Ship Finance: Income from tankers

After a difficult year and successful restructuring, this shipper could see smoother sailing ahead.

By TheStockAdvisors Mar 30, 2012 10:03AM
By Paul Tracy, High-Yield International

Ship Finance (SFL) owns a fleet of ships and drilling rigs, including intermediate-sized Suezmax-class tankers, very large crude carrier (VLCC) oil tankers, and dry bulk carriers.

Like most tanker companies, Ship Finance had a tough year in 2011 due to concerns about the impact of near record-low oil tanker and dry bulk shipping rates. The problem with the tanker and dry bulk markets is that operators ordered a large number of new ships when rates were high from 2003 to 2008.

As a result, the fleet has expanded at a rapid pace over the past two years, depressing the rates that operators can charge to lease their ships.

At one point in late 2011, spot charter rates for VLCC carriers hit just $4,400 per day, well under the daily operating costs for this class of ship in most cases, driving some tanker companies into bankruptcy.

Ship Finance is somewhat insulated from the depressed rate environment because the majority of its ships are contracted to shippers under long-term time charter agreements at fixed rates.

About 70% of the company's tankers, dry bulk carriers and rigs are under contracts with a remaining term of 10 years or more, while another 27% have a remaining term of five to 10 years.

Since most of these ships are chartered at rates that hand Ship Finance a solid return, the firm has been able to continue paying a dividend despite weakness in spot charter rates.

Another advantage for Ship Finance is its exposure to the containership and drilling rig markets. Day rates for its deepwater rigs are currently near $600,000 per day, the highest since 2008. Demand for containerships also remains relatively robust, and rates have been healthy.

The main headwind facing Ship Finance has been that a large number of fixed-rate charters covering its tanker ships are deals negotiated with Frontline (FRO), one of the largest operators in the business.

Due to persistent weakness in spot charter rates, Frontline fell on hard times last year and some speculated it would be forced to file for bankruptcy.

Rather than file for bankruptcy, however, Frontline was able to negotiate time charter rates on a number of its ships -- including those leased to Ship Finance -- to reduce its commitments under those deals.

The deal results in a reduction in cash flows to Ship Finance, but it's largely a positive for the stock because it removes a significant source of uncertainty. If Frontline had failed to negotiate this restructuring, it could have defaulted on its time charters.

While the tanker market still looks oversupplied with ships over the next two to three years, there's growing optimism that rates have bottomed.

More important, the Frontline restructuring looks to be enough to see the company through a weak rate environment over the next few years, dramatically lowering the odds of a destabilizing bankruptcy.

Ship Finance cut its quarterly dividend from $0.39 per share to $0.30 a share in March to save cash, but with the Frontline restructuring complete, the company should be able to maintain its payout going forward. Even at the lower rate, the stock currently yields 7.7%.

Ship Finance is a volatile play, but an improving market for tankers coupled with Frontline's successful restructuring make it a good choice for more aggressive investors.

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