bfk92/E+ via Getty Images SFL Corp. logo (SFL homepage)

bfk92/E+ via Getty Images

SFL Corp. logo (SFL homepage)

In my last article, on SFL Corporation (NYSE:SFL ) of 17 September 2021 titled “Don’t Look At Their Offshore Rigs Purely As A Liability”, I pointed out that I believed their two Offshore Rigs could become cash cows in the future and that their risk was more related to their high reliance on the income from their growing containership fleet.

As such, I was pleased to see that they have managed to secure five-year charters for six of the 14,000 TEU to Hapag-Lloyd, adding USD 540 million to the backlog.

The share price of SFL has done well since September last year, in comparison to a fragile market.

SFL - Tudor Invest stance (Seeking Alpha)

SFL - Tudor Invest stance (Seeking Alpha)

If you, like me, are a long-term investor, you should not pay too much attention to the monthly movements in the share price. More importantly are the fundamentals, in other words, their financial numbers, and what we can predict with some degree of certainty about the future for the business they are in.

Let us first start by looking at their financial results for 2021.

Operating revenue in 2021 came in at USD 513.4 million which was 9% higher than the USD 471 million it had on the top line in 2020.

Ships, generally speaking, becomes less worth every year so they need to depreciate their assets. In 2021 depreciation for the year was USD 138 million, which is 4.5% of the value of their fleet.

Net income, after taxes, was USD 164 million. This was a big improvement from their loss of USD 224 million in 2020. The reason for that loss was impairment taken to their fleet of USD 333 million. If we strip out the impairment, which is a non-cash item, the profit would have been USD 109 million in 2020.

Basic EPS in 2021 was USD 1.35

Even after the 20% rise in the share price last six months, the P/E is still a very attractive 7.2

Management declared a cash dividend of USD 0.20 per share for the quarter, an increase of approximately 11% compared to the previous quarter where they paid out USD 0.18 per share. The present yield is 8.2%.

SFL - 10 year quarterly dividends (Data from SFL, graph by author)

SFL - 10 year quarterly dividends (Data from SFL, graph by author)

I know some of you may point out that the present level of dividend is a far cry from the quarterly dividends we were used to, but there will always be a healthy debate about how much of the surplus cash generated shall be returned to shareholders.

Their business is very capital intensive and there is always the need to renew their fleet. That is why we simply cannot look only at cash generation versus how much dividend is distributed.

There has to be a balance.

On the topic of balance, SFL’s balance sheet as of the end of last year showed tangible assets of USD 3,125 million. Of this, USD 146 million is in cash and cash equivalents, plus marketable securities of about USD 25 million.

This is against the long term debt of about USD 2.5 billion

Their book equity ratio is about 28.4%.

Personally, I would prefer to see a bit lower debt to equity, so using some of their cash generated to allow for a somewhat more aggressive deleveraging might be a prudent move. We all know that good markets do not stay good forever.

As earlier stated, I had been hoping that SFL would try to extend some of the long-term charters on the larger container ships now that the market is good.

SFL announced recently that it has agreed to charter out their six 14,000 TEU container vessels called “Thalassa Elpida/Patris/Axia/Doxa/Tyhi & Mana” to Hapag-Lloyd AG for five years following the expiry of the vessels’ existing charters to Evergreen.

All vessels are built in 2014, except Thalassa Patris which is built in 2013.

They will finish up their present charter to Evergreen in 2023/24 and will then go on the new charter to Hapag-Lloyd which ends between Q4 of 2028 to Q4 of 2029.

The new time charter contracts will add approximately USD 540 million to SFL’s fixed-rate charter backlog, increasing the backlog to a healthy USD 3.8 billion.

Based on this estimated addition to the backlog we know that the agreed charter rate should be about USD 50,000/day per vessel.

They bought these ships back in May of 2018 with the charters to Evergreen attached. Based on what they described as an addition to the backlog at that time, the time charter rate should be about USD 56,800/day per vessel.

By the end of the Hapag-Lloyd charter, the vessels will have had 10 years of good-paying charterers enabling SFL to amortize the vessels down to much lower book values.

They have also been busy on other deals.

At the end of last year, they purchased four modern large Aframax size LR2 product tankers of 115,000 deadweights, and 3 Suezmax crude oil carriers with five years' time charters to Trafigura.

I particularly like these large product tankers, as I believe their future is bright. We see that oil companies are shutting down more and more refineries. One such example is Shell (SHEL), which is going from 54 refineries in 2004 to just 5 mega refineries and chemical hubs by 2025.

Shel's reduction in refineries (Shell 2021 Q4 results)

Shel's reduction in refineries (Shell 2021 Q4 results)

What that means is that there will be increased demand for longer voyages to carry refined products to places such as Australia where the number of refineries has dwindled over the years. BP (BP) shut their Kwinana plant, Exxon Mobil (XOM) is shutting theirs in Australia just as Shell did with their refinery in Geelong, outside Melbourne. These refineries will retain their tank farms and rely on the importation of clean petroleum products.

Australia's refineries struggled to make profits competing against Asia's mega refineries.

The middle east has also built up its refining capacity and so has China. This is not just for their domestic demand. A lot of the product is for export.

That is where these large product tankers come in handy.

With regards to their shrinking offshore drilling exposure, there has been some interesting development.

As of the end of 2021, SFL has received more than 70% of the lease hire under the existing charter arrangement for “West Linus” and “West Hercules”. This is sufficient to cover their debt servicing of the rigs. In the short term, they will hence not contribute anything towards their profits, but as the debt on these assets which importantly are used and maintained, they will be in a competitive position to the advantage of improving market conditions for the rigs. This will take some time.

I still believe they should be able to make a contribution to profits 3 to 5 years down the road.

SFL surprisingly decided to change the technical management and operation of the rig “West Linus” from Seadrill to one of their competitors Odfjell Drilling, which is a leading harsh-environment rig operator. I believe such a move would be unthinkable when John Fredriksen was a large owner of Seadrill but he no longer is. It is plausible that this request for a change of management came from ConocoPhillips (COP).

West Linus (Seadrill home page)

West Linus (Seadrill home page)

Until the approvals are in place, Seadrill will continue the existing charter arrangements for a period of up to 9 months. The bareboat charter rate from Seadrill in this transition period is USD 55,000 per day.

After the contract has been assigned to Oddfjell, SFL will receive charter hire from the rig and pay for operating and management expenses. Under the contract, the rig is earning a market-adjusted rate which will be based on market developments for similar jack-up rigs in the North Sea and will be adjusted on a semi-annual basis.

The current day rate and remaining contract length give SFL a charter backlog on “West Linus” of about USD 500 million, which comes in addition to the USD 3.8 billion.

SFL is right to be proud of its achievement of making 72 consecutive quarterly dividend payments, and as such paying out more than $28 per share in dividends. That is something which amounts to USD 2.4 billion in total.

Their fixed-rate backlog has increased by USD 1 billion in 2022 alone and now stands at about $3.8 billion. All these assets will be accretive to earnings going forward.

I finally got around to reading Benjamin Graham’s old book “Intelligent Investor”. It is the version published in 2003 where the financial journalist Jason Zweig gives his commentaries to the book.

Graham liked to do a valuation based on calculating the present value using future earnings streams. If a company had a long track record of paying out dividends, he would use their dividend stream. Perhaps, more accurately would be to look at free cash flow, excluding investments.

In 2021, SFL generated USD 3.25 per share in free cash. With their high visibility in revenues and costs over the next five years, it is fairly safe to assume that their free cash flow should be not far off what they generated last year. The only difference would be the size of future profit sharing and potentially higher costs of financing.

I used a hurdle rate of 6,5% which comprises a 2% risk-free rate, plus an equity risk premium of 4.5%.

Present value from DCF (CFI)

Present value from DCF (CFI)

On this basis, we get a Net Present Value of USD 13.50 per share

With regards to their profit-sharing of about USD 20 million last year, this is not inconsiderate.

In Q4 alone, the containership fleet generated as much as USD $3.4 million in profit split contribution related to fuel savings. This is calculated based on the spread between the two fuel types. The larger the spread, the higher the contribution.

Widening spread on fuel costs (Fearnley Research)

Widening spread on fuel costs (Fearnley Research)

Source: Fearnley Weekly Report 10 March 2022

If you believe we will see elevated oil prices in 2022, this spread is also going to be elevated.

I would be surprised to see profit-sharing being much lower in 2022.

I realize that there are many ways to calculate value. One could look at whether the price you pay is below what the net value is of their assets.

Another way is to compare their P/E with other companies in the same industry. SFL's low P/E is not unusual. If we compare it to Triton International (TRTN) their P/Es are quite similar. From this, we can perhaps deduce that investors don't want to pay up to own shares in this industry.

I hope, and expect, a healthy debate from readers.

I think that the management of SFL continues to do the right things.

They have proven this to me with their wise moves in recycling capital and building new and diversified fixed revenue streams which will enable them to continue to share their profits with all their shareholders for many years to come.

It is a Buy at this level.

This article was written by

Disclosure: I/we have a beneficial long position in the shares of SFL, SHEL either through stock ownership, options, or other derivatives. 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.