However, Ship Finance’s overall debt load is still one of the biggest risks to the business. At the close of the second quarter, Ship Finance International had total short-term debt of $188.029 million and total long-term debt of $1,274.663 million, for a total of $1,462.692 million. This compares to $1,154.627 million in shareholders’ equity, which gives the company a debt-to-equity ratio of 1.27. As a general rule, I do not like to see this ratio at much above 1.0. This is because debt is a riskier way to finance a business than equity, due to the fact that debt capital must be repaid, so periods of weakness in the company’s business can push it into financial trouble. At the same time though, debt serves to improve things like return on equity. Overall though, I would prefer to see the company bring its debt down a bit.
It seems likely that one of the reasons why people invest in Ship Finance International is because of the large dividend that the company pays out. Indeed, as of the time of writing, the stock yields 9.52%. As is always the case though, it is critical that we ensure that the company can actually afford the dividend it pays out. After all, we do not want to be in a position where we are holding a stock heading into a dividend cut. One method that we can use to judge a company’s ability to pay its dividend is looking at the free cash flow. Free cash flow is the amount of money that a company has left over from its regular operations after paying all of its bills and making any necessary capital expenditures. Free cash flow is normally calculated as operating cash flow less capital expenditures. In the second quarter of 2019, Ship Finance International had an operating cash flow of $45.048 million and capital expenditures of $844,000. As the dividend only costs the company $37.662 million per quarter at the present level of $0.35 per share quarterly, it appears that it is generating more than enough money to cover its dividend. This is the kind of thing that we like to see when holding a stock for income purposes.
In conclusion, this was a reasonably solid quarter for Ship Finance International, and we do clearly see that the company’s business is holding up quite well in the face of the escalating trade tensions. The market appears to have recognized this too, and has pushed the share price up quite a bit over the past week or two. The stock continues to be a good way to generate an income and should be considered a Hold at this point.
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Disclosure: I am/we are 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.