Frontline Ltd (NYSE:FRO) Q4 2019 Earnings Conference Call February 27, 2020 9:00 AM ET

Company Participants

Robert Macleod - CEO
Inger Klemp - Principal Financial Officer

Conference Call Participants

Jonathan Chappell - Evercore ISI
Randall Giveans - Jefferies
Gregory Lewis - BTIG
Michael Webber - Webber Research & Advisory

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Q4 2019 Frontline Limited Earnings Conference Call. [Operator Instructions].

And I would now like to hand the conference over to your first speaker today, Robert Macleod. Thank you. Please, go ahead.

Robert Macleod

Great. Thank you very much. Good morning, everyone, and good afternoon. Thank you very much for dialing in to Frontline's fourth quarter earnings call. Frontline's solid performance in the quarter was driven by increased tanker demand due to growing Atlantic-to-Asia trade, tighter available fleet capacity and the IMO 2020 implementation. Just a few short weeks into 2020, the market strength started revising -- reverse, sorry, as issues were experienced in Libya, Venezuela and Nigeria, and there were also attacks in the Middle East. Then these sanctions were lifted on the cost of fleet. To make matters much worse, the coronavirus appeared immediately impacting on world trade, oil demand and the freight market. The VLCC segment is weak as ton miles demand has decreased, whilst our Suezmaxes and Aframaxes, 2 segments where frontline has significant exposure, are enjoying better earnings on a relative basis.

The start to this year has been extraordinary. It has actually felt a bit like a horror movie at times, to be honest. But importantly, we are making money in today's freight environment, having a modern and well-run fleet is key.

Please, let's move to Slide 3 and look at the highlights from Q4. Net income was $108.8 million or $0.55 per share. Certainly, a solid quarter and the $8.7 million profits related to the Trafigura deal is not included as net income.

We declared a $0.40 dividend. The last dividend was $0.10, and was paid for Q3 of '19. VLCCs made $58,000 in Q4, and we have booked 83% at $90,000 for Q1. Suezmax has made $38,000 in Q4, and we have booked 75% around $72,000 for Q1. LR2s made around $30,000 in Q4, and we have booked 72% at $36,000 for Q1.

The $554 million ICBCL sale-and-leaseback is in the final process of being signed and will facilitate the closing of the 10 Suezmaxes we are acquiring from Trafigura.

Before going into more detail about the tanker market. I would like to hand you over -- hand the call over to Inger. Please, Inger, can you take us through the financials?

Inger Klemp

Yes. Thanks, Robert, and good morning, and good afternoon, everyone. Let's then turn to Slide 4 and look at income statement. Frontline achieved total operating revenues net of wage expenses of $224 million, and EBITDA adjusted for certain noncash items of $163 million in the fourth quarter for 2019. Frontline reported net income of $108.8 million, equivalent to $0.55 per share, and a net income adjusted for certain noncash items of $106.9 million, equivalent to $0.54 per share in the fourth quarter.

The net income in the fourth quarter excludes the $8.7 million of net cash received and accrued profit share in relation to the 5 charter-in and charter-out agreements with Trafigura, that have been treated instead as a reduction of the acquisition cost of the vessels.

Noncash items this quarter consisted of $0.8 million unrealized gain on marketable securities, a $1.1 million loss related to our interest in FMSI, and also $2.2 million gain on derivatives.

The fourth quarter shows an increase of $120 million, against adjusted EBITDA of $43 million and an increase of $106.9 million against adjusted net loss of $10 million in the third quarter of 2019. The increase in net income in the fourth quarter is explained by an increase in sort of time contract basis due to the higher reported TCE rates in the fourth quarter compared to the third quarter.

Let's then look at the balance sheet, Slide 5. The main changes to the balance sheet as of the end of December 2019 compared with September 30, 2019, relates to, first, an increase in cash and cash equivalents of $68 million, which is the net effect of CapEx payments, prepayment of debts, drawdown of debts, cash flow from operations and proceeds from issuance of shares under the ATM program. An increase in other current assets of 1 -- of $62 million, explained by an increase in receivables and inventories. An increase in short-term part over [indiscernible] some debt of $310 million, related to debt maturities of the $500.1 million facility in December 2020, which is expected to be refinanced.

An increase in equity of $130 million, mainly due to the net income for the quarter shares issued in relation to the ATM program of [indiscernible] cash dividends.

As of December 31, Frontline has $343 million in cash and cash equivalents, including undrawn amounts under our unsecured loan facility, marketable securities and minimum cash requirements. Our remaining newbuilding CapEx requirements as of December 31 amounted to $302 million, related to 1 Suezmax tanker and 1 VLCC, which are both expected to be delivered in May 2020 and 4 LR2 tankers, which are expected to be delivered in January, March and October 2021 and January '22, respectively. We estimate approximately $234 million in debt capacity for these newbuildings.

As Robert said, we are in the final process of signing the $554 million sale-and-leaseback agreement with ICBCL to finance the cash amount payable upon closing of the 10 Suezmax tankers on March 16, 2020. The lease financing has a tender of 7 years, carries an interest rate of LIBOR plus a margin of 230 basis points, has an amortization profile of 17.8 years, and includes purchase options of strong plans throughout the period with the purchase obligation at the end of the term.

In November 2019, the company signed a senior secured term loan facility with Crédit Suisse for an amount of up to $42.9 million to part finance the Suezmax tanker resale under construction at Hyundai. The facility must choose 5 years after delivery, carries an interest rate of another custom margin of 190 basis points and has a maturity profile of 18 years.

Now in February 2020, we obtained a commitment from Crédit Agricole for a senior secured term loan facility in an amount of $62.5 million, to part finance the VLCC resale. The facility, which is subject to fund documentation, will mature 5 years after deliver date, carries an interest rate of LIBOR plus the margin of 190 basis points and has an amortization profile of 18 years.

The average margin of bank debt is LIBOR plus 185 basis points at the end of the year, 31st of December, and will be LIBOR plus 195 basis points, following the new borrowing of $659.4 million, which I mentioned.

Let's then take a closer look at cash breakeven rates and OpEx on Slide 6. We estimate the average cash cost breakeven rate for 2020 of approximately $22,700 per day for the VLCCs, $19,700 per day for the Suezmax tankers and $15,600 per day for the LR2 tankers. The fleet average estimate is about $19,400 per day. These rates are the all-in daily rates that the other vessels must earn to cover the budgeted operating costs and dry dock, estimated interest expenses, TC and bareboat hires, installments on loans and G&A expenses.

For every $1,000 per day in achieved rates in excess of our cash breakeven translates to approximately $22.8 million in incremental cash flow after debt service per year or $0.11 per share, which shows the high importance of maintaining below cash breakeven rates.

In the graph that we have shown on the right-hand side of the slide, we have shown the incremental cash flow after debt service per year and per share, assuming $10,000, $20,000, $30,000 or $40,000 per day in achieved rates in excess of our cash breakeven, respectively. As an example, with a fleet average cash cost breakeven rate of approximately $19,400 per day, an average fleet TCE rate of $49,400 per day. Frontline would generate a cash flow per share after the service of $0.0339.

With this, I leave the word to Robert again.

Robert Macleod

Thank you very much, Inger. It's great to see the earnings potential we have, and the recent financing just shows the position that Frontline is in. So it's very encouraging. With that, let's move to Slide 7, please. I would like to explain why our long-term view of the market is unchanged. But let's talk about the virus first. The negative market effect created by the coronavirus is certainly strong and has hit oil demand head on. The impact on demand will play out over time and forecasts are very varied. We believe that demand will return and increase in 2020 year-over-year as we see the current situation as temporary rather than permanent. But we are obviously not in a position to predict when things will turn, but we are cautiously optimistic that the virus will be contained sooner rather than later. Once this happens, we are hopeful that we will return to a market where oil demand is healthy, U.S. Gulf to Asia volumes continue to increase, IMO 2020 plays an important role, the fleet growth continues to slow. Sentiment, as we all know, is a strong tool. It is extremely negative now, but it will turn.

Next, please. Global fleet capacity growth is slowing. Fleet growth is an important driver of long-term earnings in the tanker sector. And investors have repeatedly been disappointed in the past as overordering quickly destroys up cycles. There are currently virtually no tanker orders being placed. And while this can quickly change, the last time we saw the order book at present levels was back in 1997. We expect vessel off-hire to have a material impact on fleet capacity this year as it did in 2019. There are 137 VLCCs or 17% of the fleet due for dry dock in 2020. For Suezmaxes, the number is 109 or more than 20% of the fleet. Importantly, any off-hire related to scrubber installations is not included in this number.

Dry dock gains cannot be postponed, and global shipyards entered 2020 with the busiest schedule seen since 2007. The shipyards are even more stretched now due to the coronavirus, locking workers and suppliers. This is bound to have a very positive effect on supply throughout 2020 and probably also into 2021.

Let's look at next one, Slide 9. And believe it or not, IMO 2020 actually did happen. Throughout last year, the shipping and investment communities were focused on IMO 2020, and rightly so. In our opinion, the impact of IMO 2020 has been overshadowed by other events recently, but the effects are real and will remain a factor for quite some time. IMO 2020 has created a huge spread in owners' fuel-related costs. As an example, a modern VLCC with a scrubber will be earning $30,000 a day at the same time as a large portion of the VLCC fleet will earn around their daily operating expenses.

Frontline, as you know, has a very modern fleet with an average age of around 4 years, giving us a tremendous advantage in the current fuel price environment. And as I mentioned early on in the call in the introduction, we are at current rates, still running at a profit.

In conclusion, Slide 10, please. The company's potential in strong markets has been demonstrated in the fourth quarter results and through first quarter guidance. Frontline's position in the market is unquestionable, and the fleet is the best we've ever had. Our breakeven levels are also at historically low levels. But for now, the market headwinds remain strong. And we do not foresee any significant improvements until the virus has been contained. However, when the virus is contained and a negative headlines to subside, the tanker market could well reenter the strong earnings environment, we entered in the fall of 2019.

With that, operator, I would like to turn to questions, please.

Question-and-Answer Session

Operator

[Operator Instructions]. The first question comes from the line of Jon Chappell from Evercore.

Jonathan Chappell

Robert, first question. You mentioned both in the presentation and in the earnings release, that just given the uncertainty today and despite the long-term favorable outlook, you're being cautious. So I assume cautious means not buying any new ships, even though the market may bring asset values back a little bit. But how does that translate that into the dividend policy? It looks like about a 75% payout ratio for 4Q, the 1Q to date rates are even stronger, understanding that there's going to be a tail off for the remainder. Do you think that the Board becomes much more conservative with the payout just until there's a little bit more clarity on the demand side? Or would you expect a similar type payout of the first quarter results?

Robert Macleod

Again, in terms of being cautious, I think to take that first. I think cautious also means that we're extremely prudent in what we do on the chartering side. We're extremely focused on the running the company as best we can. Obviously, what we do on the day-to-day fixing is extremely important. So this is -- we are laser-focused when it comes to that. You can see how we start in 2020. And unfortunately, with the very high-quality fleet. We are still running in the black.

In terms of dividend, you did see that we pay the $0.10 in Q3 despite the loss in the quarter, and we followed up with a $0.40 for Q4 today. So the second half of 2019, if you look at the payout ratio, is looking -- it's looking very, very good, of course. So coming into Q1, we are off to a much better start here in Q1 than what we made in Q4. So I think the Board would now see how the well develops between now and the Q1 release and our board meeting here in May. So I think it all depends on how things pan out. If this sort of crisis, in terms of the virus, if this continues throughout, then I'm sure the Board will have a very good thing. But if this is temporary, and the world is going to a better place and getting back to normality, then I think the payout will be decent. And Q1, so far, is looking very good.

Jonathan Chappell

Okay. Great. Just my follow-up question for Inger. Looks like the short-term debt moved up pretty significantly in the December 31 balance sheet. I think there was a bullet point that wasn't addressed in the presentation saying that's part of the bigger facility and you expect it to be refinanced. How soon can you refinance that so we kind of see that debt level move down from the current liabilities back to the long term?

Inger Klemp

So we deliberately haven't really looked into that yet. So we don't have any concerns about that at all, in a way. So -- but I think we will plan to dig into that now, in the next quarter, in a way, I guess. So next time, we sit there and talk, I guess, we probably have something in place.

Operator

And your next question comes from the line of Randy Giveans from Jefferies.

Randall Giveans

Two questions for me. First, on looking at your share count and share issuances, obviously, in 3Q and 4Q when the shares are trading at large premiums to NAV, that made sense. In 1Q, with the latest Trafigura acquisition shares still outstanding. But going forward, now that your shares are back below NAV and pretty meaningfully, in our view, how do you view share repurchases at this point, either in kind of a complement to the dividend or instead of the dividend?

Inger Klemp

Sorry, we didn't completely catch the question. Are you talking about repurchases or issuances?

Randall Giveans

Yes, the latter. Now that the stock's well below NAV going to share repurchases, in addition to the dividend or in lieu of the dividend.

Robert Macleod

We are -- It's something that we are watching very carefully, how things are developing, of course, because that is the real alternative.

Randall Giveans

Okay. And then can you give some updates on your scrubber installations? How many have completed? How many are coming? And then if you have any kind of plans for further scrubber additions now that we're seeing kind of the spread tighten a little bit, but kind of be a little more stable.

Robert Macleod

So at the moment, we have 26 vessels sailing with scrubbers in operation. We have a further 6 due for installation over the next -- most of the next quarter, but partly Q3, probably as well, given our view on various delays in the yards, it might be Q3. That will bring us to 50% of the fleet. And to be clear, on the 50%, there's overweight on Suezmaxes and VLCCs and underway from LR2. So we view this econo simple, the bigger the ship, the more that makes sense. We have not made any decisions on doing scrubbers on ships outside of their docking schedule. It is something that we consider, and we're monitoring, given our ownership in Clean Marine. We have superior access in both in timing and price for scrubbers. But the answer is 26 at the moment, 6 scheduled and monitoring further.

Randall Giveans

Perfect. And then one quick question, 5-second answer is all you need. LR2, is any of those switching to dirty or have switched to dirty in the recent month or 2 with the large differentials between the crude tanker rates and the products?

Robert Macleod

11 clean, 7 dirty, one gone dirty over the last 8 weeks.

Operator

And your next question comes from the line of Greg Lewis from BTIG.

Gregory Lewis

Yes. Rob, could you talk a little bit about what you're seeing in the rate market for these? I mean, clearly, it was -- it's been a tough month. But it looks like over the last week, you've seen some stabilization and a little bit of uptick in the V market. Kind of, just any kind of color you can provide around that? Was that just a shift in sentiment? Pickup in volumes? Any kind of color would be helpful.

Robert Macleod

So the V market as we all saw, okay, was completely shot to pieces, right? And then slowly started picking up about 2 weeks ago. I think it reads to lower bottom. Around the world's got 40,000, which was the high 20,000, 30,000 for our best ships, and OpEx for 2/3 of the world fleet. This week, we've seen quite a lot of under-the-radar activity. The first ships to be taken out in the weak market are the weaker links and the older ships. So they've been picking off. And then suddenly, we're seeing, actually, today and yesterday, that the list isn't looking that bad in the Middle East. So now the modern ships are starting to sniff but the world's got 50. And then you're getting -- your best ships might be -- it probably starts with a 4, but I'm not saying it's just sort of -- it's so vulnerable out there. It could well be down 5 points by the time we've done the call. But overall, I see the V market as finding its feet and slowly getting a little bit better. We're seeing quite a few light swing jobs, which takes up some capacity in the Far East. But over on the Aframaxes and the Suezmaxes, they kept up a lot better. So that is the reason why our numbers are still -- if we fixed all our ships today, we'd still be in profit. It's because of our Suezmaxes and Afras. Because stand-alone, the leases are not great. But hopefully, we've seen the worst and we start improving from here. The FFA or the ships' market is also indicating that, but only time will show. It seems that the world is getting 1 shock after another. But surely, there must be some good news soon.

Gregory Lewis

Okay, great. And then just one more for me. One of your competitors added a couple of VLCCs in the newbuild market. I know Frontline always tries to be acquisitive when it can. I guess, 2 things. One is, I mean, clearly, the turmoil that we've seen over the last month or I guess, early -- since early mid-January. Has that dampened the appetite for buyers and sellers to come together for sales? And really, what I'm trying to understand is, are there still tankers, whether it's Suezmaxes or Vs or even, I guess, LR2s that Frontline is actively looking at in terms of potential acquisitions? Or to your points about taking a cautious tone, and say we're entering March and really don't expect us to be out in the market looking to acquire tonnage until we see maybe some more stability later this year?

Robert Macleod

We're always monitoring. And as I said earlier, short term, we're very cautious. So we're putting more in the silo now than we were or we are more on the silo than and we were a month or 2 ago. But if the right deal is out there, and then we're still there. I think our long-term view is very clear. We think this is -- but we don't think this is a permanent, it's a temporary situation. And to the deal that you referred to, the 3 ships that we saw. You might think that, that now looks like a terrible deal, but I think that deal still stands ground as a decent deal. If you -- it's for delivery and -- now we are still there. We're certainly not turned off the lights for further deals.

Operator

And your next question comes from the line of Michael Webber from Webber Research.

Michael Webber

Good. Robert, just wanted to loop back to the conversation around demand in this environment, and there's, obviously, not a lot you can control for right now. But in terms of thinking about coming out of this and an eventual demand recovery or rebound, how do you think about positioning your fleet for that? It might be too early, but I'm just curious in terms of where you're choosing to -- what are there for the so much opportunities that could develop as production is kind of ramping, kind of running beyond actual consumption levels here? Just how do you think about positioning your fleet the best to capture an eventual demand redone?

Robert Macleod

In terms of this, obviously, for the various segments. But to the 1 -- the Aframaxes and Suezmaxes, we normally have a strong presence in the Atlantic basin, and that is fortunately the case now. The Atlantic and the Mediterranean Black Sea and the Baltic has been hit a lot less. So we're in the right position there. We're not seeing that much inquiry going east. So we're sticking around. So we're in the right place, I think, where we are.

For the Vs, they are spread out as per normal. There's quite a lot of fixing out of the Middle East. And at today's levels, if I have the choice between a 40-day voyage or an 80-day voyage, I will go for the shorter voyage given our market view. As soon as we start seeing real, real changes here and the contained virus and so forth, we will be taking more ships balancing to the west on speculation. Because that will then coincide with Chinese demand coming back and giving the U.S.-China deal, what we then believe that the U.S. Gulf exports on fees will pick up tremendously. So we want to be in position with that.

And for the storage question. We saw the market into contango 2, 3 weeks ago, then Australian backwardation. Now we're back in a contango or small contango again. But I think in terms of closing stores, it doesn't defend the economics, but this could suddenly happen, of course, given how low the oil price is. So it's something we're monitoring. At the same time, we're much less of a floating storage player now than we were going back a few years. We've sold 19 old ships over the last 3 years, fortunately. And with our fleet now, we are much more focused on trading, but if we have short-term stuff we can been doing that at better rates than what the market gives us on an AG East, then we'll do it.

Michael Webber

Yes, that was kind of my follow-up question, just given the kind of the whipsaw we see in that curve over the past month. I was just curious, what are the relationships with FAFI that gives you a bit of a leg up or kind of a first look, if someone were to move quickly on floating store, just given how many -- how violent are we seeing that curve shift recently, whether that's something you'd be open to or whether that be -- whether you see any kind of incremental interest there?

Robert Macleod

There is glory into it. And then looking away from Frontline's fleet, then it's a fact that the large majority of the fleet is around the OpEx level. So when you come into that sort of category, then there will be certain takers. And what we know will happen then. Did you strain the supply on that type of ship, and that will affect the rest of us. So I'm, of course, very hopeful that it happens. And it could well be, given how depressed the market is.

Operator

And we have no further questions at this time. You may continue.

Robert Macleod

Okay. Thanks very much for calling in, everyone. And I would also like to take the opportunity to thank everyone at Frontline for their hard work and great efforts. We're going to come out of this strong. And hopefully, it's not going to be too long. Thank you very much, everyone.

Operator

And this does conclude your conference for today. Thank you all for participating. You may all disconnect.