Frontline Ltd

NYSE:FRO

Earnings Call Transcript 2018-Q1

[Operator]

Good day, and welcome to the Q1 2018 Frontline Limited Earnings Conference Call. Today’s conference is being recorded.

At this time, I would like to turn the conference over to Mr. Robert Macleod. Please go ahead, sir.

[Robert Macleod, Chief Executive Officer]

Thank you very much. Good morning, and good afternoon. Thank you for dialing in. This is Frontline’s earnings call for the first quarter of 2018. I will start the call by briefly going through the highlights of the quarter. Following that, Inger will run us through the financials. We’ll then look at Q1 earnings, and I will guide you on our Q2 earnings. We will then move on to the current tanker markets, and the outlook. The call will be concluded by taking your questions.

Okay. Let’s get started and look at the company highlights. We recorded a net loss of $13.6 million or $0.08 per share adjusted for non-cash items in the first quarter. Our results were driven by weak spot markets. Earnings on our older leased vessels were particularly weak, but our modern tonnage delivered satisfactory results given the market conditions.

During the quarter, we took delivery of two newbuilding VLCCs and one LR2. Frontline now has two VLCCs remaining in our order book both delivering next year. Our own fleet has increased from 4 million to 8.3 million deadweight tons since 2014 and the average age is down from 6.5 to around 3.5 years.

With that, I will hand the call to Inger to take us through the financials in detail.

[Inger Klemp, Chief Financial Officer]

Thanks, Robert, and good morning and good afternoon, ladies and gentlemen. Let’s then turn to Slide 4 and look at the financial highlights. As Robert mentioned, Frontline achieved a result of $13.6 million in the first quarter equivalent to $0.08 per share.

Total operating revenues net of voyage expenses were $81 million in the first quarter. Non-cash items this quarter consisted of a $5.9 million loss of termination of the lease of Front Circassia as again there is also mark-to-market loss on marketable securities, a gain on derivatives of $5.1 million and a gain on sale of shares of $1 million.

After adjusting for these non-cash items, we show an adjusted EBITDA of $14 million and adjusted net loss of $13.6 million in the first quarter against adjusted net income of $5 million in the fourth quarter 2017, which is a decrease of $18.6 million.

Let’s turn to a bit closer on the numbers in the Slide 5, income statements. The decrease in results in the quarter of $18.6 million is mainly explained by, first of all, a decrease in results on time charter basis of $17.8 million due to the decrease in time charter rates in the first quarter compared to the fourth quarter.

Further a decrease in depreciation of $4.6 million mainly related to the decrease due to the impairments on the vessels under capital lease which were just nice in the fourth quarter 2017 which was partly an offset by an increase from the delivery of three newbuildings in the first quarter.

Further a decrease – sorry, increase in ship operating expenses of $1.3 million, mainly due to delivery of the three new vessels in the quarter following nine vessels in the fourth quarter. Then, had an increase in interest expense by $1.6 million due to drawdown of debt in relation to delivery of the three vessels in the first quarter and also an increase in other expenses by $2.5 million.

Then let’s us take a look at the balance sheet on Slide 6. Changes to the balance sheet as of March 31st 2018, compared with December 31st, 2017 primarily relates to an increase in vessels of $209 million due to the delivery of the three new vessels in the quarter, partly offset by depreciation in the quarter. Then a decrease in newbuildings of $46 million due to delivery of three new vessels in the quarter and a decrease in vessels under capital lease by $26 million due to the termination of the leases on Front Circassia and also depreciation expense in the quarter.

Further, we had a drawdown of debt of $192 million related to the delivery of the three new vessels in the quarter and also a drawdown on the Hemen facility. We also had ordinary loan repayments of $26 million and a reduction in obligations on the capital leases with $31 million due to $20 million in relation to Front Circassia termination then the negative repayment of $3.10 million and $6.7 million reduction due to amortization of profit share expense in the leases.

As of December – sorry, as of March 31st, Frontline has $249 million in cash and cash equivalents including the undrawn amounts under our unsecured loan facilities, marketable securities and minimum cash requirements.

Our remaining newbuilding CapEx requirements amounts to $131 million and that is related to the two – these three newbuildings that we have remaining. And we have approximately $111 million in debt capacity under our newbuilding credit facility.

We have no near-term debt maturities. The first maturity is in November 2019 when our own senior unsecured loan facility of up to $275 million matures. We have drawn down $140 million under this facility.

Let’s then take a closer look at the cash breakeven rates and OpEx on Slide 7. We estimate that our average cash cost breakeven rates for 2018 is $22,700 per day for the VLCC, $18,500 per day for the Suezmax tankers and $16,300 per day for the LR2 tankers.

These rates are the all-in daily rates that our vessels must earn to cover budgeted operating costs and drydock, estimated interest expense, TC and bareboat hires, installments on loans and G&A expenses.

Every $1000 per day in achieved rates in excess of our cash breakeven rates translates to approximately $19 million in incremental net income per year or $0.11 per share, which shows the high importance of maintaining low cash breakeven rates.

In the upper right-hand graph, we show Frontline’s historical VLCC cash breakeven rates along with average VLCC’s spot earnings in the period 2005 to 2018. Looking back in history, it is under the year 2009 and through 2011 to 2013, where the cash breakeven rates were higher than the average VLCC spot earnings at that time.

Frontline’s current cash breakeven levels are historically low and position us well in the context of existing market conditions and will help us to generate significant cash flows in improved market conditions.

The operating expenses per day in the first quarter of 2018 were in $8,100 per day for the VLCC, $7,200 per day for the Suezmax tankers and $6,800 per day for the LR2 tankers. And no vessels are scheduled for drydock in the second quarter of 2018.

With this, I leave the word to Robert again.

[Robert Macleod, Chief Executive Officer]

Okay, thank you very much. Let’s go to Slide 8 and we’ll have a look at the Q1 performance and guide on Q2. The spot earnings for the quarter were $14,900 on the VLCCs. We made $18,000 on our VLCCs younger than 15 years excluding the two newbuildings delivered in the quarter. Our Suezmaxes made $15,400, satisfactory I would say, given the market conditions and the number was $14,800 million on our LR2s.

For Q2, we have locked in 78% of our VLCC trading days at $11,600. On the Suezmaxes we have done 70% at $14,500 and for the LR2s, the number is about $12,400 and 72% is covered.

Let’s move on to Slide 9 please and we’ll look at the present tanker markets. The past two years have seen significant growth in the global crude oil tanker fleets and the growth has continued in 2018 and is set to continue going forward.

Thankfully, the number of crude oil tankers in terms of newbuildings was lower in the first quarter of 2018 than in the prior quarter and we expect newbuilding ordering to slow down.

Scrapping has increased in 2018. According to broker reports 22 VLCCs have been scrapped so far this year, which is double the amount of scrapping we saw in 2016 and 2017 combined. Consistently higher scrap prices, combined with a very weak freight markets have compelled owners of older tonnage to dispose of their vessels at a near record pace.

The surge in scrapping is a positive factor that would help reduce net fleet growth, but it will take some time before the market rebalances. We believe that we are approaching the end of a crude inventory cycle and inventories will begin to stabilize.

There is a historic relationship between crude oil inventory levels and freight rates. Rates rise as inventories builds and decline as inventories are consumed. There are also signs that OPEC could ramp up production which would clearly benefit the tanker markets.

In summary, the headwinds we have been experiencing are, inventory draws, OPEC cuts, less congestion and high fleet growth. The tanker market has not yet reached an inflection point, the market remains soft, but the headwinds could turn to tailwinds further out.

Let’s move to the summary slide please. As we’ve seen over the recent years, oil demand remains steadily strong and new trade rules are also evolving with the U.S. exports being the main change. We also feel there is a stronger sentiment building amongst owners of the several weak quarters. As described in the previous slide, there are several factors pointing towards a stronger market, but the reality remains that the present spot markets remains weak and risks are still left.

The order book is substantial, has grown further recently and could of course continue to build. The oil inventories are full and despite slowdown in draws, the reality is, that there is room for further stock draws.

The recent hike in oil price could dampen demand, especially if the price continues to firm. Several fundamental factors are in favor of a strong tanker markets, but the fleet needs to rebalance from the present supply.

Until then, Frontline remains sharply focused on maintaining our cost-efficient operations and low breakeven levels.

With that, we would like to move to the questions please.

[Operator]

[Operator Instructions] We will now take our first question from Jon Chappell from Evercore. Please go ahead.

[Jon Chappell, Evercore ISI]

Thank you. Good afternoon guys.

[Inger Klemp, Chief Financial Officer]

Good afternoon.

[Jon Chappell, Evercore ISI]

Robert or Inger, can you explain a little bit the new arrangement in ship finance on the eight leased vessels only paying them now what the spot market covers. How long is that for? And did you have to give up anything in return for that arrangement?

[Inger Klemp, Chief Financial Officer]

Hi, Jon. It’s not a new arrangement. It actually is the current agreement which we’ve put in place in the summer of 2015. So, this is only – when we announced that in the summer of 2015 we said that this was a non-recourse entity. It’s a subsidiary of Frontline. But we don’t have any charter guarantee in place on behalf of our subsidiary Frontline Management side.

So it means that if the account that this subsidiary have Frontline Shipping Limited, if that account is depleted if it’s no more cash into that account any longer. The ability for that chartering entity to pay the first charter hire will eventually be decreasing and it will not be sufficient to pay the full charter hire payment than the cash buffer is spent.

So, that has been the situation the whole time. But we have never come into a situation before now that we are getting closer to, let’s say, there is no cash buffer in the account any longer.

[Jon Chappell, Evercore ISI]

Okay. Thanks. And so then, how does this withstands for a few quarters say where there is no cash up in the account. You need to pay the spot rate as opposed to the base rates. Is there some type of make-up agreement to Ship Finance? Or you just forfeit those quarterly payments?

[Inger Klemp, Chief Financial Officer]

It will be a kind of debt that we will accrue, I mean that chartering entity Frontline Shipping Limited would accrue it on debt to Ship Finance, which will be let’s say within that non-recourse books as I referred to, so.

[Jon Chappell, Evercore ISI]

Okay, okay.

[Inger Klemp, Chief Financial Officer]

Yes.

[Jon Chappell, Evercore ISI]

I understand. Thanks, Inger. And then also, I mean, you mentioned that almost $250 of liquidity. You grew another $50 million on the Hemen facility which is pretty expensive relative to your other facilities. Why did you draw that in the second quarter? Or in the first quarter if you had enough cash on hand to meet your capital commitments, no debt repayments this year and the liquidity position that you are in.

[Inger Klemp, Chief Financial Officer]

Although we did drew on that facility because we, in the first quarter, we had quite some lots of net CapEx to pay. We had three newbuilding deliveries in the first quarter. So, that’s the main reason why we drew on that facility. It’s no other, let’s say, alternative, we don’t have any bank debt which we can use for the net CapEx elements of delivery.

[Jon Chappell, Evercore ISI]

Got it. Okay. And then, finally, just one for you, Robert. You mentioned that you were not quite there on the inflection point you had, clearly there has been a lot of excitement about potential reversal of the OPEC cuts maybe 1 million barrels a day. Could you just kind of walk us through the puts and takes of that?

And what I mean is, if OPEC is increasing production, let’s say, by 1 million barrels a day, because it’s making off for Venezuelan oil the softer market and potentially the Iranian oil that can no longer go to Europe. Is that moved the inflection point forward? Is it a net neutral event? How does that kind of change the ton mile delivery?

[Robert Macleod, Chief Executive Officer]

No I think, as you are describing it now with the situation in the Iran if that to come down half million and even further down, then it will be a neutral. So I think it’s important here to look at the picture overall and I’m looking at it with – and, yes, there is excitement now.

But we are still waiting for the fundamental move, but I think, as I said the headwinds experienced especially in 2017 but also in Q1. Those headwinds are, I think, it will at some point become tailwind. So, I think, OPEC on its own one, but combined with the stop in inventory draws and so then things could stop moving. But it is too early to say that it is actually happening.

[Jon Chappell, Evercore ISI]

Okay. I appreciate that. Thank you, Robert. Thanks, Inger.

[Operator]

[Operator Instructions] We will now take our next question from Magnus Fyhr from Seaport Global. Please go ahead.

[Magnus Fyhr, Seaport Global]

Yes, good afternoon. Just a follow-up question there on the OPEC production. I mean, there has been some noise here, I guess, in the last week. I don’t know, if you seen the pickup in the spot market. I mean, they’ve been very depressed to low cash breakeven. But, what’s been going on here in the last week and as far as spot rates, because it seems like there has been a little bit of a pickup.

[Robert Macleod, Chief Executive Officer]

I think, well that’s - it’s been picking up over the last couple of weeks. We’ve seen the Aframax is on the confident move. We’ve seen the Suezmaxes tighten in the Black Sea and the Mediterranean. We've also seen a bit of improvement here on the VLCC. So, let’s say, in terms of movement, the Aframax is clearly been the ones that are been coming of most, the Black Sea has been seeing rates go from 5,000 to 6,000 to 20,000 plus in a matter of days.

But that’s not - that is quite normal in that side. We are – we have seen for a while in that, but it’s good to see that the volatility is back. But these markets move up and down lot. So, on these, we've seen – seen it come up a little bit, but, sort of at the bunker prices and, I would say, it’s too early, definitely too early to say that the rates are showing strength.

It’s still in the teens and the older ships are at single-digit. So, let’s see, yes, positions are looking a little bit thinner. So, it’s some optimism, but again, we have to be cautious to and our view for now is that some positive factors might be coming up, but we have to wait before we confirm that things are actually getting better.

[Magnus Fyhr, Seaport Global]

Okay. And I guess, with OPEC your meeting on June – at late June, I guess, that wouldn’t be impacting the market till maybe late summer and I guess with the seasonality, should we kind of expect something maybe late third, early fourth quarter?

[Robert Macleod, Chief Executive Officer]

Yes, I mean, those holdings come back, that will take a bit of time unless all just we’ve seen in the past that the ramp up comes earlier than what’s been said. But, I think, to the first catalyst I am seeing in terms of market improvement and which could be what we are seeing now.

But I highlight, it only could be is that the inventories are, we are stopping the draw and that that’s stabilizing and then we are seeing some holdings come back. But it’s, let’s see what happens over the summer here. But, I agree with you. We are going to be into Q3 before we see the real effect of any change in OPEC.

[Magnus Fyhr, Seaport Global]

All right. And not getting ahead of ourselves here, your current fleet, you’ve got a couple of older vessels here. You’ve got two newbuildings left. I mean, do you feel like, I mean, I’ve seen newbuilding prices move up. Do you think there are opportunities in the second-hand market to acquire more vessels. So do you feel comfortable with the fleet that you have today?

[Robert Macleod, Chief Executive Officer]

I mean, we are always open to grow, especially on the VLCC segment. So, we are inspecting ships frequently. We are not considering ordering newbuildings. I think there is more than enough newbuildings than older here.

But we will monitor very closely resell opportunities for ships delivering next year and I should say, we are looking at second-hand as well. But again, the liquidity remains relatively low on the second-hand, but the weakness of the market and the longer this goes on the more opportunities. So, we are more attentive to that than ever before.

[Magnus Fyhr, Seaport Global]

All right. Great. And just lastly on scrapping. I know in the last conference call, you had some – you’ve thrown some numbers out there. What are you thinking about scrapping now as far as potential more candidates, I think there has been mid-20 scrapped so far this year? But, what do you see out there over the next couple of months?

[Robert Macleod, Chief Executive Officer]

No, I mean, the comments from last quarter was – well, I think surprised a few – when I said that 40 to 50 will be scrapped and are more confident in that now than I was then. So it looks like we are on target for that and if that becomes reality, then we are going to be looking at 2018 where the fleet growth when we have to see its plus, minus, zero.

But, that is exactly what we need here to get this fleet to rebalance and it will take time, because we’ve had fleet growth that’s – with a hundred ships here in 2016, 2017 combined and virtually very low where 12, 13 going out. So, it’s obvious now why we are where we are, but, rebalancing and then things will hopefully get better.

[Magnus Fyhr, Seaport Global]

All right. Great. That’s it for me. Thank you.

[Magnus Fyhr, Seaport Global]

Thank you.

[Operator]

We will now take our next question from Fotis Giannakoulis from Morgan Stanley. Please go ahead.

[Fotis Giannakoulis, Morgan Stanley]

Yes. Hi, Robert. You mentioned about the increase in oil flows from OPEC increasing production. I wanted to ask you, whether this last few days that this discussion has emerged. If you have seen any increase in floating storage it seems that last week numbers were a little bit higher than a month ago.

But I am wondering if you think that this increase in OPEC production or even the commentary about increasing the OPEC production can drive at least floating storage inventories higher or even overall inventories higher and increase further oil flows.

[Robert Macleod, Chief Executive Officer]

When it comes to storage, I am pretty confident when I say that, we are at a low point in terms of numbers here or ships being held on storage which is more blending and that sort of storage evolve and become tanker of course.

I think we are at a bottom point there. We've not seen any increase over the last few weeks. But what we have seen is – what we’ve had is questions relating to it, which is the first time in a long time, but obviously, a question is one thing and it actually happening, it’s something else.

[Fotis Giannakoulis, Morgan Stanley]

And thank you on that. And I want to ask about what are the sources of liquidity. You have obviously this kind of $35 million remaining from the Hemen revolver. What other sources of liquidity do you have? In case, that the impact of OPEC return takes a little bit longer?

[Inger Klemp, Chief Financial Officer]

Currently, we don’t have any other, let’s say alternatives than that.

[Fotis Giannakoulis, Morgan Stanley]

Would you – what would you consider? Would you consider sales and leasebacks or asset sales? Can you discuss with your lenders potentially easing some of the debt repayments temporary relief you have to?

[Inger Klemp, Chief Financial Officer]

I think that is we are looking into financing acquisition possibilities going forward. It will be a mix of different financing or let’s say instruments which will be put in place. So, that is the concern we have.

[Fotis Giannakoulis, Morgan Stanley]

Okay. Thank you. I appreciate your answers.

[Operator]

We will now take our next question from Espen Fjermestad from Fearnley. Please go ahead.

[Espen Fjermestad, Fearnley Securities]

Hey, good afternoon. I just had a question on the two VLCC that you charter in 2021 with options for a third year. I mean, it looks quite attractive and I really checked with this, all the owners are doing meaningful money on that. So, curious to hear what kind of liquidity there is in the market for such deals? Thank you.

[Robert Macleod, Chief Executive Officer]

Well, it’s something we’ve been looking for and we always look for. So, we find it attractive as well. We get – we got both ships delivered in the Middle East. We got them in load area. So we have flexibility on the redelivery. So, what happened with the deal and we will keep looking for similar and take it on if we think it makes sense.

[Espen Fjermestad, Fearnley Securities]

Okay. Thank you very much.

[Operator]

[Operator Instructions] We will now take our next question from George Berman from IFS Raymond James. Please go ahead.

[George Berman, IFS Raymond James]

Good morning gentlemen. Thanks for taking my call.

[Inger Klemp, Chief Financial Officer]

Good morning.

[George Berman, IFS Raymond James]

I have a couple quick questions on the differences currently experienced between the West Texas U.S. crude and Brent crude. It seems to me that there could be a lot of arbitrage opportunities. Are you seeing any additional quoting or requests for transportation in that area?

[Robert Macleod, Chief Executive Officer]

The export - yes - you're absolutely right on the spread there. But obviously, we trade the freight in that and not get all, but we are seeing more volume moving out and there are more and more questions. But, there is no sort of fundamental change.

[George Berman, IFS Raymond James]

Okay. So, you haven’t seen any major pickup of exports from the U.S. I understand there is some limitations that how much can be exported. But it seems to me that this morning the difference between U.S. and Brent is about $11 that this is getting almost ridiculous.

[Robert Macleod, Chief Executive Officer]

Yes, no, it’s certainly as high. But, lastly, it’s steadily increasing. But nothing out of what we’ve seen, seen steadily change.

[George Berman, IFS Raymond James]

Okay. Thank you.

[Robert Macleod, Chief Executive Officer]

Thank you very much.

[Operator]

We will now take our next question from Mike Webber from Wells Fargo Securities. Please go ahead.

[Unidentified Analyst]

Hey guys. This is Greg on for Mike. Just going off to storage point from earlier and thinking about IMO 2020 and a potential need for storage of high sulfur fuel. How do you see that materializing for the VLCCs? Do you think that’s a real there?

[Robert Macleod, Chief Executive Officer]

At the moment, it’s very, very difficult obviously to answer to – with a definite answer. But it is potential. That could – it will be a surplus product versus what it is today. So, it could happen and we are exploring this and other opportunities for the - deal the older ships in our fleet.

[Unidentified Analyst]

Gotcha. Do you see that happening in the first few quarters following 2020 or do you think it could be an end up dragging out further later into the year.

[Robert Macleod, Chief Executive Officer]

I think, we'll see, it depends and if suddenly if contango comes in, in middle June, this product is very, very unlikely. But I think from the summer of 2019 onwards, but it’s difficult to time. But that’s my guess.

[Unidentified Analyst]

Okay. Very helpful. That’s all I got. Thanks.

[Operator]

[Operator Instructions] As there are no further questions, I would like to turn the conference back to yourself for any additional or closing remarks.

[Robert Macleod, Chief Executive Officer]

Okay. Thank you very much. I would like to thank everyone at Frontline for their great efforts. And thank you very much to all of you who called in. All the best.

[Operator]

This concludes today’s call. Thank you for your participation, ladies and gentlemen. You may now disconnect.