Ship Finance May Be Looking To Grow The Business Again

A high-yield play on shipping, Ship Finance SFL has never been the easiest stock for investors to follow. Between eccentric non-GAAP accounting, little sell-side coverage, and share price volatility tied to the volatile and cyclical shipping industry, the shares have moved around a fair bit over the last five years. While the dividend has been more stable for about two years, it is still more than 20% below the peak $0.45share, last paid in Q1’17, and an uncommonly high yield has long been one of the key attractions of this stock.

Appreciating that the dividend is relatively safe but far from guaranteed, this continues to look like a good option for investors willing to take on some higher risk in the pursuit of higher yields. The company has a significant portion of revenue locked up until multiyear time charters with high-quality counterparties and an empty order book should mean substantial cash flow coming in over the coming years. While I’d like to see management prioritize debt reduction and an increased payout, investors should be prepared for capital deployment into M&A, as it still sounds as though that’s where management’s attention is now.

On-Target Results In Q1

It seems like there are almost as many ways to adjust Ship Finance’s earnings as there are analysts covering the company, but I favor a pretty simple approach – reported operating revenue which is different than earned charter hire and an EBITDA based upon reported vehicle operating expense and administrative expense.

Operating revenue rose 26% yoy and fell about 2% qoq, with lower spot rates in the dry bulk business. Vessel operating expenses rose more than 5% yoy and fell about 4% qoq, while administrative expenses rose 32% yoy and 63% qoq. With that, the simplified EBITDA I prefer jumped 37% yoy and slipped about 2% sequentially. Both operating revenue and EBITDA were a bit higher than I expected, with Ship Finance reporting lower operating expenses and higher administrative expenses than I’d expected the latter will be something to monitor going forward.

The company ended the quarter with $164 million in cash, close to $100 million securities most of which is its 11M stake in Frontline FRO, and ample liquidity. During the quarter, the company borrowed $104 million against its fleet and repaid a $124 million bond loan from 2014. With five unencumbered vessels in the fleet, Ship Finance still has plenty of options to generate liquidity if need be.

As far as the fleet goes, this was a quiet quarter after adding three containerships and selling three vessels in the fourth quarter. More than 60% of the company’s charter hire is on time charters, and the charter backlog is up to $3.8 billion with a 8.3yr revenue-weighted duration close to nine years for the containerships and over eight years for the dry bulk. The company still has nine of its 22 dry bulkers on spot.

Mixed Signals In Rates

Rates spiked for many vessel types in the fourth quarter of 2018 and have since come back. While Ship Finance does have a sizable time charter backlog, the shares still do trade in response to near-term rate behavior, so it is worth watching.

VLCC a type of tanker rates are about a third lower than when I last wrote about Ship Finance, but the market is temporarily depressed by extended refinery turnarounds and lower OPEC supply, both of which should improve later in the year.

In dry bulk, Capesize rates are about half of what they were in August, Panamax rates are about 25% lower, and Supramax rates are about 30% lower, while Handysize are about 15% lower. Although iron ore and coking coal prices have been heading higher, there are growing concerns of lower Chinese steel production, and iron, coal, and steel account for about half of all seaborne dry bulk cargo. There could also be some additional pressure from lower grain imports to China, as the outbreak of African Swine Fever will reduce feed needs.

Containership pricing is a little more idiosyncratic. Demand has remained fairly healthy for larger ships up about 5% since August, but increased deliveries of larger ships has hurt demand for smaller ships, with quotes for 4.5K TEU vessels down about 25% since August. Although there are valid worries about trans-Pacific trade given the trade dispute between the U.S. and China, there has also been a trend toward consolidation in the liner shipping industry 70% of the market is now controlled by six companies, and I believe this should help market stability.

Looking To Buy Again?

Given management’s comments over the last few months, I think they want to be active in M&A. Having shrunk its tanker fleet, management has expressed interest in adding crude tankers, shuttle, tankers, andor LNG tankers. I think management is mostly happy with its containership portfolio, and if anything might be willing to consider paring down its spot dry bulk fleet if it can’t find charters.

I have mixed feelings about this. The ability of Ship Finance’s management to accurately predict market trends has been mixed at best, with the company making a poorly-timed entry into offshore energy assets a few years ago. On the other hand, management has been clear about looking to match vessels to long-term charters with high-quality counterparties, and that should significantly limit the risk of acquiring new vessels in markets like LNG tankers.

Whether Ship Finance can find attractively-priced deals remains to be seen. Contracted new-builds would be an option ordering a newly-built ship with a charter already in place when the ship is delivered, but that would take a while to generate actual revenue.

The Outlook

Not much has changed about my fundamental outlook for Ship Finance, and I still believe the company can generate around $200 millionyear in free cash flow. I do believe that management would like to deploy more capital into M&Afleet acquisition, but management seems willing to be patient for the right deals, and I expect debt paydowns in the meantime. While an increased payout would be welcome, I believe that will likely only come when management has the fleet it wants, secured with longer-term charters that would give them increased visibility and comfort with a higher payout.

The Bottom Line

Ship Finance continues to offer a robust yield as one of its prime attractions, and it also remains a more stable investment options for investors who want some exposure to the shipping industry. I believe the payout is secure for now and I believe management is pursuing a less risky strategy the time charters, so this remains a name to consider for those who want higher yields and can accept some higher risks in pursuit of them.

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