Frontline Ltd. (NYSE:FRO) Q2 2019 Earnings Conference Call August 27, 2019 9:00 AM ET

Company Participants

Robert Macleod - Chief Executive Officer
Inger Klemp - Chief Financial Officer

Conference Call Participants

Randy Giveans - Jefferies
Jon Chappell - Evercore
Gregory Lewis - BTIG
Lukas Daul - ABG

Operator

Ladies and gentlemen thank you for standing by. Welcome to today's Second Quarter 2019 Frontline Limited Earnings Conference Call. At this time all participants are on a listen-only mode. There will be a presentation followed by the question-and-answer session. [Operator Instructions] I must advise you that this conference is being recorded today on the 27th of August, 2019.

I would now like to hand the conference over to your first speaker today Robert Macleod. Please go ahead sir.

Robert Macleod

Thank you very much. And good morning and good afternoon everyone. Thank you very much for dialing into what is Frontline's second quarter earnings call. There are very exciting market dynamics in play now as the market looks to -- looks set to improve further from the recent recovery. Last week we announced the purchase of 10 Suezmaxes and we hold options for a further four. We do this at a time we believe is ideal. More on that very shortly. This call will conclude by taking questions.

Let's get started and look at the company highlights for the quarter. Net income was $1.1 million. Adjusted for non-cash items, we made $4.2 million in the quarter. For the VLCCs the spot TCE was $25,600. Q3 bookings show 83% of the days booked at $28,000. This number will likely decrease as stated in the press release due to accounting treatment of voyage charters. Suezmaxes came in at $16,200 and 70% of Q3 is done at $18300. On the Aframaxes or LR2s low $18,000s in Q2 and similar guiding for 68% of Q3.

We recently obtained financing commitment at very attractive terms on our 2020 Suezmax delivery in May and we have been continuously able to secure attractive financing.

Let's look at the right side of the slide and the Trafigura-Suezmax deal. As I will discuss later, we have a very constructive view on the market and we believe we are right at the stretch of a market upturn that could be the start of a strong tanker cycle.

This view gave us the conviction to acquire 10 2019-built Suezmaxes all of which are fitted with scrubbers from Trafigura. Five vessels will be chartered back to Trafigura for three years at $28,400 with a profit-sharing scheme where we will receive 50% of all profits. We find this to be an -- a very attractive deal and it also protects our downside.

Importantly, we don't have to wait for the acquisition to close to get access to the vessel earnings. We will take the ships on time charter within the next few weeks or months. And five vessels will immediately be time chartered back to Trafigura. We are very pleased with Trafigura becoming a strategic shareholder of Frontline and we see potential synergies going forward given their significant presence in the global oil trading markets.

We've also which is independently from this deal formed a joint venture with Trafigura to establish a global supplier of marine fuels. We believe we are exceptionally well positioned ahead of IMO 2020 through this joint venture and other steps already taken by the company including our investment in scrubber manufacturer, FMSI.

IMO 2020 looks to us to be the biggest event in the shipping market and the tanker trade for decades and we believe it will play out very positively for our shareholders.

With that said, I'll hand the call over to Inger to take us through the financials in detail please.

Inger Klemp

Thanks Robert and good morning and good afternoon ladies and gentlemen. Let's turn to Slide 4 and 5 and look at the financial highlights and the income statement. Frontline achieved total operating revenues net of voyage expenses of $103 million and EBITDA adjusted for certain non-cash items of $56 million in the second quarter.

Frontline reported net income of $1.1 million equivalent to $0.01 per share. And the net income adjusted for certain non-cash items of $4.2 million, equivalent to $0.02 per share in the second quarter. The non-cash items this quarter consisted of $1.7 million unrealized gain on the marketable securities, a $0.8 million share of result of associated company and a $5.6 million loss on derivatives.

The second quarter shows a decrease of $40.7 million against adjusted EBITDA of $96 million and a decrease of $41.1 million against adjusted net income of $45.5 million in the first quarter of 2019.

The decrease in net income in the second quarter is mainly explained by decrease in the time charter basis due to the lower reported TCE rates in the second quarter compared to the first quarter.

Let's then take a look at the balance sheet on Slide 6. The changes to the balance sheet as of June 30th compared to March 31st, 2019 mainly relates to an decrease in cash and cash equivalents of $5 million which is the net effect of CapEx payments to the payment of debt, draw down on debt, the cash from operations, and the proceeds from issuance of shares and the ATM program water; an increase in vessels of $70 million due to the delivery of Front Discovery in April and depreciation in the quarter; a decrease in vessels under finance leases by $3 million due to depreciation; net increase in debt with $31 million in the quarter following the $59 million payment and $89.5 million in drawdowns; a decrease in obligations under finance leases with $3.3 million due to amortization of property expense and lease repayments; and finally an increase in equity of $10.5 million, representing the net income in the second quarter and $9.3 million of share issuance proceeds in relation to the ATM program.

As of June 30th, Frontline had $257 million in cash and cash equivalents, including the undrawn amounts under our unsecured facility, marketable securities and minimum cash requirements. Our remaining increase in CapEx requirements amounted to $225 million related to one Suezmax tanker and one VLCC which are both expected to be delivered in May 2020 and two LR2 tankers which are expected to be delivered in January and March 2021.

We have tied approximately $164 million in debt capacity for these new buildings. We have no near-term debt maturities. The first debt maturity is in November 2020 when our senior unsecured loan facility amounted to $175 million matures. We had drawn down $120 million under this facility and $155 million remains available undrawn as of June 30, 2019.

Then let's take a closer look at cash breakeven rates and cash generation potential on slide 7. We estimate average cash cost breakeven rate for the remainder of the 2019 were approximately $24,500 per day for the VLCCs; $21,300 per day for the Suezmax tankers; and $16,200 per day for the LR2 tankers. These rates are the all-in daily rates that our vessels must earn to cover budgeted operating cost of the dry dock estimated interest expenses TC and bareboat hire installments on loans and G&A expenses. We had included dry dock costs for four VLCCs, four Suezmax tankers and one LR2 tanker in second half of 2019.

Frontline's above cash breakeven rates, offers a strong downside protection against low-rate environment and at the same time, it creates a great upside potential in the strengthening tanker industry. Every $1,000 per day in achieved rates in excess of our cash breakeven translates to approximately $22 million in incremental net income per year or $0.12 per share, which shows the net -- the high importance of remaining -- maintaining our low cash breakeven rates.

In the -- on the right-hand side of the slide, we have shown incremental net income per year and per share assuming $10,000, $20,000 and $30,000 per day in achieved rates in excess of our cash breakeven respectively. The operating expenses per day in the first quarter of 2019 with $10,500 for VLCCs, $7,500 for the Suezmax tankers and $7,100 for the LR2 tankers. We did dry dock two VLCCs in the second quarter and one Suezmax tanker are scheduled for dry dock in the third quarter of 2019.

And with this, I leave the word to Robert again.

Robert Macleod

Thank you very much. Let's look at the key market developments. We are once again seeing the market behave in a cognizant manner this year as we also saw in the first quarter when U.S. exports began to surge. Within Q2, we witnessed the largest decline in global refinery throughput seen this decade due to extended maintenance ahead of IMO 2020.

Looking back, I would actually say the rates kept up pretty well given what was going on with the refineries. Recently, VLCC rates have again moved up sharply. Refineries are now restoring capacity and throughput looks to be rebounding quickly. Crude oil demand growth is forecasted to be strong for the balance of the year after softening through first half.

For the balance of 2019, we expect the tanker market to remain volatile due to crude oil supply concerns and geopolitical tensions that continue to trend higher. Importantly, used crude oil production is growing year-over-year, while OPEC production is declining following production costs. This is leading to increased exports from the Atlantic, which we expect to continue. This expectation is supported by both increasing U.S. production and export capacity which has been coming online steadily. A large portion of incremental production is flowing to Asia, supporting strong growth in tonne-mile demand.

Next slide please. We'll have a look at how deliveries decline after 2019 and older vessels will face costs. The growth of the crude oil tanker fleet is a key factor for our markets. So far in 2019, 41 VLCCs have been added to the global fleet, compared to three vessel demolitions, an additional 33 VLCCs are scheduled to be delivered in 2019 with 43 more to follow in 2020 before the order book declines sharply.

Despite continued deliveries of newbuilding vessels in the short-term affective crude tanker capacity growth is expected to slow as vessels are taken out of service, regular dockings, scrubber or ballast water installation and other preparations for the IMO 2020 regulations.

While the pace of recycling has slowed significantly compared to last year, there are still 170 VLCCs that are greater than 15 years and we believe large number of older vessels will be taken out of the market, and either be recycled or go on floating storage as part of the regulation-driven phasing out of older vessels.

Let's move to the summary slide please. There are obviously various factors to support our positive market outlook and we constantly – development. In the short term, we've already seen the market rebound following extended refinery maintenance ahead of IMO 2020.

Although, global growth is forecasted to slowdown, the pace of growth remains positive. The fact that incremental production is coming from the U.S. and a good deal of it is heading East it is a clear positive for tonne-mile demand growth. Replacing miles in Middle East with ballasts in the Atlantic is widely viewed as positive for tanker markets given the increase in distance travels.

Finally, the vessels supply picture looks very positive. The new vessel deliveries have put pressure on our market for the last two years. As we do look at that, there's still a fair amount of vessels to be delivered over the next 18 months. But this probably is eclipsed by the number of vessels greater than 15 years. And we should also see some effective reduction in capacity as vessels are temporarily taken out of the trading markets.

On the other hand the risk of a global slowdown in GDP growth is dominated in news headlines, a new risk that has added volatility to the equity market. Finally, there's always the chance that IMO 2020 implementation will not proceed as expected. And although, we believe in fuel spreads to widen as we approach 2020 it could of course narrow and diminish scrubber economics.

To conclude, we expect the markets to remain volatile, but continue to trade higher. Crude oil tanker demand will continue to see the significant boost as crude demand increases in the second half of this year. Although, there are always risks related to slowing global demand multiple possible market drivers should result in a strong tanker earnings for the balance of the year, and we expect this trend to kick-off 2020, positively for us. We believe Frontline is well positioned going forward now with even greater earnings potential.

With that, though I'd like to turn over to the questions please.

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from the line of Randy Giveans from Jefferies. Please ask your question.

Randy Giveans

How is it going? How are you all doing this morning?

Robert Macleod

All good. Thanks, Randy.

Randy Giveans

All right. So looking at your fleet in the recent months, you've ordered a few newbuildings acquired some re-sales most recently bought those 10 Suezmaxes from Trafigura. So how are we thinking about kind of further fleet growth from here? Are you pretty satisfied with the fleet following this most recent large acquisition?

Robert Macleod

I think looking at the fleet overall obviously over the last three four years, we've transformed from – in terms of average rate, we really brought it down. We had a lot of ships deliver. We sold off a lot of the old ships. So I think the – and the process there has been very positive for the company. We've been looking actively at growth for periods here. And we have to say, we've done some re-sales.

And last week, we did a Trafigura deal. We overall – as you look at our fleet, we've had full exposure through the LR2s for some time, which in terms of size we're pretty happy with. We'd like the – as a preference we'd like the crude segment in terms of growth. We found the growth on Suezmaxes. But I think it's fair to say the way our fleet is structured now then in terms of future growth then VLCCs would have our special attention.

Randy Giveans

Sure. Okay. That makes sense. And then looking at your investment in the joint venture with Trafigura, was there a monetary cost to this to acquire your percent ownership? And also will there be financial risk from either profitable or unprofitable bunker trading? Or is it solely kind of an operational play for your fuel requirement?

Robert Macleod

In terms of – with this – we would put small amount of working capital into it. And that's it. So, there's no investments as such and in terms of risk profile, we will be very conservative so we capitalize.

Randy Giveans

All right. And I guess last quick question. Do you have an updated kind of cadence for off-hire days and kind of CapEx spend on the scrubber installations? Like, how many scrubbers do you expect to have by January 2020 in the next three to four months here?

Robert Macleod

So we've been – so the simple numbers have at about one-third of our fleet will have been installed by Q1. Given the Trafigura deal, we are fast-forwarding the amount with the deal. So, by Q1 next year, we'll be just below half the fleet.

Randy Giveans

Q1 half fleet. Excellent. Hey, thank you so much for the color and congrats on the deals.

Operator

Thank you. Our next question comes from the line of Jon Chappell from Evercore. Please ask your question.

Jon Chappell

Thank you. Good afternoon guys. Robert, it's a follow-up on the other question in the fleet. So you obviously made a pretty big transaction. You talked about maybe focusing on the VLCCs going forward. At what point do you feel that you're in kind of harvest you're done spending? You already have a fleet that's under a four years of age and you kind of transition to the Frontline over to where capital return takes priority over continuing to build the size of the fleet?

Robert Macleod

No. I think, we -- in terms of earnings power now, we're seeing a just pull-through the slide where we have substantial. So I think the focus now will be to possibly reduce something on the VLCCs. We certainly don't have to. If this market takes off as we expect then we have greater than actually it is.

As for our strategy coming into this then we paid now spot for quite some time because we've had a belief that we will see a strength in the market coming into 2020. So hopefully this plays out. And then we will take opportunities say, like we did when doing the Trafigura deal to lock in some charters. And we will do some of that and have a conservative approach to the cycle.

Jon Chappell

And I know it's not kind of the leggy MO of Frontline to delever. But after this Trafigura deal, it looks like about 80% leverage if we take the high end of the cost range just for this deal alone which brings Frontline back above 60%. So how do you think about using cash flow from operations if this cycle plays out as you and I both expect to delever -- the balance sheet a little bit as opposed to maybe jacking up the dividend?

Inger Klemp

I guess this is something the Board will have to discuss going forward how we're going to approach that. But according to our dividend strategy that remains unchanged in a way. And that says, as you know that the excess cash flow from the company shall be used to a more or less for dividends going forward.

Jon Chappell

Okay. The last one. Robert, it's kind of fresh, so I don't know if you've had a chance to assess it yet, but the addition of crude oil to China's retaliatory tariff list. You mentioned yourself the importance of the Atlantic in the long-haul trade and we are to believe that that's what's really been supporting the market in the face of these OPEC cuts.

Have you assessed either operationally what it potentially means for your fleet? Or financially from a supply-demand perspective if these tariffs were to be enacted and the U.S. became uneconomic -- U.S. crude become uneconomic in China what that -- what may that do to your outlook on the tanker markets?

Robert Macleod

So, I think it's an excellent question. But on this call and I'll refrain to conclude remarks.

Jon Chappell

Okay. Thanks Robert. Thanks Inger.

Robert Macleod

Thanks.

Inger Klemp

Okay.

Operator

Thank you. The next question comes from the line of Gregory Lewis from BTIG. Please ask your question.

Gregory Lewis

Yes, thank you and good afternoon. Robert, I guess thanks for providing the kind of the guidance for Q3. But yes, I guess at this point we are almost in September. Just kind of curious we've seen a nice run-up in VLCC rates over the last couple of weeks. Do we have any kind of visibility at this point into what Q4 bookings already look like? Have we started to get anything on the books for Q4?

Robert Macleod

No. For the Q4, we've done a little bit, but very little. And we're seeing in sales what we've seen over the last few weeks there's a lot of momentum in the market the Vs have moved the Suezmaxes are on the move. So I think to look at the quarters, I'd say that Q3 is as I say, we've already booked -- up a lot when the market started turning.

So I think we should look at Q3 as being not a great quarter. We've seen -- you've seen the guidance, right? But the good thing is that we're starting. The market moves so that the Q4 bookings they started at low percentage where we're seeing the higher numbers. So, hopefully, we'll teed off here to get a really good Q4. But yes, the next month will show.

Gregory Lewis

Okay. And then with the Trafigura acquisition, I guess, congratulations on that. That Suezmax guidance that you gave on that slide, does that include those vessels? Or was that more like the end of Q2 so prior to the acquisition of those vessels?

Robert Macleod

No. That the spot guidance, no that's excluding those.

Gregory Lewis

Okay. So that's excluding those. Okay. Great. And then just one more for me. I guess, as we look at the decision to go into the Suezmaxes, it seems like over the last couple of years there's -- you've been mentioning yourself the order book for the Suezmaxes has come down. Strategically like how should we think about Suezmaxes in the crude market now?

Jonathan mentioned clearly, there's been a lot of oil moving from the U.S. to Asia. That's not really a Suez trade. Just kind of how you're thinking about the Suez market given just you made a pretty substantial acquisition into the space?

Robert Macleod

We like the Suezmax segment. We already had 18 ships in the segment all modern. And thinking about the Suezmax, you can triangulate them. So if you look at our earnings when these VLCCs are down into low-teens for example, then normally the Suezmaxes trade just above and that's due to the triangulation. And they're doing a lot of West Africa, they're also doing a lot of the Atlantic -- going East. So they're doing some long-haul trades also short sea, so it's a very sort of flexible and versatile ship unit which -- also with the relationships we have in the market, it's a very good segment for us. So I think in terms of commercial performance over the last four, five quarters then Suezmax stands out as probably our strongest.

Gregory Lewis

Okay, perfect. Thank you for taking my questions. Have a great day.

Operator

Thank you. The next question comes from the line of Robert [Indiscernible]. Please ask your question.

Unidentified Analyst

Yes, hello Robert. Thank you for doing a good job. How do you see the horizon as far as coming back to a dividend? First quarter of 2020, second quarter? Could you give us some color on when that might occur?

Robert Macleod

I think the -- obviously this will as Inger said on the other question, I think it will be down to the Board. But the way I see this is that we're coming into positive territory. And in terms of the facility payable to Mr. Fredriksen, we've drawn now $120 million. And the overall -- company's looking good. And I would say it's -- or it's fair to say that we'll return to paying out dividend sooner rather than later.

Unidentified Analyst

All right. Thank you. Could you give us some color on what's going on these days in the Strait of Hormuz, where you had problems in the past. Do you see coming down? Or is it still very tenuous?

Robert Macleod

We're all very much on the alert still.

Unidentified Analyst

Okay. It is a -- is it affecting your bookings from that area? Some companies have actually decided to stay away. You have not decided to do that, right?

Robert Macleod

No. We've not decided to stay away with the -- so we are doing business there, but we have chosen other trades due to the sewer situation. So, obviously, the Frontline tier was a very, very contention [ph] and we've gone down in terms of bookings. But we are still trading in the area, but with heightened security and we're keeping a very close eye on everything that's going on.

Unidentified Analyst

Okay. Good. Could you give me a little color on how you see Brazilian production? And how that may balance for instance? What's going on in the United States with tariffs, with China et cetera et cetera? Will it change things very much? And how is Brazil coming as far as paying out exporters?

Robert Macleod

It's one of the like earlier question. It is a difficult one to be precise and conclusive on. But if you look at the exploration and the plant in the country and the investors being brought in also from upstate Norwegian company Equinor then I think it's fair to say that it looks like it's going to be a growth area in terms of exports.

Unidentified Analyst

Okay. Well that’s it for me. Thank very much for taking my questions.

Robert Macleod

Thank you.

Operator

Thank you. The next question comes from the line of Lukas Daul from ABG. Please ask your question.

Lukas Daul

Thank you. Good afternoon, Robert and Inger. Just a quick one on the 10 Suezmaxes you're adding. How should we sum in, in terms of startup base et cetera?

Robert Macleod

So, the first one was delivered. So back to the deal, we take exposure on these ships as soon as we can. So, the first one actually delivered at the time of signing and then we're about to take reign of the second one. And so they don't call it the same time. It -- the delivery is connected to calling various ports. I think we should be -- we should have all the ships within September.

Lukas Daul

Okay. Within in September. And then on -- you sort of mentioned in the press release, when you announced that -- looking at different options how to finance it? Or could you sort of shed a bit of light on that? What would be the ideal financing structure?

Robert Macleod

What I would say is – yes, we're not going it to be too pleasant on global, because we have various options now. What we can say is that as soon as this deal was done we've done some pre-checking. The finance is definitely available to Frontline and it is at very, very attractive terms. We will aim to conclude finances soon as we can. We will then lower the cost that we are currently paying. So it's a top priority for us to close the transaction and do the finance here soon.

Lukas Daul

Okay, sounds good. Thanks.

Operator

Thank you. [Operator Instructions] Dear speakers there are no further questions at this time. Please continue.

Robert Macleod

Okay. Then thank you very much. And I would like to thank everyone at Frontline for all the hard work and great efforts. And thank you all for calling into this presentation. All the best.

Operator

That does conclude teleconference for today. Thank you for participating. You may all disconnect. Have a nice day.