Frontline Ltd

NYSE:FRO

Earnings Call Transcript 2017-Q4

[Operator]

Good day. And welcome to the Fourth Quarter 2017 Frontline Limited Earnings Conference Call. Today’s conference is being recorded.

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

[Robert Macleod, Chief Executive Officer]

Thank you very much. Good morning, and good afternoon everyone. Thank you for dialing in. This is Frontline’s earnings call for the fourth quarter of 2017. I will start the call by briefly going through the highlights of the quarter and subsequent events. Following that, Inger will run us through the financials. We’ll then look at Q4 earnings, and I will guide you on our Q1 earnings. We will then move on to the current market conditions, the crude tanker order book, and I’ll try to predict the tanker fleet development going forward. The call will be concluded by taking your questions.

Let’s get started please and look at the company highlights. We recorded net income of $5 million adjusted for non-cash items in the fourth quarter. For the full year, we recorded a net loss adjusted for non-cash items of $4.4 million. Following the end of the quarter, we took delivery of two new building VLCCs and one LR2 tanker. We now have two VLCCs remaining in our current order book. We have also just terminated the long-term charter of 1999 built VLCC. Our $275 million facility would have and has been extended by 12 months.

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

[Inger Klemp, Chief Financial Officer]

Thank you, Robert. And good morning and good afternoon, ladies and gentlemen. Let’s turn into slide four and get the financial highlights. Frontline achieved total operating revenues net of voyage expenses of $99 million in the fourth quarter and report a loss of $248 million equivalent to $1.46 per share. The loss during the quarter was driven by $142.9 million impairment loss from the nine leases leased from inventory finance and $112.8 million impairment loss on goodwill, which I will discuss in more detail later in the presentation.

After adjusting for these non-cash impairment losses and the gain on derivatives of $2.3 million, we show an adjusted EBITDA of $62 million and adjusted net income from operation of $5 million in the fourth quarter, a dividend of $0.03 per share. Frontline generated net loss attributable to the company of $265 million or $1.06 per share for the year ended December 31,2017. And the net loss adjusted for certain non-cash items was $4.4 million or $0.03 per share for the year ended December 31, 2017.

Let’s then look a bit closer on the numbers in the slide five, income statement. As I mentioned, the loss in the quarter was driven by non-cash impairment losses of $142.9 million on nine VLCCs leased from Ship Finance. The lease hold interest in these capital leases was recorded at fair value at the time of the merger between Frontline and Frontline 2012 based on the discounted value of expected cash flow from the vessels.

Based on the deterioration and forecast rates since the merger and the reduced remaining useful economic life of the vessel as they approach the end of the leases, Frontline has recognized an impairment loss on all of its leased vessels. Calculated as the difference between the discounted value of expected cash flow from the vessels [indiscernible] 2017 and the carrying value of the vessels coming out of the lease at that time.

The loss in the quarter was further driven by $112.8 million impairment loss in relation to goodwill. At the time of the merger between Frontline and Frontline 2012 on November 30, 2016, the share price of Frontline Limited was 16.15 and the company recorded goodwill of $275.3 million. As a result of declining charter rates, declining vessel values and the fall in the company’s share price since date of the merger and in the fourth quarter of 2017 specifically, Frontline performance to goodwill impairment as a result of which it was determined that the carrying value of the company was in excess of the fair value. And Frontline has recorded an impairment loss on goodwill of $112.8 million in the fourth quarter.

Then after adjusting for these non-cash imperilment losses and a gain on derivatives for $2.3 million, Frontline achieved net income in the quarter of $5 million against [indiscernible] [23] in the third quarter. And the improved sales from operation in the quarter of $28 million is mainly explained by an increase in basis of $22.6 million, which is due to the increase in the time charter rates in the fourth quarter compared to the third quarter. Then we had a decrease in lease termination payments of $4.8 million.

We also had an increase in contingent rental income by $0.3 million. In the third quarter, we increase contingent rental income of $6.7 million and in the fourth quarter, income was $7 million. And the contingent rental income in the fourth quarter results from an actual profit share of zero, which was $7 million less than the amount occurred in the lease obligations payable when the leases were recorded at fair value at the time of the merger of Frontline with Frontline 2012.

We further have a decrease in ship operating expenses of $0.8 million, primarily due to no vessels in drydock in the fourth quarter. Whilst in the third quarter -- the third quarter into the financial statement of drydock of two vessels which were drydocked in the second quarter. We further have decrease in charter hire expenses of $1.1 million due to the effect of the delivery of vessels on time charter. We also had an increase in interest expense by $1.1 million due to draw down on of debt in relation to delivery on the five vessels in second quarter and five vessels in the third quarter. And finally, we also had an increase in other expenses by $0.4 million.

Let us now take a look at our balance sheet on slide six. The changes to the balance sheet as of December 31st from September 30th, primarily relates to a decrease in vessels on the capital leases by $166 million due to the recognition of impairment loss of $142.9 million on the nine vessels leased project finance and also $13.9 million of related depreciation in expense. An impairment loss of goodwill of $113 million has reduced the asset and also a decrease in vessels of $20 million due to depreciation in the quarter.

Total liabilities decreased by $28 million, which mainly relates to a draw down debt of $10 million in the quarter ordinary loan repayment of $25 million and a reduction obligation on the capital leases with $10 million due to the regular repayments of $3 million and $7 million reduction due to anticipation of profit share expense in the lease. Equity has decreased by $249 million, mainly due to the loss in the quarter, which was driven by impairments as discussed.

As of December 31, 2017, Frontline has $307 million in cash in category risks, including undrawn amount under our unsecured loan facility, multiple securities and in the cash requirements. Our remaining new building CapEx requirements amounted to $305 million and we have approximately $252 million in debt capacity under our new building credit facilities. As Robert already mentioned, Hemen Holding, Frontline’s largest shareholder has agreed to expand the terms of the senior unsecured loan facility for up to $225 million by 12 months to November 2019. We have drawn down $19 million under this facility and have no other near term debt facility.

Let’s then take a closer look at cash breakeven and OpEx on slide seven. We estimate average cash cost breakeven rates for 2018 were approximately $22,200 per day for VLCC, $18,200 per day for the Suezmax tankers and $16,000 per day for the LR2 tankers. These rates are the all-in daily rates that our owned and leased vessels must earn to cover budgeted operating costs and dry dock, estimated interest expense, bareboat hires, installments on loans and G&A expenses. While we have competitive rental expenses and admin expenses, the low cash breakeven rates are mostly attributable to the long-term amortization profile and the low interest costs on our debt facilities.

Every $1,000 per day in achieved rates in excess of our cash breakeven rates calculate to approximately $19 million in commensurate 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 spot earnings in the period 2005 to 2017. Looking back in the history, it is only the year 2009 and 2011 to 2013 where the cash breakeven rates were higher than average is for 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 generate significant cash flow and improved market condition.

The operating expenses today in the fourth quarter 2017 were in $8,200 for the VLCC, $7,100 for Suezmax tankers and $6,600 for LR2 tankers. And no vessels are scheduled for drydock in the first quarter of 2018.

With this, I leave the word to Robert again.

[Robert Macleod, Chief Executive Officer]

Thanks very much, Inger. Let’s turn to slide eight and look at the Q4 performance and the Q1 guidance. The spot market earnings in the fourth quarter increased as compared to the prior quarter. They remain soft compared to historical levels. The growth in global fleets over the last two years has had a persistent negative effects on tanker rates. In the fourth quarter, inventory draws also hurt the freight market to a greater degree than anticipated.

In addition, there were very few delays caused by port congestion given lower oil volumes shipped. The spot earnings for the quarter were 19,400 on VLCCs, 19,500 on Suezmax, and 14,400 on our LR2s. For Q1, we have locked in 68% of our VLCC trading days at $17,000. On the Suezmax, we have fixed 66% of our trading days at $15,600. On the LR2s, the number is about 16,300 and 73% is covered.

Let’s move to the current market on slide nine. Fleet growth continues to weigh on rates. Rates have trended at or near the bottom of the prior year range since early 2017 and have at times deepening OPEC levels. The rate environment today is the worst we've seen for number of years. The VLCC market is especially bad and some offered rates in various occasions in Asia are well below OpEx levels. So a several factors to focus on as we wait for market rebound to develop. Many of these factors provide significant headwinds in 2017, but they could turn to tailwinds later this year.

These factors include; crude oil inventories, production growth, demand growth and of course fleet growth. I will discuss these factors in the next slides. Let's look at inventory first, slide 10. Historically, there has been a long-term relationship between crude inventories and freight rates. And particularly there have been periods when time periods have declined as we moved from inventory bills to draws. Setting aside our other variables, the chart tells the story. According to this, OECD inventories are again set to build off a significant draw downs in 2017. The builds are not forecasted to be as dramatic as in 2014 and 2015 when oil prices were collapsing, but inventory builds are nonetheless constructed for the tanker markets.

Turning to demand please. Positive trends continue with the 2018 global crude oil demand forecast increased by 1.4 million barrels per day. Since 2014, more than 80% of the growth in oil demand is reflected in incremental seaborne demand or ton miles. Half of the wells demand growth is in India and China. Supply is also forecasted to grow and majority of supply growth is forecasted to come from increased U.S. production. This continues to trend with increases in supply coming from regions that are geographically dislocated from key areas of demand growth.

Last week, a Saudi flagged VLCC left Louisiana offshore oil port the only ports in the U.S. able to accommodate VLCCs with a cargo destined for China. Since the last crude oil export balance lifted, China and other Asian nations have become large buyers of U.S. crude. Accordingly, increased fuel production coupled with additional export capacity will provide a benefit for ton mile growth. Despite these potential tailwinds, the most important factor is the order book.

Please turn to page 12. 50 VLCCs were delivered last year and another 58 VLCCs have two fascinating delivery dates. But some of these are expected to be pushed to 2019. Vessel scrapping began to pick up last year with 13 VLCCs sent to the breakers. This trend has accelerated in 2018. At least seven VLCCs have been sold for scrap so far and there are several additional units being offered to sell for scrapping.

Scrapping is a real alternative. Page 13, please. As can be seen on this graph, the spread between scrap and second half values have narrowed significantly. Combined with a poor spot market, it seems to us to be the perfect catalyst for scrapping. It is not unreasonable to expect the significant number of VLCCs to be scrapped in 2018, based on the fact that there are 45 VLCCs to be full that fourth or fix special survey this year. Another 39 are due next year. A prolonged weak spot market will increase scrapping.

We believe that over 20% of the VLCC fleet will be candidates for scrapping in the coming years. When you consider that the current VLCC order book is equal to about 14% of the existing VLCC fleet, it’s easy to see how supply demand dynamics can quickly change. We therefore expect that the market will gradually tighten as vessels are retired from global fleet and oil demand continues to grow.

Let’s move onto the summary slide things. We expect the near pressure on crude tanker age to continue, but we believe that the market will ultimately return to balance as the vessel supply slows and scrapping inevitably picks up. Important fundamental factors are in favor of a strong tanker market, but the fleet needs to rebalance from the present oversupply, which could happen faster than many anticipate. Frontline is in a unique position to take advantage of the current market. When inflection points in the market arise, we have significant capacity to act quickly in the interest of our shareholders. We believe these factors will drive value appreciation over the long run and position us to carry on our tradition of returning value to our shareholders.

And with that, I would like to turn over to questions please.

[Operator]

[Operator Instructions] And our first question from the queue is Amit Mehrotra from Deutsche Bank. Please go ahead, your line is now open.

[Chris Slater, Deutsche Bank]

This is Chris Slater on for Amit. So my first question is around floating storage. Obviously, with going into backwardation here, it's good to bringing down the global inventory stocks, but also we’ll assuming bring units out of floating storage back into the operating fleet. So I was just wondering if you guys could provide any color on maybe how many units you have seen already come out of floating storage and how many will still come out?

[Robert Macleod, Chief Executive Officer]

I think it’s important here to split floating storage into two different types. We have one type that is containment driven and we have one type that is blending. The contango driven storage, i. e. the higher price going forward storage has totally left the market and it’s probably been nine to 12 months since we’ve seen that. So I would say that that holiday is out now unless there’s a special trade, which there can’t be, but that the storage we don’t really see. The storage we do is for example fuel oil storage in Singapore where you were blending grades to upgrade the grade and that storage and that we do see and we did not expect that to access.

I would say the storage we see now is unlikely to become any lower and I don’t see a contango coming back anytime soon, but they could if we have drastic full in the oil price of course. So I don’t see much threat in terms of ships and storage coming back trading.

[Chris Slater, Deutsche Bank]

And then second question, so your Q1 spot rate guidance is well above what we've seen the published rates year-to-date. Is that the premium that you guys are putting out there? Is that just due to whether the positioning of the vessel or some of these contracts signed back into Q4 when rats were a bit higher? Any color on that would be great.

[Robert Macleod, Chief Executive Officer]

No, I think we go back to Q3. We were lower than we’ve been for a while versus our competition. And then now we come back, especially on the Suezmax, we are on the earnings. I think one important thing to mention here is that measuring earnings over a course, it’s a short period and you have a number of vessels in balance and so forth that will hit it. But overtime, the chartering performance is, as the numbers speak for themselves and we are very pleased with the commercial performance in Frontline.

[Operator]

Thank you. And now our next question from the queue will be Gregory Lewis from Credit Suisse. Please go ahead, your line is open.

[Gregory Lewis, Credit Suisse]

Could you talk a little bit about what you’re seeing in the second hand asset price market? I mean clearly you have that slide where you show the convergence between scrapping and second hand vessels. I’m just -- I mean is there just a lack of buyer showing up in second hand market right now or is there really just a lack of ships for sale?

[Robert Macleod, Chief Executive Officer]

Maybe answer to the question with your last line there, it remains fairly low in liquidity, say the price have come up a little bit in the mode. So I think what we stated in Q2 and Q3 last year that we’ve probably seen the bottom looks to be a right, but overall activity slow, access to finance remains challenging for quite a few. So I think not much really have changed.

[Gregory Lewis, Credit Suisse]

And then just as we look ahead to the 2018 deliveries, I mean it sounds like you’re expecting a lot of those to push forward out into 2019. It seems like the market is pretty optimistic on the outlook, rate of outlook for ‘19. How do you balance those delivery delays slipping in the ’19 with a healthier market in ’19? Any color around that would be super helpful. Thanks.

[Robert Macleod, Chief Executive Officer]

No, I think in terms of vessels being pushed, it will follow the normal trend of 15% to 20% will be pushed back to next year. I expect this year to be probably a bit higher than that. But ultimately, I expect the VLCCs to be able to -- will get delivered. So it doesn’t really make that much of a difference but some push back there will be and that’s quite normal.

[Operator]

Thank you. So then we’ll take our next person from the queue, Fotis Giannakoulis from Morgan Stanley. Please go ahead, your line is now open.

[Fotis Giannakoulis, Morgan Stanley]

Robert, I want to ask you about this continuing discussion on both the lighter crude that we see in the U.S. and whether there is a capacity for U.S. refineries to absorb all this light crude. What is your view? How do you think about this effect the trade and the demand for crude tankers? And then if you have seen lately any movement of light crude towards long haul destinations towards Asia? It seems that the date that we have seen so far from EIEA all the light crude is going towards Europe. Is there any change in the last few weeks in the gas destination of the light crude?

[Robert Macleod, Chief Executive Officer]

I think when it comes to observing, I think that the stance to be significant volumes that are being exported. And I think with -- in terms of the -- well the destined that is very much down to trading and that yes, we’ve seen it go to Europe. But I don’t have an accurate answer for you, because the data -- this is happening very -- this is happening as we speak really. So I think it’s something we watch closely but I can’t give you a very accurate answer in terms of where it’s destined. I do think that will change and it remains to be seen. But it’s a very important factor for the overall tanker market and do obviously follow it very closely.

[Fotis Giannakoulis, Morgan Stanley]

Can you give us a little bit of an overview of the cost of exporting out of the U.S. to different destinations? And what is the cost to do a reversal altering towards VLCC that will facilitate the long haul exports. And also what do you expect to be the capacity with the loop now operating and facilitating exports. What would be the capacity in your view for U.S. crude exports going forward?

[Robert Macleod, Chief Executive Officer]

I think there is a lot of numbers here that you're asking. Just off the back of envelop, what I can comment in terms of destinations is that dollar per barrel freight has basically never been cheaper. And when it comes to the capacity and so forth, instead of giving you approx number, I would like to come back to you with that accurate run down and that outside of this call, if I may please.

[Fotis Giannakoulis, Morgan Stanley]

And in regard to the supply outlook, we have seen some very heavy order book that is putting under a lot of pressure the current market. Do you see any additional demand for orders? And at what point, you will start to worrying about the anticipated next year or 2020 recovery because of increasing orders. And also if you can comment about the potential scrapping, how many vessels do you expect to be scrapped during this year and next given the current market and the age of the fleet?

[Robert Macleod, Chief Executive Officer]

When it comes to the orders to take that first. Yes, we have moved -- so lot of activity first half of '17, it has slowed down. There will be always the orders, now I think most of them will be related to fleet renewal. And I think the rush that we saw first half of '17 was very much driven by the low price where pretty desperate to get some orders in. Now they’re not in that same position, there are other segments are doing performing better. So I expect the ordering activity to come down. I think I touched on the demand side -- on the scraping, and there’s a lot of questions sent on, I'm getting new order. So I touched on the scraping in detail here and I think that scraping will be significant this year. But then again it’s never happened that we’ve scrapped ourselves from a bad market to a good market.

So realistically, I think that -- my guess is that the scrapping number will be in access of 30 this year, possibly 40, but that is a guess and we’ll have to wait and see what the facts are. But what I do expect, it will be or could be close to the number that actually gets delivered. So you will have a pretty low if any fleet growth this year. And on your other question on the demand side, the oil demand looks very strong. It keeps increasing every year. It’s obviously the most important factor for the tanker market, and that’s been in our favor for quite some time, and I don’t expect that to change. It is simply the order book that has changed things to where we are now.

And I think slowly and surely we’ll get back and my guess is as I write into report it’s towards the end of the year. But it’s always difficult to put this exact. But our long-term view in Frontline is that things will get better and they will be in for quite a good right as with the new regulations coming in and 2020 as you say. So we are looking at basically at the future.

[Fotis Giannakoulis, Morgan Stanley]

Thank you, Robert. One last follow-up about the new regulations and how this impacted trading of older vessels and how they relate -- this related to scrapping. Can you give us an idea of what is the actual consumption differential between your youngest vessels and your oldest vessels. And how does this translate with the new regulations into dollars per day?

[Robert Macleod, Chief Executive Officer]

On the last, on the dollars per day then I’ll say it depends on where the oil price is. So I’ll keep it tons and then everybody can get the oil price instead. So what I could say is that the new regulations is a catalyst for scrapping, because new regulations on the old ships that means investments. And when you have a vessel that is 17 years old and it’s worth the same as scrap and you both have a docking coming up and you have additional investments. Then you really have to believe very strongly about the future tanker market to make that investment.

So therefore I think it will be a catalyst for scrapping and therefore I think ’18 will have -- the scarping number will be significantly higher than 2017. But again, it’s very difficult to, if many things can change but steel price looks in line strong. And when it comes to the difference between the old and the newer ships, it’s somewhere around 25 tons to 30 tons a day market the difference. So the difference is significant.

[Operator]

Thank you [Operator Instructions]. We will take our next question with Magnus Fyhr from Seaport Global. Please go ahead, your line is now open.

[Magnus Fyhr, Seaport Global]

Just a couple of questions, first on fleet renewal opportunities. I mean there has been a couple of transactions in the public market and with the rates environment weaker here and some headwinds. What do you see among the private players opportunities there for any larger fleets?

[Robert Macleod, Chief Executive Officer]

So it’s a good question, and also we follow this very closely. There are opportunities here and there this without naming any fleet. So we are constantly looking and there are and -- but the thing is there will be increasing opportunities. So we are at Frontline we’ve got -- we’ve kept our powder dry and we keep looking and we will renew on the VLCC to some stage. But where we are now is more sit back and assess the opportunities. We do expect there to be more this year and then we’ll see how the year develops.

[Magnus Fyhr, Seaport Global]

And just a follow up on the new regulations, I mean lot of the focus with the treatment system, and that got pushed out two years. And I mean it seems like all the shipping companies would be ready for the new low sulfur. But when you talk to your clients what -- it seems some pretty big undertakings among the refineries to get ready for this new regulation. How would you handicap that a new regulation 2020 getting pushed back?

[Robert Macleod, Chief Executive Officer]

Let's see how things develop. But if we go back when the balance was pushed back that came as a great surprise to most. And I think in terms of IMO, they surprised the market and I am pretty certain that that neither of these two will get pushed back, that’s my personal view, but after what happened and reactions we saw last year. But let's see what actually happens there but I would be surprised.

[Magnus Fyhr, Seaport Global]

And what's your positioning there as far as using the low sulfur fuel versus installing scrubbers?

[Robert Macleod, Chief Executive Officer]

It’s something where you’re seeing -- you're spending a lot of time on. What I can say is that we will not be installing scrubbers in all ships that’s for sure. But on certain ships we’ll install, we are considering and we will update on that soon. We are spending a lot of time in it.

[Magnus Fyhr, Seaport Global]

I've seen over the place on installing these scrubbers. What would you peg a scrubber system for VLCC currently?

[Robert Macleod, Chief Executive Officer]

I think if it’s a newbuilding, you're talking about $2.5 million to $3 million extra. And if you're retrofitting a scrubber then it’s really that figure but the 15 cost is also significant and your off hire will also be significant. So you’re probably talking about $5 million to $6 million all depending on which system you decide to install. So these are just very rough figures but it’s a pretty big investment.

[Operator]

Thank you. As there are no further questions in the queue, I would like to hand the call back to our speakers 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 all for calling into this presentation. All the best.

[Operator]

Thank you. So ladies and gentlemen that will conclude today’s conference call. Thank you for your participation. You may now disconnect.