Frontline Ltd (NYSE:FRO) Q2 2020 Earnings Conference Call August 27, 2020 9:00 AM ET

Company Participants

Robert Macleod - CEO
Inger Klemp - CFO

Conference Call Participants

Randall Giveans - Jefferies
Jonathan Chappell - Evercore ISI
Chris Tsung - Webber Research & Advisory
J. Mintzmyer - Value Investor's Edge

Operator

Ladies and gentlemen, thank you for standing by. Welcome to today's Quarter Two 2020 Frontline Limited Earnings Conference Call.

I'll now hand you over to your first speaker, Robert Macleod. Please go ahead, thank you.

Robert Macleod

Thank you very much. Good morning and good afternoon, everyone. Thank you very much for dialing into our second quarter earnings call. First, I'd like to express gratitude towards our shore staff and crew members for their extraordinary efforts and dedication, which clearly are defining factors to our strong results. Our markets are very volatile, but the volatility seen in last 12 months have been extreme and serves as a reminder of how little it takes for the tanker market to rally. Frontline's performance in the first half of 2020 was a strongest since 2008 and we've also made solid bookings for the third quarter. Despite the recent fall in rates, 2020 will be a very good year for Frontline.

Let's now move to Slide 3 and have a quick look at the highlights from the second quarter; net income of $200 million, just over $1 per share certainly a solid quarter. Adjusted for non cash items, the net income was $206 million. We declare a $0.50 dividend; the last dividend was $0.70 for Q1, 2020. We opted to repay $60 million on our Hemen facility in the quarter which is the main reason for the reduced dividend. Inger has done some great work in financing; she will take us through that later on the call.

Two new buildings were delivered in the quarter; one Suezmax and one VLCC leaving us with only 4 ice class LR2s on order and they deliver next year. VLCCs made $75,800 in Q2 and we have booked 76% of Q3 at around $61,000. Suezmax has made $51,100 in Q2 and we've booked 77% of Q3 at $29,500. LR2s made just shy of $37,000 and we have booked two thirds of Q3 at $14,500. These Q3 rates do not include the long- term time charges. And then before moving on to the market, I will hand the call over to Inger to take us through the financials.

Inger Klemp

Thanks Robert, and good morning and good afternoon, ladies and gentlemen. Then I think we should turn to slide 4 and look at the income statement of the highlights. Frontline achieved total operating revenues net of voyage expenses of $301 million and adjusted EBITDA of $259 million in the second quarter of 2020. And we report the net income of $200 million approximately and $1.01 per share and adjusted net income is $206 million or $1.04 per share in the quarter.

The adjustments this quarter was in total $6.4 million net and they consisted of a $5.9 million loss on derivatives, a $0.9 million unrealized gain on marketable securities; a $2.7 million share of losses on associated companies and a $1.3 million amortization of acquired time charter.

The adjusted net income increased by $27 million this quarter and it was mainly driven by an increase in our time charter equivalent earnings due to the higher reported TC rates for our VLCC and LR2 tankers in the second quarter along with a gain of $12.4 million as a result of the sale of one VLCC previously recorded as an investment in finance lease.

Let us then take a look at the balance sheet highlights. The main happenings in the second quarter which affects the balance sheets where that we took the delivery of the Suezmax, Front Cruiser and also we took delivery of Front Dynamic, and we drew down debts on these vessels. We -- as Robert mentioned, we repaid our senior unsecured facility with $60 million. We entered into two new loan facilities to refinance two loan facilities with total balloon payments of $349 million, which were due in December 2020 and in March 2021 on terms in line with Frontline's other loan facilities. We then also paid $138 million in dividends and we earned adjusted net income of $199.7 million.

At the end of the quarter, Frontline has $462 million in cash and cash equivalents including undrawn amounts under our senior unsecured loan facilities, multiple securities and minimum cash requirements. The current portion of long-term debts include $214 million debt maturity of the $466.5 million facility due in April 2021 and $80.3 million debt maturity of the $109.2 million facility in June 2021, which we both expect to refinance.

Other remaining new building CapEx requirements at the end of the quarter was $161.1 million relates to the four LR2 tankers where two of them are expected to be delivered in January and February 2021, and two are expected to be delivered in August 2021. In this connection Frontline has obtained a financing commitment for a loan facility in an amount of up to $133.7 million from CEXIM and Sinosure to partially finance four LR2 tankers. This facility will have tenure of 12 years; it will carry an interest rate of LIBOR plus the margin in line with Frontline's other loan facilities and it will have an amortization profile of 17 years. And the facility is subject to final documentation.

Let's then take a closer look at the next slide on the cash breakeven and OpEx, slide six. We estimate average cash cost breakeven base for the remainder of the 2020 of $22,600 per day for VLCC, $18,900 per day for the Suezmax and $15,700 per day for the LR2 tankers. And the fleet average estimate is about $19,100 per day. These are the rates the all-in daily rate that our vessels must earn to cover the budgeted operating cost and product estimated interest expense, TC and bareboat hire; and installments on loans and G&A expenses.

In the graph on the right hand side of this slide, we have shown as usual the incremental cash flow at the debt service per year and per share assuming $10,000, $20,000; $30,000 or 40,000 per day achieved in excess of our cash breakeven rates, respectively. And the numbers they include vessels on time charter out and we are looking at a period of 365 days from July 1st, 2020. As an example with fleet average cash cost breakeven rate on $19,100 per day and assuming that we have $30,000 on top of the average free TCE rate would be then $49,100 and sometimes we then generate the cash flow per share at the debt service of $3.49.

With this I leave the word to Robert again.

Robert Macleod

Thank you very much. Let's have a look at the Q2 Tanker Market on slide 7. So the first six months of 2020 brought a dramatic crude oil demand correction, the likes of which we've never seen. The demand shock brought on by COVID-19 was so large and sudden that global commercial inventories quickly surge to record levels effectively utilizing all available land-based capacity. At the same time, the crude oil market went into Contango, encouraging traders to store oil on tankers and driving demand for short-term charters of our ships. This in turn resulted in exceptionally strong tanker rates which are reflected in our results for the second quarter of 2020.

The freight market has since declined to lower levels and although the signs of recovery are evident as economies continue to reopen, the recovery in demand is unlikely to be linear and the extent and duration of the impact of COVID-19 is difficult to predict. COVID-19 related challenges have been extensive through the industry. These include logistics around crew changes, delayed discharge and diminished capacity at shipyards for dry docks and surveys. These are all factors that positively impact effective fleet supply. There is significant month-to-month volatility in the demand forecast as shown on the charts at the bottom of the slide.

Let's move to slide 8 please and have a look at the global fleet capacity growth which is slowing. The vessel supply side of the equation continues to improve which is very positive. The order book as a percent of the total fleet is at the lowest level since 1997. At the same time, the average age of the VLCC fleet as of the end of the second quarter of 2020 is at the highest level since September 2002. By the end of next year, there will be 65 vessels older than 20 years and an additional 85 older than 17.5. The effect of slowing fleet supply growth will be pushed out to 2021 or 2022 but it should be material and lead to a sustained period of higher rates. We do like the current situation where new vessels enter the market at a controlled pace. The order group continues to shrink and retirement of vessels is inevitable.

Present markets and a bit of outlook. The demand shock is likely behind us but volatility can be expected. The present freight market remains under pressure; crude production is down almost 10% since January and the lost volume reduces the volume that is normally shipped, meaning that the cargo counts are down by as much as 20% to 25%. On the positive side, inventories are being drawn a short-term pain but possibly long-term gain. Forecasts suggest that a significant portion of the OPEC cut could return in the coming months and combined with the Northern Hemisphere moving toward winter this gives grounds to believe in a stronger freight market. So in conclusion, the large moves in tank rates during the last 12-months illustrates the tight balance in the market and the fact that it does not take much for the tanker market to rally.

Looking ahead to 2021 and beyond recovering demand for crude oil transportation will coincide with rapidly declining fleet growth, which supports our long-term highly constructive market outlook. So as a Frontline, we enjoy the youngest fleet and lowest breakeven levels in the history of our company. Frontline's earnings potentially substantial, $23 million annualized for every $1,000 above $18.7 million. So we are very well positioned.

With that let's turn over to questions please.

Question-and-Answer Session

Operator

[Operator Instructions]

Your first question it's coming from the line of Randall Giveans from Jefferies.

RandallGiveans

Howdy Robert and Inger. How are you? Great. Well, yes, I guess first question is around the dividend, right. So in the fourth quarter of 2019, the first quarter of 2020 you paid dividends above I guess 70% of net income. Now for the second quarter you reduce this to 50%; I think you mentioned part of it's because of the $60 million pay down back in April on that Hemen facility. So I guess is that the entire reason for it or are you kind of bridging to a weaker dividend next quarter? And then should we expect at least 50% of net income going forward?

IngerKlemp

That's the entire reason for it but if you add that sort of top I guess you will get to $0.80 dividend which I guess is probably what you assumed.

RandallGiveans

If you include the Hemen $60 million is that what you referring to?

IngerKlemp

Yes. So that's the entire reason for that the dividend is $0.50.

RandallGiveans

Okay and then going forward it's a 50% of net income fair assumption.

IngerKlemp

Going forward, it's standard normal as we have in a way; it's not changed at all in a way. We just this quarter opted to repay the facility with $30 million which is $60 million I mean which is $0.30 per share. That's what happened this quarter.

RandallGiveans

Okay and about the Hemen facility; I believe that was done back in April, right? Do you expect to repay the remainder of that here in the third quarter?

IngerKlemp

No. We don't know yet. We haven't really decided what to do with the remaining part of it in a way. It might be it that we can extend the facility; it might be that we repay, we will have to see.

RandallGiveans

Okay and then I guess last question around your scrubbers. What's the status of the scrubber installations? I know you postponed a few. I think it was four, any expectations on when those will be installed or kind of your plans going forward on remaining scrubbers.

RobertMacleod

So, Randy, we've done -- we've got a couple being installed as we speak, but the four that we postponed we've not done anything further with. So what we'll do is that when these ships that we're supposed to have these scrubbers installed; when they dry dock over the next coming quarters then we will prepare these ships. So all the underwater work will be done which is a small cost and then the actual scrubbers can be fitted, they're retrofitted and they are now stored at our production facilities in Indonesia. So we'll see, the spread is improving a little bit but we have the optionality and for the time being they will remain in storage.

Operator

Your next question comes from the line of Jon Chappell from Evercore ISI.

JonathanChappell

Thank you. Good afternoon, Inger and Robert. A couple quick clarification questions first. I think we're always hear where the quarter-to-date bookings look very elevated basically because of the load to discharge accounting. I know you guys really try to flush out the differences here so maybe a way to ask it is as you look at the rest of the quarter the other 24% let's say for the VLCCs; is there any extreme or out of the ordinary uncontracted or contracted vessels where let's call it that stub part of the rest of the quarter would be higher or lower than the market averages?

RobertMacleod

So it all depends obviously whether we fixed the loading dates at end of September or early October that's what's going to determine. So it's -- but there's nothing -- just to answer the second part of your question there's nothing specific; there's nothing special but what I would say about the earnings, it's important here to look at earnings over several quarters. So if I was to sort of say if you ask me how Frontline has done on VLCCs so far this year then my take is that we had a very good Q1; we outperformed our pace, we're giving some of that back in Q2 as you see from the numbers. And my guess is that we're on a pretty good rate level and a good percentage share for Q3. So I would say outperform in Q1, we know, slightly below in Q2 and then I think we're looking quite good for Q3.

JonathanChappell

Okay and then just another clarification, Robert. I think you said that the long-term contracts are not included in the quarter-to-date rates. In the press release it says these short-term charters are included in the forecast. So what's between the long term and the short term? I guess you have two that are 9.5 months and one that's 12-months and then you have four that are just below six months. So just to be clear that the ones that are just below six months that is included in the quarter-to-date and then the longer ones are not.

RobertMacleod

Yes, correct. So basically the six months charters which are basically six months plus minus one, so it's a minimum period of five months. So those deals that we consider spot in the numbers and anything above which then starts in the eight months deals and we have a couple of one-year deals and we've got the five Suezmax on the three-year deals. So anything above six months that is then considered longer term and are not included.

JonathanChappell

Got it and then also I noticed in the disclosures that you have seven ships chartered, two affiliates of Hemen; I'm assuming those are these seven that you did in the second quarter. Just curious is there any options associated with those or were those kind of strict on the timing?

RobertMacleod

There are no options attached.

JonathanChappell

Okay. Final question, Robert, is I think you've laid out a very balanced second half of the year outlook for the market. And clearly given the start to third quarter you will be cash flow positive and Inger kind of laid out the dividend strategy. When you think about the cash going forward, do you think this period of let's call it choppiness or uncertainty provides you with an opportunity to add tonnage or do you think that you spend this next six months continuing to deliver the balance sheet to position yourself for the favorable 2021-22 outlook that you spoke of?

RobertMacleod

We're pretty happy with the size; we're very happy with the age. As I said in the intro, we -- the company's in a very good shape. But so I don't think we need to do anything. If opportunity come up for example like something like the Trafigura deal we did which we quite liked. Then maybe but base cases to enjoy what we have and then harvest from that through having hopefully what is the best operation.

Operator

Your next question comes from the line of Chris Tsung from Weber Research.

ChrisTsung

Hi. Good afternoon, Robert and Inger. How are you? I kind of wanted to just touch on the cash breakeven levels again. On Slide 6, I know Jon asked this earlier, too, but I guess I'm asking it from a slightly different angle. So on Slide 6, the cash breakeven levels of like $19,000 on a fleet average. In the press release it says that the charter coverage is not included in the breakeven level. So I was wondering, would that mean the breakeven levels excluding the time charters, would show a slightly higher breakeven for the fleet?

RobertMacleod

No. I mean the cash breakeven rates that we disclose are the total cost that our fleet has divided by the different number of days for each segment and then shown on a gross basis. If you have contract coverage about the breakeven rates that would obviously take down the cash breakeven rates for the spot vessels. So they do not increase them.

ChrisTsung

Right. So like if the charter -- if the contract coverage takes it down if we were to exclude it, would that bring it up and you're saying the answer is no?

IngerKlemp

That's even -- Yes.

ChrisTsung

Okay. All right. I just wanted to clarify. And I kind of wanted to just ask about your investment in Clean Marine. I guess when the investment was made back in October of 2019, I guess, it seemed like it would be a smart hedge for IMO 2020 in scrubbers in general. And fast forward 10, 11 months now, COVID, OPEC and market vol, what are your plans for this investment going forward?

RobertMacleod

Well, we'll see how this develops. We're now -- we own about 17% and the company has a production facility which is owned in Indonesia. It's got its stocks and so forth. And we have -- we only our investment is now -- we only have a very small loan to the company. So we don't really have any risk there. We don't see the need to put any money into the company. And I think there will be some positive news at some point going down the road. It's not turning out to be as lucrative as what we were hoping of course, but the downside was so the risk and it was always controlled and limited.

ChrisChung

Right. I see, okay. Makes sense. And just last question. Just given the news about the voluntary cuts from several key OPEC members, the congestion that's happening around Chinese ports and Hurricane Laura in the U.S. Gulf. I'm just curious in terms of how you guys choosing to position your fleet in the near term?

RobertMacleod

What we're doing now is that and this is -- it's an extremely difficult market to predict. And that is the obvious thing to say here because it's, I've been doing this for a few years and my sort of gut feel is that we are going towards a more normal market. We're well, well down on volumes as we know. It looks from the last stats that we're seeing then the world production is 3 to 4 million barrels lower than the consumption, which is obviously hurting freight but it could be -- could build a better case as we move towards winter and Q4, it's normally a strong quarter; so my under -- sort of with no sort of high conviction I've got a feel that things will get better as we move towards the end of the year and what we're doing with the fleet is that we are trying to reposition in the Suezmax in the Atlantic Basin. And if we have the choice between a long voyage at current rates or a shorter one, we opt for the shorter one.

There are some potential triggers out there so we're watching it all very closely. And we've got a feel that things might get better. At the same time the volumes remain low, so it all depends on the cargo count. What we've seen in the Middle East over the summer where basically one out of three cargos has disappeared has obviously dented the earnings, but hopefully something -- demand will steadily come back and there could be some better times ahead. But I'm very cautious; I'm not going to put on the bullish hat just yet.

Operator

Your next question comes from the line of J. Mintzmyer from Value Investor's.

J.Mintzmyer

Thanks for taking my questions. I do excellent. Thanks. So first of all congrats on a good quarter. As we're looking towards the shifting interest rate environment, I know, you've done a few swaps and hedges in the past on some of your debt profiles. I know you also have a new debt profile coming up with the new builds. Is there any plan to expand or extend those interest rate swaps? Is any of that in the works? Are you going to maintain some floating exposure?

IngerKlemp

So we do have entered into quite a lot of interest rate hedges now recently. So I guess at the moment we have no further plans for entering into even further interest rate hedges but we had on -- we have $550 million of all the hedges now at the moment and also as short as an additional portion of about $100 million which is very soon going to mature. But so at the moment I think we are happy with that.

J.Mintzmyer

Okay. It makes sense, yes. I was tracking you had about one third or so hedge. I was wondering if that was -- those plans have changed. Jon asked earlier about kind of your cash plans and if you looked at maybe expanding or new builds or second hands or anything like that. Sort of a related question, Frontline carries a nice premium to some of your tanker peers. I think Frontline's probably the only -- one of the only tanker companies that carries what you could say is like a respectable valuation in today's market. Is there any opportunity out there for Frontline to become an equity consolidator? I know there's some peers in the Norwegian market, for example, we won't names today but they're trading at the significant discount NAV. Is there some opportunity for consolidation there or is that sort of off the table?

RobertMacleod

No. There are opportunities and as you say we have the pricing. We're well below where the premium we normally are at and that premium is there for the obvious reasons. We do have a main shareholder who remains hugely supportive and that will remain so, but in terms of consolidation, yes, we are a potential consolidator but we are happy what we have now. We'll we will keep tracking opportunities. So let's see what comes up and what makes sense, but with the size we already have then our earning potential is already there and which you can clearly see from the Q2 numbers.

J.Mintzmyer

Excellent. You'll have to forgive me for this one, Robert, the parting question here but we talked back in April and you had kind of a fun bet gamble about if rates would come back down unsurprisingly that you'd be walking across Norway. So I just wanted to check in on that and see when the trips planned and maybe it's after COVID we can get a group together.

RobertMacleod

Yes. I'll tell you what you would probably enjoy the walk. Of course, it's a beautiful walk as long as you start from the east side and then walk towards my hometown. Then it's the right. you're going the right way, but J you settle the bet, so it ended up being a dinner and but I must say with the confidence I had a bet was high and they did come very, very close, but fortunate enough I got away with it.

Operator

Your next question comes from the line of [Louis McGovern], a Private Investor.

UnidentifiedAnalyst

Hello, Robert and Inger. Hey, I'm calling from Pittsburgh which is the home of the steel industry that a good Scotsman named Andrew Carnegie had made famous. And I was curious what effect does scrap steel rates have on the retirement of vessels?

RobertMacleod

Sorry so did you scrap steel price?

UnidentifiedAnalyst

Well, the decision to retire vessels; I know it has to do with the five-year intervals and so forth and the market of you know but do high or lower scrap prices affect your decisions in the industry to retire ships. I just wondered if the rate of scrap steel would go up if that would result in more retirements which would be beneficial for your industry.

RobertMacleod

An interesting question and the fact is that, yes, it does and to give an example so our larger set so by the way our older ship now is 2009, so we don't have really any candidates but if you look at the market. As I mentioned in the introduction, there are a growing number of older ships and looking at the last 18-months then the value-- the steel value has fluctuated between $11 million and $18 million. So now it's at the lower end of that scale; so it's part of the decision making here whether it to scrap or not it's obviously then linked to this price because it is a good portion of the value of the contract.

UnidentifiedAnalyst

Well, maybe you could talk some of these ship builders into offering bonuses to the scrappers to tie in a sale of the new vessel to scrapping a ship.

RobertMacleod

Yes. That could be a way of doing it or combining making a pool of all the old ships and the get the balance back quicker that way.

Operator

We have no further questions coming from the phone lines. Please continue.

Robert Macleod

Okay. I think we'll round off. So I'd just like to thank everyone for calling in. And also to my colleagues and everyone at Frontline. Thank you very much all your efforts.

Operator

Ladies and gentlemen, this does include our conference call for today. Thank you for participating. You may all disconnect.