Frontline Ltd

NYSE:FRO

Earnings Call Transcript 2021-Q3

[Operator]

Good day, and thank you for standing by. Welcome to the Q3 2021 Frontline Limited Earnings Conference Call [Operator Instructions]. Please be advised that today's conference is being recorded [Operator Instructions].

I would now like to hand the conference over to your speaker today, Lars Barstad. Please go ahead.

[Lars Barstad, CEO]

Thank you very much, and good morning and good afternoon to everyone. And welcome to Frontline's third quarter earnings call. These are indeed volatile times, although maybe not as volatile as we hope for in freight. Q3 '21 marked the bottom of the tankers post COVID-19. This is seasonally a low point in the markets, but everything seems to have been amplified in these times we currently live in. Towards the end of the quarter, we actually started to see a recovery in demand for freight as export volumes grew, which has continued into the fourth quarter. Right now, we are, as of the rest of the world, worried about the implication of this new Omicron variant of the COVID-19 virus. What will OPEC+ do in that respect and will something come out of the ongoing Iranian nuclear talks in Vienna.

Well, let's start with the facts on Frontline's third quarter and look at the highlights on Slide 3. Q3 '21 performance reflects the challenges the tanker markets faced this quarter. It is, however, a proof that our business model, our efficient operations, our modern fleet and very hardworking team managed to outperform most of our peers. In the third quarter, Frontline achieved $10,500 per day on our VLCC fleet; $7,900 per day on our Suezmax fleet; and $10,700 per day on our LR2/Aframax fleet. So far in the fourth quarter, we have booked 79% of our VLCC days at $21,600 per day; 72% of our Suezmax days at $17,900 per day; and 64% of our LR2/Aframax days at $16,000 per day. All numbers in this table are on the load-to-discharge basis but I do think they show that the markets have indeed recovered from the third quarter, although we have yet to see rates reaching for the skies.

I'll now let Inger take you through the financial highlights.

[Inger Klemp, CFO]

Thanks, Lars, and good morning and good afternoon, ladies and gentlemen. Following the acquisition that we did of the 8 VLCCs in the first half of the year, we have in [detail] financing side. And in the third and the fourth quarter, we have entered into term loan facilities and obtained financing commitments for a total amount of up to $507 million to partially finance the acquisition on the two [2019] built VLCCs and also the six VLCC newbuilding contracts. These facilities will finance 65% of market value and they will carry an interest rate of LIBOR plus a margin of 170 basis points. And they will have an amortization profile of mostly 20 years but also 18 commencing from the delivery date from yard. When we factor in $33.4 million available under the term loan facility entered into in November 2020 to partially finance the delivery of the last LR2 tanker, we have established bank debt of up to $540.4 million. The company has also raised gross proceeds of $51.2 million under the equity distribution agreement and also net cash proceeds of approximately $67 million through the sale of four LR2 tankers. And following this remaining commitments as per September 30th for Frontline's newbuilding program consisting of one LR2 tanker and the six VLCCs and for the acquisition of the two 2019 built VLCCs is fully funded.

Through these new financings, we reduced our borrowing costs and we also reduced our industry leading cash breakeven base, providing significant operating leverage and sizable returns during periods of market strength and help protecting our cash flows during periods of market weakness. Frontline has also extended the terms of the senior unsecured revolving credit facility of up to $275 million by 12 months to May 2023, leaving Frontline with no loan maturities until 2023. Then let's turn to Slide 4 and look at the income statement. Frontline achieved total operating revenues net of voyage expenses of $69 million and adjusted EBITDA of $17 million in the third quarter of 2021. We reported net loss of NOK33.2 million or $0.17 per share and adjusted net loss of $35.9 million or $0.18 per share in the third quarter. The adjustments consist of $1.2 million gain on derivatives and $0.2 million gain on marketable securities and $1.3 million amortization of acquired time charters. The adjusted net loss in the third quarter increased by $12.7 million compared with the second quarter. And this increase in loss was driven by a decrease in our time charter equivalent earnings due to lower TCE rates and the recognition of a gain on the marketable securities sold in the second quarter of $4 million. This was partly offset by a decrease in ship operating expenses of $3.2 million, primarily as a result of lower dry docking costs.

Then let us take a look at the balance sheet on Slide 5. The total balance sheet numbers have increased with $6 million in the third quarter. And the balance sheet movements in the quarter are primarily related to taking delivery of the LR2 tanker Front Favour, in addition to ordinary debt repayments and depreciation. As of September 30, 2021, Frontline has $190 million in cash and cash equivalents, including undrawn amounts under our senior unsecured loan facility, marketable securities and minimum cash requirements. Frontline's remaining newbuilding and acquisition CapEx of $659.4 million as per September 30, 2021 is fully funded by $540.4 million in estimated debt capacity and also of the $118.2 million in cash raised with the ATM and the sale of the four LR2 tankers, which I mentioned. The company has also no debt maturities until 2023, as I also mentioned. Then let's take a closer look at cash breakeven rates and OpEx on Slide 6. We estimate average cash cost breakeven base for the remainder of 2021 of approximately $21,400 per day for the VLCCs, $17,800 per day for the Suezmax tankers and $14,100 per day for the LR2 tankers. And the fleet average estimate is about $17,600 per day. These rates are the all-in daily rates that our 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.

We recorded OpEx expenses in the third quarter of $8,200 per day for the VLCCs, $7,200 per day for the Suezmax tankers and $8,800 per day for the LR2 tankers. We dry docked two LR2 tankers in the third quarter and expect to dry dock one VLCC and one Suezmax tanker in the fourth quarter. Then the graph on the right hand side of the slide shows free cash flow per share and free cash flow yield basis current fleet and share price of November 26th as alternative TCE rates. Let's take an example, if we assume historic Clarkson TCE rates for non-ECO vessels in the period 2000 to 2021, November 2021, adjusted them for Frontline fleet scrubber and ECO vessels, Frontline will have a free cash flow yield of 38%. Free cash flow yield potential increases with higher assumed TCE rates and also on a fully delivered basis.

With this, I leave the word to Lars again.

[Lars Barstad, CEO]

Thank you very much, Inger. Let's move over to Slide 7 and look at the third quarter tanker market. So tanker rate bottomed during Q3 and this is seasonally kind of the normal weakest moment of the year. But I think it's safe to say that this is not a normal year. We actually haven't had any normal year since 2019. So global oil consumption averaged 98.6 million barrels per day that's up 1.9 million barrels from the second quarter. Supply averaged 96.8 million, also increasing by close to 2 million barrels per day. But we continue to grow then kind of very close to 1.8 million barrels per day of inventories. OPEC+ plus supply rose an average of 1.4 million barrels per day. And I think it's important here to note that a lot of the key OPEC suppliers came out of their peak demand period, which is when they burn fuel for electricity generation and basically for cooling and this normally happens in September, so towards the end of the quarter.

We saw strong demand growth in North America and in Europe, whilst the Asian demand recovery was muted also in the third quarter like we saw in the second quarter. What was special about the quarter that we went through was that oil and energy prices were extremely volatile. We saw natural gas prices, coal prices, also other commodities that are affected by energy prices rise rapidly during the quarter. And all the markets kind of performed strongly as we came to the end of the quarter. I think it's important to note here, if you look at the graph on the left hand side at the bottom of the slide, so total world consumption is now actually not that far off from where we started in January 2020 before the pandemic hit us. And in December, we're actually -- some market commentators actually arguing for us to end up in or at 100 million barrels per day. What we have seen, which is on this slide on -- the chart on the right at the bottom of the slide, is that oil in transit has developed quite well during the last couple of months. We saw that during Q3, we remain at these kind of depressed levels where kind of oil in transit increased and then decreased again and increased, and you have these kind of this choppy movement. But now as we went into November, we started to see that is oil and water, which is basically a picture of demand or utilization in the tanker fleet increased rapidly to where we are now.

So let's move to Slide 8 and have a look at the order books. So tanker ordering was obviously muted during third quarter. We saw one Suezmax order and eight LR2 Aframax orders. No VLCCs were reported ordered as far as we could see in the quarter. What did happen though was that the delivery window for ordering in any kind of useful number of tankers is now starting to get limited for '24 even. 2023 is destined to show very few VLCC and Suezmax deliveries. Newbuilding prices are indicated at very high levels. There hasn't been much price discovery in this market, particularly for the VLCCs as no kind of newbuilds has been ordered really during the last four to five months. But it's obviously governed by a combination of high steel prices and low availability. And basically, the considerations that shipowners need to make now, if you are to go into the market and order a VLCC, say at $110 million or $115 million or $120 million depending on who you speak to, you're actually making a bet on steel prices come 2023. So this is obviously a bet that a lot of people are hesitant to take at this point in the curve.

The VLCC order book is now at 71 units, that's a little bit north of 8% of the existing fleet. But we still have this situation where 113 VLCCs will be above or past the 20 year mark during that period as the current order book delivers. For Suezmax, there are 41 units in the order book and 116 will be passing 20 years using the same metrics. One thing that's kind of changed a little bit during the third quarter is that recycling has started to show some promise. And let's move to Slide 9. So with the record high recycled steel prices, activity is finally accelerating. As you see on the chart at the top there, so 2017 and 2018 were the last big periods for vessel retirement. And now in Q3 alone, we saw close to 0.76% of the global tanker fleet sold for recycling. We are in a situation now where alternative use for tankers is extremely limited. As most of you may know, that kind of in earlier markets, you've had the opportunity to either convert a ship for storage or even it could be converted into an vessel, so basically an oil-producing unit. Obviously, these markets are closed -- it is right now.

And we also see that during the pandemic, it's becoming evident that the capacity for recycling was seriously contracted. So basically, there has been COVID pandemic in countries like India, Pakistan and Bangladesh. So basically, year-to-date, we've seen 15 VLCCs, 11 Suezmaxes, 18 [Aframax] and eight LR2s that are reported sold for demolition. And broadly speaking, this amounts to actually close to 2% of the existing fleet. So basically, we believe that this might accelerate going forward as the recycling values are still extremely strong. Then let's move to Slide 10. So there's a lot of noise in the market currently and the parts of this presentation could be on the potential impact from the Omicron virus. But I believe we'll need a few weeks to learn more about this variant to even know where we're heading. What we do know is that in the recent weeks, we've had kind of a message of US releasing oil from their strategic petroleum reserve. There are obviously other X again factors playing up as well, but let's focus on this one.

So US have released volumes from their SPR on a few occasions over the last 18 months. And despite US inventories being below five year averages, this country is actually not particularly short of crude oil. And after the recent releases, we have actually observed slightly higher exports with a significant part of the volume going to Asia, and particularly so in October and November this year. And it's obviously not the SPR volume itself that is directly kind of heading into Gulf Coast and being exported but it's basically there is an ample kind of supply of oil in US. And what an SPR release creates is that you depress the local prices for crude and this basically makes that crude attractive to Chinese or Asian buyers. China, India and South Korea, and Japan have pledged to join the US effort and release from their SPRs but apart from India, none have been very specific on volume. And we have to remember that these Asian countries are far more sensitive to severe supply disruptions because they have very limited domestic production capacity. And the Northern Asian region is facing record high energy prices as they now head into winter. So whether it be released -- whether it's oil will be released at all from the SPR now after having a $10 drop in oil prices is obviously a question. But if it should happen, it could actually trigger a ton mile increase.

So let's move to the summary and let's go through a couple of the things that are at play right now. So demand and supply of oil continues to rise, but the latest the virus version is obviously now clouding the outlook. Tanker markets have recovered since Q3 '21 but it's still challenged by oil supply and not fully at pre-pandemic levels. Tanker recycling, I think, this is a very important thing to note that tanker recycling has finally started to make an impact on vessel supply. And then we have all these [exogenous] factors that we really don't know much of at this point. So the US SPR release, OpEx strategy going forward. They just postponed the meeting for a couple of days in order to find out more on the virus outbreak, and they resumed Iranian nuclear talks in Vienna. So there's a lot of stuff that is going to happen over the next couple of weeks.

Oil in transit continues to rise and energy prices are at record highs as the Northern Hemisphere is heading into winter. I think the most important part here is that Frontline's financial commitments are now fully funded with reduced overall funding costs, and we are indeed well positioned as the story of this market unfolds. Finally, I've used this graph below before and it shows year-on-year basically various segments and how the trades are performing. And we do see that for tankers, it's actually showing a growth of 3.8% year-on-year in October compared to October 2020. So tankers have been lagging all the other asset classes in shipping for a while but now we're actually starting to perform with.

So with that, I'll like to open up for questions.

[Operator]

[Operator Instructions] Your first question today comes from the line of Chris Tsung from Webber Research.

[Chris Tsung, Webber Research]

I wanted to just ask about the four LR2s that were sold. Were they clean part to the sale or are they still relatively dirty?

[Lars Barstad, CEO]

No, they were trading clean.

[Chris Tsung, Webber Research]

And then I think last quarter, there was seven dirty and then 13 clean. What's the composition of your fleet now?

[Lars Barstad, CEO]

It's actually quite -- 35% trading dirty and 65% trading clean.

[Chris Tsung, Webber Research]

And to dry docking, I think Inger, you said one VLCC and one Suezmax in Q4, roughly, how many days would you estimate for these two?

[Inger Klemp, CFO]

How many days? Around 20 days, that's the kind of standard.

[Chris Tsung, Webber Research]

20 days for each, so 40 in total?

[Inger Klemp, CFO]

Yes.

[Chris Tsung, Webber Research]

And lastly, a quick one from me. How much is remaining under the equity distribution agreement?

[Inger Klemp, CFO]

The equity distribution agreement is a total of $100 million. So when we now have raised $41.2 million, the difference is $48.8 million remaining.

[Operator]

Your next question comes from the line of Greg Lewis from BTIG.

[Greg Lewis, BTIG]

I guess I wanted to discuss a little bit more about the decision to sell the LR2s. What was it about those vessels maybe that made them more attractive than some of the other vessels in the fleet? Is it more of realizing the acquisition, what was that last year on the Suezmaxes? Was the function of those vessels being in the sale leaseback transaction really the fact that those were product vessels versus crude? Or really, what I'm wondering is I think we're all optimistic that we're going to see a recovery in tanker rates in '22, hopefully. But I guess what I'm wondering is, could we see more of those similar types of transactions maybe with some of your crude vessels.

[Lars Barstad, CEO]

So over the last year, we've obviously grown tremendously in our exposure to the VLCC market. This is something we've communicated for a long period of time that this has been our ambition. Historically, we have seen that kind of the return we are able to give our shareholders is kind of the best return we're able to give is from the larger vessels. So kind of in that process, we've obviously reached far in order to increase that fleet quite a lot. And then with the -- during the year and this is kind of a weird one, the asset class that has appreciated the most is, in fact, LR2s. So whilst all asset prices have risen but the LR2s have been tremendously strong. So basically, we saw this as an opportunity to capture value at the point in the curve. There could be that we'll kind of divest in other vessels as well. But it's kind of -- our focus is to grow and maintain our VLCC position that's where we believe we'll get the best kind of bang for the buck. And then the LR2 segment is a very interesting one. We believe in that market. We found it kind of prudent to capture this value as we felt kind of the price we can achieve on these four units, the oldest four we have in the fleet, Chinese built, our ability to capture value there, so we basically took it.

[Greg Lewis, BTIG]

And then in going, thank you for the presentation and in talking about the VLCC market. You referenced historical prices. Really, what I'm trying to understand is, as I look at the VLCC fleet today, let's just put those 100 vessels that are -- the 20 year-old vessels you referenced, 115 or whatever that -- over 100, let's say. Do we have any sense for how much of the, call it, the modern VLCC fleet is scrubber fitted?

[Lars Barstad, CEO]

Actually, on the model, I don't have that number in front of me. But what I've looked at is that at this point in time, about half of the VLCC fleet is scrubber fitted. And I would assume that the most modern vessels are basically as they come from the yard. But then most of the scrubber investments have probably happened on the kind of non-ECO, more [thirsty] units because that's where kind of it makes most economical sense. But I don't have that split kind of in front of me but about half of the fleet is sailing with a scrubber.

[Greg Lewis, BTIG]

And then just one more for me. As I think about -- hold on a second as I think about -- I'll queue in if it comes to me, it just escaped my mind.

[Operator]

[Operator Instructions] Your next question comes from the line of Jon Chappell from Evercore.

[Jon Chappell, Evercore]

Inger, I'll ask Greg's question for him. So you got a lot done on the financing side in 3Q, and it seems like you're all squared away now, which checks a big box as far as meeting the newbuild commitments. I'm just curious on the equity distribution. Why did you feel necessary to issue equity at that size given all the financing you had lined up and the fact that you're basically covered now even without the more expensive equity?

[Inger Klemp, CFO]

Well, the movement that we did there was accretive to the company in a way because the NAV of the Frontline share was far below the share price at the point in time we printed those shares. So we felt it was a good wise thing to do for the company.

[Jon Chappell, Evercore]

And on the macro side, Lars, clearly, there's a lot of things we can't identify right now. And this question was probably more fitting two weeks ago before more things thrown out there. But everyone's put out this very optimistic view, ourselves included, on why things should get better. It's just the spring is coiling. The inventories are really low, production is increasing, demand is increasing, the fleet shrinking. Yet we're still at these very low levels where every once in a while, you get a little bit of an increase and you think here we go, here at the start of the cycle and then it pulls back again. Other than OPEC just being a little bit stingy with their releases, what has been kind of the limiting factor in letting this recovery from the third quarter trough really gain momentum? And other than the things you've addressed already, are there any other concerns you have about the sustainability going into early '22?

[Lars Barstad, CEO]

I think obviously, there is probably not one correct answer to that question. But our experience is that in some segments, you are suddenly in a position to push so you could kind of push rates northbound. But then other kind of parts of the pie or the spec is experiencing kind of issues. So basically, what we've had now for the last couple of weeks is that we've had really, really good demand in the VLCC space. We see Middle East exporting finally kind of according to the OPEC program. Whilst prior, we suspect that the other countries have actually consumed or kept a lot of the oil in domestic or domestically. But [obviously] then you get West Africa with production issues. So suddenly that volume kind of tapers off. There's also been, over the last couple of months, a situation where for the long haul oil, you need the arbs to be open. So basically for Atlantic Basin oil to be priced in a manner where it's attractive to Asian refiners. And that has not really been the case and this is basically as demand recovery has happened relatively kind of quickly during this -- or the second half of this year, at least in in Europe and in the US.

So basically, the local oils in -- around the Atlantic Basin have been kind of relatively good priced, basically meaning that the Asian refiners can't really compete. So you've had a couple of these factors during this fall. And we're still shy of a couple of million barrels of production until we are at pre-COVID levels. So obviously, there are new ships that have been delivered throughout the year. So I think it's a mixture of those three reasons. With regards to pricing and how crude price is priced, whether if it's going to go into Asia or stay local that could rapidly change. With regards to the production increase, I think that's more risky now, whether OPEC actually will increase volumes into Q1. But one thing that's for certain is that we are very close to a balance but we have yet to have kind of -- I think I mentioned this before that the market has like three or four cylinders, and we need to fire on all cylinders in order for it to get some traction. And regretfully, we have one cylinder fail when all the other cylinders go.

[Jon Chappell, Evercore]

And if I could just follow up with one point there. I mean all eyes are going to be on OPEC this week. Obviously, they tend to be really driving the sentiment in the tanker markets right now. Given what you noted about the arbs and the SPR release in the US leads to lower domestic prices here, which could lead to more exports, which are longer haul. Does OPEC carry the same amount of sway in the tanker markets that it once did or is it more of a sentiment driver than an actual fundamental driver?

[Lars Barstad, CEO]

I think it's more of a sentiment driver than an actual fundamental driver, to be quite honest. I think -- and the proof is that throughout this year, we've had OPEC kind of both adding then suddenly not adding, then kind of delaying meetings and also kind of relatively small portion of production increases has kind of been reflected in their exports. We have OPEC producers that are actually over -- in overcompliance basically because they have production issues. So I think it's more the headline. What we see in our little pond of global transportation of crude oil, we just see volumes gradually increase. And obviously, if OPEC suddenly finds that they don't want to increase in January, I think you'll have price action and suddenly Atlantic barrels will then be attracted kind of -- or be moved out to Asia again. So for us, on the tanker side, that's far more important than kind of what OPEC may decide for one month kind of…

[Operator]

[Operator Instructions] Your next question comes from the line of Randy Giveans from Jefferies.

[Chris Robertson, Jefferies]

This is Chris Robertson on for Randy. Just to follow up on the ATM issuance there. Can you just talk about how you decided upon the amount that was issued in October? And if let's say rates stay weak in 2022, would you look to utilize that again with a further issuance?

[Inger Klemp, CFO]

Based on the current share price, we will not consider to utilize the ATM further.

[Chris Robertson, Jefferies]

Okay…

[Lars Barstad, CEO]

And I'd like to add to that, that kind of Frontline has had ATM programs before. And we've always been extremely disciplined and only acted kind of when it's accretive and when the conditions are there for it. So that should also kind of further answer that question.

[Chris Robertson, Jefferies]

Yes, definitely. Thanks for the additional color.

[Operator]

Thank you. There are currently no further questions. I will hand back for any remarks.

[Lars Barstad, CEO]

Yes. Thank you very much for calling in, and thank you for the time. Also, obviously, thank you to the entire Frontline team who's done a fantastic job again this quarter. Stay safe.

[Operator]

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.