Ship Finance International Earnings Call NUGGETS: Valuation Gap, Container Spin-Off

On Tuesday, Ship Finance International Ltd (NYSE:SFL) reported its second quarter earnings and discussed the following topics in its earnings conference call. Take a look.

Valuation Gap

Justine Fisher – Goldman Sachs: So, the first question I have was on the charts that you had showing the valuation gap between the newbuilds and the secondhand vessels. They’re interesting charts to look at, because you can definitely see the diversions in the market, but the first question about those is. The valuation gap could probably also be characterized as a pricing gap and so why would you not buy the lower price secondhand vessels and then stead by the newbuilds. I mean I guess, the reason maybe fuel saving, but I was wondering if there was any other reason.

Ole B. Hjertaker – CEO: Well, you have a combination of fuel savings which of course contributes to part to the value gap but also access to financing. What we see is that, typical in softer markets basically in all industries, you have export the credit agencies tied – to support on financing, which gives you in many ways better access to financing than for a one-off drybulk carrier that is five, six, seven years old. The banks who may look at financing that will probably give you a lower advance rate and it may even also be more expensive from a cost of capital perspective. So, I think it’s a combination of two things, it’s both improved efficiency, which commence a difference in price, but also cost of capital is different, and therefore you should see a bigger price gap between newbuildings and secondhand vessels. From our side, we look at relative value. So, we look at modern assets only, but we would be happy to buy secondhand vessels if the pricing is right and if the relative pricing is right also compared to booking a newbuilding with delivery say two years from now.

Justine Fisher – Goldman Sachs: Are you able to get or do you think that you would if you had for vessels coming online, would you be able to get better market time charter rates for a new build as opposed to let’s say a three to four year old vessels, obviously for a ten year vessel there probably is going to be a difference, but is it charter rate, diverging for new versus let’s five year old vessels as the values are diverging?

Ole B. Hjertaker – CEO: You have to adjust for the fuel efficiency. So, say if VLCC can burn just – pick a number 10 tons less per day in fuel for a newbuilding, that will of course be reflected in the charter rate you’re able to come at. But apart from that, as long as the vessel is modern, and is otherwise in good shape you can find charters also for secondhand vessels, but from our side, of course what we look is, is a combination of the price we pay for it, the charter rate we think we can get over the life of the vessel, and also the residual value at the end of the charter. Right now in some segments and if you look at for big drybulk vessels where market rates currently are below operating expense level, at least according to some brokers, you can say that there is actually a negative carry in owning the vessels for the near-term, and therefore you know a delivery two years from now can actually be a benefit, if you believe that you will have very low revenues on the vessel. But (indiscernible) impact on the value.

Justine Fisher – Goldman Sachs: So that’s another reason that you newbuild as opposed to a second hand that’s because it’s actually a good thing if you don’t have it, but if you can buy it at cheap price and started operating two years from now then you don’t have a negative carry in the interim?

Ole B. Hjertaker – CEO: Correct. Unless the second hand value price was attractive enough. So we think – so we think still it’s a good investment.

Justine Fisher – Goldman Sachs: Okay. Another question I had was just on Seadrill options, can you refresh our memory as to whether and then when Seadrill has put options to – I guess call options to purchase some of the offshore vessels that you operate for them, whether you lease to them?

Ole B. Hjertaker – CEO: Yes, the next options Seadrill has to purchase deepwater drilling rig is in October 2014 for the West Polaris. They had the opportunity to call that or purchase that rig but they had to call that two weeks ago and they haven’t done that. So next call option is in October 2014. Then we have one rig West Hercules which they have a call option in November 2014 and then West Taurus in February 2015. Then they have purchase option say with on average at two-year intervals from those purchase option dates. We are happy to send the exact schedule to you. It was also disclosed actually in the 2009 20-F on page 84 and 85. There’s a detailed breakdown on a rig-by-rig basis with both combination of the charter rates in the different periods and also the purchase option dates and the purchase option prices.

Justine Fisher – Goldman Sachs: I’ll definitely go and look at that. So, is it – I mean, maybe it’s too early to say, but have you guys had any discussions with them about what they might do in ’14? I mean, if rig values are up, they could purchase the rigs and then resell them if they wanted to, I don’t know if that’s something they’d even want to do, but have you guys had any discussions with them as to what they might choose to do with those options?

Ole B. Hjertaker – CEO: No, we have not discussed that specifically. I mean, they – as it’s their option, we wouldn’t expect them to communicate that to us until it’s time – until they decided to call. But it’s two years from now, so many things may change until then and we cannot make any projections or estimates of what they may or may not do. These rigs have been on very high charter rates, but now as we have amortized down so much of the debt, the charter rates also comes down based on the schedule. So from Seadrill’s perspective I’m sure they also look at the very attractive net cash flow that’s coming out from these rigs. So they pay the variable charter hire to us. Then of course you had to add on operating expenses, but they have recently concluded charters on these rigs at levels way over that. So there’s also a nice cash flow contribution for them.

Justine Fisher – Goldman Sachs: Then the last question I have is on the bond maturity next year. Can you talk about the various options that you guys are thinking of as far as your placing this bond and you don’t want to say obviously exactly what you’re going to do, but are you considering secured financing to replace this bond or the Norwegian bond market, the U.S. unsecured market, and how do you view those various options for refinancing?

Ole B. Hjertaker – CEO: We have access to different, call it, sources of capital. We have around $3.1 billion in the secured bank debt market. We are present in the European convertible bond market. We have a Scandinavian bond outstanding and of course, we also have in the U.S. market. So I believe we have various accesses to financing. We have call option. We can call the bond now on 30 days’ notice at par, so we have a lot of flexibility. We still have 15 to 16 months until the maturity of that bond and given the relative size, it’s less than $300 million, I believe the size of our Company and not least the strong support we have from our big shareholder Mr. John Fredriksen who owns 40% of the Company and his standing in the capital markets, I think we are quite comfortable with our ability to refinance that before or at maturity at an attractive rate, but I cannot give you any guiding as to exact when or how we will do that. That we will do on our, what we can call, an opportunistic basis where we will look at various options and choose the one we believe is the most attractive for the Company.

Container Spin-Off

Martin Carlsberg – Pereto Securities: I’m just wondering if you could give us an update on the container spin-off you were talking about potentially in the last quarter report. I don’t see it mentioned in this quarter’s report.

Ole B. Hjertaker – CEO: Yes, we mentioned the container segment in the last quarterly report as we saw as potentially interesting segment and what we have done after that is that we have restructured it so that we have the ability to spin it off if and when we believe timing is right and we believe it will benefit our shareholders in the long-term. Part of the reasons for setting that up and making that – setting up the structure is that we believe it could be interesting from a consolidation perspective. We see several entities and structures in the container market, both the listed companies but also on the private side and portfolios controlled by the banks where there could be potential for asset consolidation. And having that ability to do that not only in, call it, Ship Finance parent company but also on a segment specific setup for the containers, we believe is a benefit. So, it’s something we have. We have it, you could say, structurally ready. We can do it if and when we believe timing is right, but we want to do that in connection with the transaction or with the structure where we can illustrate and show the market that it will be accretive to Ship Finance’s shareholders. So, we will get back to that when timing is right and we wish to do something specific.

Martin Carlsberg – Pereto Securities: Second question on the covenants. Good to see that you’re in compliance the minimum value courses. I’m wondering given that especially drybulk and I guess also in tankers we have a situation where ship bulk values are quite a bit above what the actual transaction value seems to be. Could you give some idea how this might affect liquidity going forward, if values on tankers and drybulk were to come down to more sort of real levels?

Ole B. Hjertaker – CEO: Yes, of course it’s difficult to guess what the market maybe in the future. I think it’s a good thing. We don’t have any value covenants relating to drybulk vessels, so we don’t have any issues there irrespective of where the market may go. On the tanker side, we had already as of June 30, we have paid down the loans to a scrap value for the vessels, so if we had to scrap all the vessels, with scrap value we’re in the region of $580 per lightweight ton. As we continue to pay down the debt fairly quickly on those vessels, we are paying down more than $80 million per year just relating to the assets on charter to Frontline. At the year-end, we will be down to low-500s in scrap exposure on the assets. So, what we can say is that, if you look at the graph in the presentations on tanker values, we saw an extreme peak of course in 2007, 2008 on asset values, at that time, we did not lever up the vessels, so we had relatively conservative financing at the time and after that of course first value trashed down 50% almost overnight in 2009. We did not have any issues with (indiscernible) then, and then we’ve seen also a significant drop in value over the last 12 months and we still haven’t had any issues on the minimum value side. So, we are of course prudently following this closely, and believe we have structures in place and not least, the fact that we paid down so much on our financings, means that even if value should slip downwards, we can still maintain a nice buffer.

Martin Carlsberg – Pereto Securities: Lastly for me on the dividends, you’re paying $0.39 this quarter whereas your cash sweep from the tankers is $0.21 and the way the market looks, it doesn’t look there is going to be a much cash sweep at this in the second half of this year, do you feel confident that you will be able to maintain the $0.39 dividend going forward even without cash sweep from Frontline in the second half?

Ole B. Hjertaker – CEO: I think as a general observation, the board does not communicate future dividends. So, the board decides the dividends on a quarter-by-quarter basis. Also, the board when they set the dividend they do not look at immediate, necessarily the earnings in that specific quarter, I think the board has a more long-term approach when they look at dividend levels, and there is no link in the report from the board between the cash sweep from Frontline and the exact dividend payout. So, we cannot comment on future dividends and you can also say that we can – nor can we predict what the tanker market will be over the next few quarters. There is another prominent ship owners whose market observation is that the market may go up, go down, or remain stable, and while that is amusing I think it’s equally important to – it’s more the uncertainty here that is interesting to observe, and also that the volatility in many ways is a friend, because the cash sweep is based on the revenues for these vessels over the year. What we’ve seen both in the first quarter and the second quarter is a buildup not only of cash sweep but also on the profit split on top, and that will effectively serve as a buffer if the market should be lower later in the year. So we believe that there will be a cash sweep accumulating from a lower level than – if we adjust for sub-charters and the buffer that’s built up than the actual cash sweep levels nominal on a vessel for vessel basis.