Ship Finance Limited, (NYSE: SFL), the company whose stock I purchased in my mock portfolio released its quarterly earnings report today. The earnings report of companies listed on major stock exchanges, especially those under the auspices of the SEC in the United States, are the investor's guide to the financial health and quality of their investments or potential investments.
The link to the full quarterly presentation from Ship Finance can be found here. I particularly like the quarterly reports from Ship Finance Limited because they include details on the vessels that they own. This adds depth to the financial details and allows a deeper understanding of the business. With any earnings report, however, the numbers are generally the most important thing (with the exception of strategic direction).
So let's digest a bit of the SFL earnings report. First off, we own SFL because it is a stable high-yield dividend payer. So let's make sure that is still the case. This quarter, SFL increased its regular dividend by a penny to 42 cents/ share per quarter or $1.68/ share annually. Increasing dividends are a good thing, especially in light of 44 consecutive quarters of dividend payouts. Note that shareholders who buy SFL before March 6 (and hold it past that date) will receive the dividend. Since paid out dividends directly reduce a company's assets (cash), the value of the company drops by a corresponding amount often resulting in an offsetting share price drop on the ex-dividend date. With continued positive financial performance (or expectations of the same) the share price should recover that drop in relatively short order.
Of course, dividends are only as good as a company's ability to pay them and keep paying them for the foreseeable future. So, we'd like to see earnings per share in excess of the dividends- at least on an annual basis if not every single quarter. That's were SFL looks a little dicey. With a dividend of 42 cents/ quarter, they only earned 27 cents per share this quarter and $1.32/ share, they are paying out more than they are earning... How is that sustainable?
We have to look at the components of those earnings. Net earnings includes things like depreciation. In the latest quarter, depreciation was equal to very roughly, 19 cents/ share and amounted to over 62 cents/ share for the year. By itself, removing this from the net income equation means that the company would be able to cover the dividend IF they didn't need reserves to eventually replace those ships as they age to obsolescence.
Of course, the ships, although they may be quite long-lived, do need to be replaced. Ship Finance Limited, generally secures third party financing for its new ships. This means they need to meet regular loan payments against that financing, but don't need to amass huge amounts of cash to buy ships outright. With the value of the ship itself as collateral against the loan, base charter incomes which cover the loan payments and operating expense of the vessel, and vessels that outlive the term of the loan (or are sold at or above prices that cover the remaining loan balances before end of life) then each vessel acquisition can be incremental to net income without negatively impacting the ability to pay dividends.
When charter rates drop below expense costs (exclusive of depreciation), then we have a problem. That can and does happen in certain segments. Diversifying their fleet composition across sectors helps ensure that as a whole, charter income remains above threshold even if not for each ship.
In order to secure third party financing, SFL must meet certain financial requirements on a continuing basis. Those requirements are imposed by the financing contract in order to ensure that SFL will remain capable of making loan payments over the life of the loans. These covenants ensure that cash flow, liquidity, and other financial measures point to continuing solvency. A commitment to an unsustainable dividend would cause these financiers some considerable angst. If it came down to SFL failing to meet the requirements of their financing agreements, they could either secure new financing to retire the old debts, cut "optional expenses" like future dividends, or perhaps sell assets or investments.
If we ever saw SFL cut dividends, we would expect the stock price to fall dramatically since the value of the company's stock is largely based on its dividend yield, which at today's close is 10.6% annually. For dividends to be cut, we'd need to see a sustained drop in free cash flow. I don't see anything pointing to that at the present time or foresee any trends pointing in that direction.
Other danger signs would be increasing levels of debt without corresponding increases in assets. SFL's balance sheet is essentially flat year on year.
We also look at trends. For example, SFL's net income for 2014 was $122 million versus $89 million for 2013. With a prospect for increasing oil tanker rates in early 2015, we might expect this year to get off to a good start...
All in all, after the release of the company's quarterly report the stock price rose by 3.5% today. Generally after an SFL quarterly report, people notice the dividend yield and shares rise, at least through the ex-dividend date. We'd look for it to top $16 easily in the next two weeks. On the other hand, at $18/ share the dividend yield is still over 9%...
SFL is, in my opinion, undervalued. That plus the dividend yield is why I purchased it for my mock $500 portfolio to demonstrate that investing even a small amount can yield a substantial return. It doesn't take money to make money. It takes hard work, discipline, and perseverance.
Disclosure: SFL is a component of my own personal real-life investment account and/or one or more accounts that I manage for others.
The link to the full quarterly presentation from Ship Finance can be found here. I particularly like the quarterly reports from Ship Finance Limited because they include details on the vessels that they own. This adds depth to the financial details and allows a deeper understanding of the business. With any earnings report, however, the numbers are generally the most important thing (with the exception of strategic direction).
So let's digest a bit of the SFL earnings report. First off, we own SFL because it is a stable high-yield dividend payer. So let's make sure that is still the case. This quarter, SFL increased its regular dividend by a penny to 42 cents/ share per quarter or $1.68/ share annually. Increasing dividends are a good thing, especially in light of 44 consecutive quarters of dividend payouts. Note that shareholders who buy SFL before March 6 (and hold it past that date) will receive the dividend. Since paid out dividends directly reduce a company's assets (cash), the value of the company drops by a corresponding amount often resulting in an offsetting share price drop on the ex-dividend date. With continued positive financial performance (or expectations of the same) the share price should recover that drop in relatively short order.
Of course, dividends are only as good as a company's ability to pay them and keep paying them for the foreseeable future. So, we'd like to see earnings per share in excess of the dividends- at least on an annual basis if not every single quarter. That's were SFL looks a little dicey. With a dividend of 42 cents/ quarter, they only earned 27 cents per share this quarter and $1.32/ share, they are paying out more than they are earning... How is that sustainable?
We have to look at the components of those earnings. Net earnings includes things like depreciation. In the latest quarter, depreciation was equal to very roughly, 19 cents/ share and amounted to over 62 cents/ share for the year. By itself, removing this from the net income equation means that the company would be able to cover the dividend IF they didn't need reserves to eventually replace those ships as they age to obsolescence.
Of course, the ships, although they may be quite long-lived, do need to be replaced. Ship Finance Limited, generally secures third party financing for its new ships. This means they need to meet regular loan payments against that financing, but don't need to amass huge amounts of cash to buy ships outright. With the value of the ship itself as collateral against the loan, base charter incomes which cover the loan payments and operating expense of the vessel, and vessels that outlive the term of the loan (or are sold at or above prices that cover the remaining loan balances before end of life) then each vessel acquisition can be incremental to net income without negatively impacting the ability to pay dividends.
When charter rates drop below expense costs (exclusive of depreciation), then we have a problem. That can and does happen in certain segments. Diversifying their fleet composition across sectors helps ensure that as a whole, charter income remains above threshold even if not for each ship.
In order to secure third party financing, SFL must meet certain financial requirements on a continuing basis. Those requirements are imposed by the financing contract in order to ensure that SFL will remain capable of making loan payments over the life of the loans. These covenants ensure that cash flow, liquidity, and other financial measures point to continuing solvency. A commitment to an unsustainable dividend would cause these financiers some considerable angst. If it came down to SFL failing to meet the requirements of their financing agreements, they could either secure new financing to retire the old debts, cut "optional expenses" like future dividends, or perhaps sell assets or investments.
If we ever saw SFL cut dividends, we would expect the stock price to fall dramatically since the value of the company's stock is largely based on its dividend yield, which at today's close is 10.6% annually. For dividends to be cut, we'd need to see a sustained drop in free cash flow. I don't see anything pointing to that at the present time or foresee any trends pointing in that direction.
Other danger signs would be increasing levels of debt without corresponding increases in assets. SFL's balance sheet is essentially flat year on year.
We also look at trends. For example, SFL's net income for 2014 was $122 million versus $89 million for 2013. With a prospect for increasing oil tanker rates in early 2015, we might expect this year to get off to a good start...
All in all, after the release of the company's quarterly report the stock price rose by 3.5% today. Generally after an SFL quarterly report, people notice the dividend yield and shares rise, at least through the ex-dividend date. We'd look for it to top $16 easily in the next two weeks. On the other hand, at $18/ share the dividend yield is still over 9%...
SFL is, in my opinion, undervalued. That plus the dividend yield is why I purchased it for my mock $500 portfolio to demonstrate that investing even a small amount can yield a substantial return. It doesn't take money to make money. It takes hard work, discipline, and perseverance.
Disclosure: SFL is a component of my own personal real-life investment account and/or one or more accounts that I manage for others.
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