SFL Corp Ltd. annual report, Q4 FY2015

SFL Corp. Ltd. (Ship Finance International Limited) — FY2015 Form 20-F Summary

Reporting period: Fiscal year ended December 31, 2015. The filing is an annual Form 20-F, not a standalone fourth-quarter filing; separate Q4 results are not clearly provided in the filing text. The company is a Bermuda-based owner and charterer of vessels and offshore assets, reporting under U.S. GAAP.

Business context

SFL owns and charters tankers, dry bulk carriers, container vessels, car carriers, chemical tankers, drilling rigs and offshore supply vessels. Its strategy is to generate relatively stable cash flow through medium- and long-term time and bareboat charters, while expanding and diversifying its asset base. At December 31, 2015, the active fleet totaled 70 vessels and rigs, compared with 67 at December 31, 2014.

Key financial metrics

Metric	2015	2014	Change
Total operating revenues	$406.7 million	$327.5 million	+24%
Net operating income	$166.0 million	$145.1 million	+14%
Net income	$200.8 million	$122.8 million	+64%
Basic EPS	$2.15	$1.32	+63%
Diluted EPS	$1.88	$1.24	+52%
Dividends declared per share	$1.74	$1.63	+7%
Cash provided by operating activities	$258.4 million	$132.4 million	+95%
Cash and cash equivalents	$70.2 million	$50.8 million	+38%
Consolidated debt	$1.67 billion	$1.73 billion	-4%
Debt including equity-accounted subsidiaries	$2.50 billion	Not clearly provided on the same basis	Not clearly comparable
Stockholders’ equity	$1.24 billion	$1.15 billion	+8%

Calculated margins were approximately 40.8% for net operating income and 49.4% for net income in 2015, compared with approximately 44.3% and 37.5%, respectively, in 2014. The net operating margin declined because of higher impairment and depreciation charges, while net margin benefited from significant non-operating gains.

Revenue and operating developments

Time charter revenue increased to $160.8 million from $93.1 million, primarily reflecting eight Capesize dry bulk carriers and three container vessels added during 2015, together with prior-year container deliveries.
Profit-sharing revenue increased to $59.6 million from $33.8 million. This included $19.9 million of cash-sweep revenue from Frontline and $37.2 million under the new 50% Frontline profit-sharing arrangement, plus $2.5 million from UFC.
Direct-financing lease interest income declined to $34.2 million from $45.4 million because lease balances amortize over time, charter rates were amended, and vessels were sold.
Operating expenses increased to $248.1 million from $206.3 million. Vessel impairment charges rose to $42.4 million from $11.8 million, including impairments on two offshore supply vessels and two container vessels.
Net gains on asset sales were $7.4 million, compared with a $1.4 million loss in 2014. There was no 2015 gain on charter termination, versus $25.3 million in 2014.

Material changes versus the prior comparable period

In June 2015, Frontline charter amendments reduced fixed daily charter rates to $20,000 for VLCCs and $15,000 for Suezmax tankers, increased profit sharing to 50%, and raised the fixed management fee payable to Frontline Management from $6,500 to $9,000 per vessel per day.
SFL received 55 million Frontline shares, valued at approximately $150.2 million, as compensation for the amendments. Following Frontline’s merger with Frontline 2012, SFL’s interest was approximately 7% at year-end and was classified as an available-for-sale investment.
SFL acquired eight Capesize dry bulk carriers for $272.0 million and chartered them back to Golden Ocean affiliates under ten-year charters. It also took delivery of three newbuilding container vessels.
The company sold five 2,800 TEU container vessels after an indirect performance guarantee was exhausted and sold three Suezmax tankers. Consolidated debt decreased modestly despite substantial acquisition activity.
Other non-operating items improved from a $10.2 million net loss in 2014 to a $32.6 million net gain in 2015. The 2015 result included a $44.6 million gain on Horizon loan notes and warrants, a $28.9 million gain on redemption of Frontline loan notes, and a $20.6 million impairment charge on available-for-sale securities.

Cash flow, liquidity and debt

Operating cash flow was $258.4 million. Investing activities used $205.8 million, mainly for newbuildings and vessel purchases. Financing activities used $33.3 million, including $162.6 million of dividends.
Consolidated debt was $1.67 billion, including $616.6 million of unsecured borrowings and $1.05 billion of secured floating-rate facilities. Including equity-accounted subsidiaries, total borrowings were $2.50 billion.
Available borrowing capacity was approximately $178.1 million at the consolidated level and $150.0 million at equity-accounted subsidiaries, for total availability of approximately $328.1 million.
Substantially all vessels and rigs were pledged as security. The company reported compliance with all loan covenants at December 31, 2015.
Debt maturities included $208.0 million due in 2016, $185.2 million in 2017, $532.6 million in 2018 and $255.7 million in 2019 on a consolidated basis. Including equity-accounted subsidiaries, contractual debt repayments totaled approximately $2.50 billion.
Contractual commitments included $261.9 million for newbuilding purchases and $406.1 million for two 15-year bareboat charter-in commitments for large container vessels.
Interest-rate swaps effectively fixed approximately $1.0 billion of floating-rate debt. Management estimated net exposure to interest-rate fluctuations at approximately $98 million; a one-percentage-point rate change would affect annual interest expense by approximately $1.0 million.

Guidance, outlook and management commentary

Management expected the tanker market to remain relatively favorable in 2016, supported by high utilization and strong spot rates, although lower oil prices could reduce production and floating-storage demand.
Dry bulk markets were expected to remain very weak, with capacity growth exceeding demand and charter rates likely to remain near historically low levels.
Container markets were expected to remain difficult because fleet capacity growth was projected to exceed demand, sustaining surplus capacity and low charter rates.
Offshore drilling conditions were expected to deteriorate further in 2016 due to low oil prices, reduced exploration spending, lower utilization and declining day rates. Management noted that one jack-up rig had a charter expiring in February 2018, while most drilling assets had longer-term fixed-rate charters.
At year-end, Apexindo was unable to pay agreed charter hire for a jack-up drilling rig. SFL was assessing alternatives, including termination or restructuring of the charter.
The company stated that charter cash flows were expected to fund short- and medium-term debt service and working capital requirements, but additional borrowing or equity issuance would likely be required for long-term capital needs.

Principal risks and unusual items

Revenue and liquidity depend heavily on charterers and counterparties. Frontline accounted for 33% of 2015 operating revenues, and related parties remain significant customers, suppliers and guarantors.
Seadrill-related offshore assets are exposed to low oil prices, reduced drilling demand, charter renegotiation risk and counterparty credit risk. SFL guaranteed $250.0 million of debt at equity-accounted subsidiaries.
Vessel values were materially below carrying values for portions of the dry bulk, container and offshore portfolios, creating impairment and covenant risk if market conditions deteriorate further.
Charter rates, vessel values, global trade, Chinese demand, oil prices, interest rates, foreign exchange rates and financing availability are highly volatile.
Environmental, ballast-water, emissions, safety, pollution, piracy, sanctions and geopolitical requirements may increase costs or restrict operations. Pollution insurance was stated at up to $1 billion per vessel per occurrence, but may not cover all liabilities.
Dividend payments are discretionary and subject to debt covenants, cash availability, subsidiary distributions and charterer performance. The company paid $1.74 per share in 2015 and declared a further $0.45 per share dividend in February 2016.
The company recorded a $20.6 million impairment on corporate bonds and a $42.4 million vessel impairment charge in 2015. Reported net income also benefited from significant one-time or non-recurring gains.
The company believed it was not a passive foreign investment company for 2015, but stated that PFIC status could arise in future years. It also relies on the U.S. Section 883 shipping-income tax exemption, which could be lost if ownership conditions change.

Important facts for investors to verify

Reconcile the annual figures with any separate Q4 2015 earnings release, because this Form 20-F does not provide a clear standalone fourth-quarter income statement.
Assess recurring earnings excluding the $44.6 million Horizon gain, $28.9 million Frontline loan-note redemption gain, asset-sale gains and derivative or securities valuation effects.
Review the ability and willingness of Frontline, Seadrill, Golden Ocean, Apexindo and other charterers to meet obligations, including the Apexindo payment issue.
Analyze consolidated debt together with the $831.2 million of debt at equity-accounted subsidiaries and SFL’s related guarantees.
Test vessel values, minimum-value covenants, available revolver capacity and refinancing needs against continued weakness in dry bulk, container and offshore markets.
Review the economics and accounting consequences of the Frontline charter amendments, the 55 million Frontline shares received, and the reduction of fixed tanker charter rates.
Verify newbuilding funding, delivery schedules, charter commitments and the $406.1 million obligation related to the two charter-in container vessels.
Evaluate related-party transactions, revenue concentration, management fees and potential conflicts involving Hemen, Frontline, Seadrill and Golden Ocean.