SFL Corp Ltd. annual report, Q4 FY2019

SFL Corporation Ltd. — FY2019 Form 20-F Summary

Reporting period: Fiscal year ended December 31, 2019. The filing was dated March 27, 2020 and was prepared under U.S. GAAP. SFL is a Bermuda-based maritime asset-owning and chartering company with vessels, container ships, tankers, dry bulk carriers, car carriers, and offshore drilling assets. The company changed its name from Ship Finance International Limited to SFL Corporation Ltd. in September 2019.

Financial performance and position

Metric	2019	2018	Change
Operating revenue	$458.8 million	$418.7 million	+9.6%
Net operating income	$137.8 million	$117.6 million	+17.1%
Net income	$89.2 million	$73.6 million	+21.1%
Basic EPS	$0.83	$0.70	+18.6%
Dividends declared per share	$1.40	$1.40	Unchanged
Cash from operating activities	$249.7 million	$201.0 million	+24.2%
Cash and cash equivalents	$199.5 million	$211.4 million	-5.6%
Total assets	$3.89 billion	$3.88 billion	Broadly stable
Stockholders’ equity	$1.11 billion	$1.18 billion	-6.2%

Approximate calculated margins were 30.0% for net operating income and 19.4% for net income in 2019, compared with 28.1% and 17.6%, respectively, in 2018. Operating cash flow was approximately 54.4% of revenue.

Time charter revenue increased to $339.2 million from $292.7 million.
Interest income from sales-type leases, direct financing leases and leaseback assets increased to $60.3 million from $39.7 million.
Profit-sharing revenue increased to $5.6 million from $1.8 million, primarily reflecting stronger tanker and dry bulk markets.
Operating expenses increased to $321.1 million from $306.1 million. Depreciation increased to $116.4 million, and vessel impairment charges were $60.1 million.
Other non-operating income was $57.5 million, including a $67.7 million gain on debt and equity securities. This included a $40.8 million realized gain on Frontline shares and a $25.0 million mark-to-market gain on remaining Frontline shares.
Interest expense increased to $145.1 million from $113.9 million, principally because of higher finance lease interest and a larger lease-financed fleet.
Cash flow from investing activities was a use of $169.9 million, while financing activities used $89.2 million.

Debt, liquidity and commitments

Consolidated debt principal was $1.63 billion at December 31, 2019. Including debt of equity-accounted subsidiaries, total borrowings were approximately $2.25 billion.
Finance lease liabilities were $1.11 billion, bringing total borrowings and lease liabilities to approximately $3.36 billion.
Debt maturities include $253.1 million due in 2020, $523.2 million in 2021, $265.1 million in 2022, $299.7 million in 2023 and $282.0 million in 2024.
Approximately $1.0 billion of floating-rate debt was effectively fixed through interest-rate swaps. The company reported net interest-rate exposure of $166.6 million; a one-percentage-point rate change was estimated to affect annual exposure by approximately $1.7 million.
Substantially all vessels and rigs were pledged or subject to finance leases. Assets pledged under ship mortgages had a book value of approximately $1.75 billion.
Management stated that the company was in compliance with its debt covenants at year-end. Key covenants include minimum cash of $25 million, positive working capital, leverage limits and vessel-value requirements.
Contractual cash obligations totaled approximately $4.0 billion, including debt repayments, interest, finance lease obligations, finance lease interest, and scrubber and ballast-water-system commitments.
2019 commitments included approximately $33.4 million for scrubber installations and $9.2 million for ballast-water treatment systems on 18 vessels.
The company paid four quarterly dividends totaling $1.40 per share, or approximately $150.7 million, despite net income of $89.2 million.

Material changes versus 2018

The active fleet expanded from 86 vessels and offshore assets at year-end 2018 to 92 at year-end 2019. Additions included three feeder container vessels and three 300,000-dwt VLCCs; no vessels were disposed of during 2019.
Revenue and net income improved, supported by acquisitions completed in 2018 and 2019, a full year of revenue from recently acquired container vessels, higher lease interest income and improved profit sharing.
Vessel impairment charges remained significant at $60.1 million, following $64.3 million in 2018. The 2019 charges related principally to five offshore support vessels and two feeder-size container vessels.
Finance lease liabilities rose substantially compared with earlier years, although the balance declined modestly from $1.17 billion in 2018 to $1.11 billion in 2019.
Debt increased, while cash declined modestly. Stockholders’ equity declined by approximately $73.7 million, primarily reflecting dividends and accumulated other comprehensive losses.
Maersk, MSC, Golden Ocean and Frontline remained important revenue sources. Maersk represented approximately 30% of consolidated operating revenue, MSC 14%, Golden Ocean 11% and Frontline Shipping 4%.
Income from equity-accounted associated companies, primarily the three drilling-unit entities chartered to Seadrill-related counterparties, represented 35.0% of net income, down from 39.1% in 2018.

Outlook, commentary, risks and unusual items

Management’s strategy is to expand and diversify the asset base and emphasize medium- to long-term fixed-rate charters to generate stable distributable cash flow.
The filing states that market conditions became materially less certain in early 2020 because of COVID-19, falling oil prices, trade disruption and financial-market volatility. The company could not reasonably predict the duration or severity of the pandemic’s effect.
COVID-19 risks include reduced cargo demand, port closures, crew-change restrictions, supply-chain disruption, counterparty stress and reduced access to debt or equity financing.
Seadrill remains a significant credit and concentration risk. Under Seadrill’s restructuring, charter hire for three drilling units was reduced by approximately 29% for five years beginning in 2018, with amounts added back later. West Taurus was idle, and a further Seadrill restructuring could result in losses or covenant pressure.
Solstad-related charter hire was deferred under a standstill arrangement. In February and March 2020, all five offshore support-vessel charters were terminated; four vessels were sold and the fifth was scheduled for recycling.
IMO 2020 sulfur regulations increased compliance costs and fuel-price risk. As of March 27, 2020, 12 vessels had scrubbers and seven were undergoing retrofits. The company expected higher fuel costs and inventories in 2020.
Ballast-water-system installations, greenhouse-gas regulation, fuel availability, vessel values and charter-market volatility may require additional capital spending or reduce profitability.
The company relies heavily on counterparties and related parties. Hemen Holding beneficially owned approximately 22.5% of the common shares as of March 2020, and potential conflicts of interest exist with affiliated shipping companies.
The company reported no material defaults, dividend arrearages or unresolved SEC staff comments. Management and the independent auditor concluded that disclosure controls and internal control over financial reporting were effective.
Potentially unusual 2020 items include a $4.4 million expected gain from settlement of Frontline-related loan notes, the sale of Front Hakata for $33.5 million with a $3.2 million early-termination payment, and the issuance of NOK 600 million of senior unsecured bonds in January 2020.

Facts investors should verify

Whether charterers, particularly Seadrill-related entities, Frontline Shipping and Solstad-related counterparties, continue making payments under amended or terminated arrangements.
The refinancing and repayment of 2020–2024 debt maturities, including the NOK 500 million bonds due in 2020 and the 5.75% convertible bonds due in 2021.
Compliance with minimum-cash, working-capital, leverage and vessel-value covenants under worsening shipping and credit-market conditions.
The sustainability of $1.40 per share annual dividends relative to earnings, operating cash flow and scheduled debt and lease payments.
Actual COVID-19 effects on utilization, charter rates, port operations, cargo demand, fuel costs and counterparty credit quality.
The recoverability of vessel and lease assets, including the $60.1 million 2019 impairment charge and assets whose carrying values exceeded estimated charter-free market values.
Future costs and economic benefits of scrubbers and ballast-water treatment systems, including contingent fuel-saving and charter-rate payments.
Exposure to related-party transactions, customer concentration, potential conflicts involving Hemen-affiliated companies and the company’s limited guarantees of approximately $266.1 million of debt at equity-accounted subsidiaries.
Whether the company remains eligible for U.S. tax exemptions and avoids passive foreign investment company status for U.S. shareholders.