Frontline plc Q2 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by. Welcome to today's Quarter Two 2020 Frontline Limited Earnings Conference Call. I'll now hand you over to your first speaker, Robert Macleod. Please go ahead, thank you.

Thank you very much. Good morning and good afternoon, everyone. Thank you very much for dialing into our second quarter earnings call. First, I'd like to express gratitude towards our shore staff and crew members for their extraordinary efforts and dedication, which are clearly defining factors in our strong results. Our markets are very volatile, but the volatility seen in the last 12 months has been extreme and serves as a reminder of how little it takes for the tanker market to rally. Frontline's performance in the first half of 2020 was the strongest since 2008, and we've also made solid bookings for the third quarter. Despite the recent fall in rates, 2020 will be a very good year for Frontline. Let's now move to Slide 3 and have a quick look at the highlights from the second quarter: a net income of $200 million, just over $1 per share, which is certainly a solid quarter. Adjusted for non-cash items, the net income was $206 million. We declare a $0.50 dividend; the last dividend was $0.70 for Q1 2020. We opted to repay $60 million on our Hemen facility in the quarter, which is the main reason for the reduced dividend. Inger has done some great work in financing; she will take us through that later on the call. Two new buildings were delivered in the quarter: one Suezmax and one VLCC, leaving us with only 4 ice class LR2s on order that will deliver next year. VLCCs made $75,800 in Q2, and we have booked 76% of Q3 at around $61,000. Suezmax made $51,100 in Q2, and we've booked 77% of Q3 at $29,500. LR2s made just shy of $37,000, and we have booked two thirds of Q3 at $14,500. These Q3 rates do not include the long-term time charges. And then before moving on to the market, I will hand the call over to Inger to take us through the financials.

Thanks, Robert, and good morning and good afternoon, ladies and gentlemen. I think we should turn to slide 4 and look at the income statement highlights. Frontline achieved total operating revenues net of voyage expenses of $301 million and adjusted EBITDA of $259 million in the second quarter of 2020. We report a net income of $200 million, approximately $1.01 per share, and adjusted net income is $206 million or $1.04 per share in the quarter. The adjustments this quarter totaled $6.4 million net, consisting of a $5.9 million loss on derivatives, a $0.9 million unrealized gain on marketable securities, a $2.7 million share of losses on associated companies, and a $1.3 million amortization of acquired time charters. The adjusted net income increased by $27 million this quarter, primarily driven by an increase in our time charter equivalent earnings due to the higher reported TC rates for our VLCC and LR2 tankers in the second quarter, along with a gain of $12.4 million subsequent to the sale of one VLCC previously recorded as an investment in finance lease. Let us then take a look at the balance sheet highlights. The main occurrences in the second quarter that affected the balance sheets were the deliveries of the Suezmax, Front Cruiser and Front Dynamic, and the drawdown of debts on these vessels. As Robert mentioned, we repaid our senior unsecured facility with $60 million. We entered into two new loan facilities to refinance two loan facilities with total balloon payments of $349 million, which were due in December 2020 and March 2021, on terms in line with Frontline's other loan facilities. We also paid $138 million in dividends and earned adjusted net income of $199.7 million. At the end of the quarter, Frontline had $462 million in cash and cash equivalents, including undrawn amounts under our senior unsecured loan facilities, multiple securities, and minimum cash requirements. The current portion of long-term debts includes $214 million debt maturity of the $466.5 million facility due in April 2021 and $80.3 million debt maturity of the $109.2 million facility in June 2021, which we both expect to refinance. Other remaining new building CapEx requirements at the end of the quarter were $161.1 million related to the four LR2 tankers, with two expected to be delivered in January and February 2021, and two in August 2021. In this connection, Frontline obtained a financing commitment for a loan facility in an amount of up to $133.7 million from CEXIM and Sinosure to partially finance four LR2 tankers. This facility will have a tenure of 12 years; it will carry an interest rate of LIBOR plus the margin in line with Frontline's other loan facilities and it will have an amortization profile of 17 years. The facility is subject to final documentation. Let's then take a closer look at the next slide on cash breakeven and OpEx, slide six. We estimate the average cash cost breakeven base for the remainder of 2020 at $22,600 per day for VLCC, $18,900 per day for Suezmax, and $15,700 per day for the LR2 tankers. The fleet average estimate is about $19,100 per day. These are the rates the all-in daily rate that our vessels must earn to cover the budgeted operating cost and estimated interest expense, TC and bareboat hire; installments on loans, and G&A expenses. In the graph on the right side of this slide, we have shown, as usual, the incremental cash flow at the debt service per year and per share, assuming $10,000, $20,000, $30,000, or $40,000 per day achieved in excess of our cash breakeven rates, respectively. And the numbers include vessels on time charter out, and we are looking at a period of 365 days from July 1, 2020. As an example, with fleet average cash cost breakeven rate at $19,100 per day and assuming that we have $30,000 on top of the average free TCE rate, that would be $49,100, generating cash flow per share at the debt service of $3.49. With this, I will leave the word to Robert again.

Thank you very much. Let's have a look at the Q2 Tanker Market on slide 7. The first six months of 2020 brought a dramatic crude oil demand correction, the likes of which we've never seen. The demand shock brought on by COVID-19 was so large and sudden that global commercial inventories quickly surged to record levels, effectively utilizing all available land-based capacity. At the same time, the crude oil market went into Contango, encouraging traders to store oil on tankers and driving demand for short-term charters of our ships. This, in turn, resulted in exceptionally strong tanker rates, which are reflected in our results for the second quarter of 2020. The freight market has since declined to lower levels, and although signs of recovery are evident as economies continue to reopen, the recovery in demand is unlikely to be linear, and the extent and duration of the impact of COVID-19 are difficult to predict. COVID-19 related challenges have been extensive throughout the industry. These include logistics around crew changes, delayed discharge, and diminished capacity at shipyards for dry docks and surveys. These are all factors that positively impact effective fleet supply. There is significant month-to-month volatility in the demand forecast as shown on the charts at the bottom of the slide. Let's move to slide 8, please, and have a look at the global fleet capacity growth, which is slowing. The vessel supply side of the equation continues to improve, which is very positive. The order book as a percentage of the total fleet is at the lowest level since 1997. At the same time, the average age of the VLCC fleet as of the end of the second quarter of 2020 is at the highest level since September 2002. By the end of next year, there will be 65 vessels older than 20 years, and an additional 85 older than 17.5 years. The effect of slowing fleet supply growth will be pushed out to 2021 or 2022, but it should be material and lead to a sustained period of higher rates. We do like the current situation where new vessels enter the market at a controlled pace. The order group continues to shrink, and the retirement of vessels is inevitable. Present markets and a bit of outlook: the demand shock is likely behind us, but volatility can be expected. The present freight market remains under pressure; crude production is down almost 10% since January, and the lost volume reduces the volume that is normally shipped, meaning that the cargo counts are down by as much as 20% to 25%. On the positive side, inventories are being drawn, which is short-term pain but possibly long-term gain. Forecasts suggest that a significant portion of the OPEC cut could return in the coming months, and combined with the Northern Hemisphere moving towards winter, this lends grounds to believe in a stronger freight market. In conclusion, the large moves in tank rates during the last 12 months illustrate the tight balance in the market and the fact that it does not take much for the tanker market to rally. Looking ahead to 2021 and beyond, recovering demand for crude oil transportation will coincide with rapidly declining fleet growth, which supports our long-term highly constructive market outlook. Frontline enjoys the youngest fleet and lowest breakeven levels in the history of our company. Frontline's earnings potentially substantial, $23 million annualized for every $1,000 above $18.7 million. So we are very well positioned. With that, let's turn over to questions, please.

Your first question is coming from the line of Randall Giveans from Jefferies.

Howdy Robert and Inger. How are you? Great. Well, yes, I guess the first question is around the dividend, right? In the fourth quarter of 2019 and the first quarter of 2020, you paid dividends above, I guess, 70% of net income. Now for the second quarter, you reduced this to 50%; I think you mentioned part of it's because of the $60 million pay down back in April on that Hemen facility. So I guess is that the entire reason for it, or are you kind of bridging to a weaker dividend next quarter? And then should we expect at least 50% of net income going forward?

That's the entire reason for it. If you add that sort of top, I guess you will get to a $0.80 dividend, which I guess is probably what you assumed.

If you include the Hemen $60 million, is that what you're referring to?

Yes. So that's the entire reason the dividend is $0.50.

Okay, and then going forward, is a 50% of net income a fair assumption?

Going forward, it's standard normal as we have it in a way; it's not changed at all. We just this quarter opted to repay the facility with $30 million, which is $60 million, I mean, which is $0.30 per share. That's what happened this quarter.

Okay, and about the Hemen facility; I believe that was done back in April, right? Do you expect to repay the remainder of that here in the third quarter?

No, we don't know yet. We haven't really decided what to do with the remaining part of it. It might be that we can extend the facility; it could be that we repay, we will have to see.

Okay, and then I guess the last question around your scrubbers. What's the status of the scrubber installations? I know you postponed a few. I think it was four; any expectations on when those will be installed or kind of your plans going forward on remaining scrubbers?

So, Randy, we currently have a couple being installed, but the four that we postponed have not progressed further. Our plan is to prepare these ships for the installation of scrubbers when they dry dock in the upcoming quarters. All the necessary underwater work will be completed, which is a minor cost, and then we can fit the scrubbers. They have been retrofitted and are now stored at our production facilities in Indonesia. The spread is improving slightly, but for now, they will stay in storage as we have the flexibility to decide later.

Your next question comes from the line of Jon Chappell from Evercore ISI.

Thank you. Good afternoon, Inger and Robert. A couple of quick clarification questions first. I think we always hear where the quarter-to-date bookings look very elevated basically because of the load to discharge accounting. I know you guys really try to flush out the differences here, so maybe a way to ask it is as you look at the rest of the quarter, the other 24%, let's say for the VLCCs; is there any extreme or out-of-the-ordinary uncontracted or contracted vessels where let's call it that stub part of the rest of the quarter would be higher or lower than the market averages?

So it all depends obviously whether we fixed the loading dates at end of September or early October, that's what's going to determine. But just to answer the second part of your question, there's nothing specific; there's nothing special. What I would say about the earnings is it's important here to look at earnings over several quarters. If you were to ask me how Frontline has done on VLCCs so far this year, then my take is that we had a very good Q1; we outperformed our pace. We're giving some of that back in Q2, as you see from the numbers. And my guess is that we're on a pretty good rate level and a good percentage share for Q3. So I would say outperform in Q1, we know, slightly below in Q2, and then I think we're looking quite good for Q3.

Okay and then just another clarification, Robert. I think you said that the long-term contracts are not included in the quarter-to-date rates. In the press release it says these short-term charters are included in the forecast. So what's the difference between the long term and the short term? I guess you have two that are 9.5 months and one that's 12 months, and then you have four that are just below six months. So just to be clear, the ones that are just below six months, that is included in the quarter-to-date and then the longer ones are not.

Yes, correct. So basically the six-month charters, which are basically six months plus minus one, so it's a minimum period of five months. So those deals that we consider spot are in the numbers, and anything above, which then starts in the eight months deals and we have a couple of one-year deals and we've got the five Suezmax on the three-year deals. So anything above six months is then considered longer term and is not included.

Got it, and then also I noticed in the disclosures that you have seven ships chartered, two affiliates of Hemen; I'm assuming those are these seven that you did in the second quarter. Just curious, is there any options associated with those, or were those kind of strict on the timing?

There are no options attached.

Okay. Final question, Robert, is I think you've laid out a very balanced second half of the year outlook for the market. And clearly given the start to the third quarter, you will be cash flow positive, and Inger laid out the dividend strategy. When you think about the cash going forward, do you think this period of, let's call it choppiness or uncertainty, provides you with an opportunity to add tonnage, or do you think that you spend this next six months continuing to strengthen the balance sheet to position yourself for the favorable 2021-22 outlook that you spoke of?

We're pretty happy with the size; we're very happy with the age. As I said in the intro, the company's in a very good shape. But I don't think we need to do anything. If opportunities arise, like something similar to the Trafigura deal we did, we might consider it. But the base case is to enjoy what we have and then harvest from that through having hopefully the best operation.

Your next question comes from the line of Chris Tsung from Weber Research.

Hi. Good afternoon, Robert and Inger. How are you? I kind of wanted to just touch on the cash breakeven levels again. On Slide 6, I know Jon asked this earlier too, but I guess I'm asking it from a slightly different angle. So on Slide 6, the cash breakeven levels of like $19,000 on a fleet average. In the press release, it says that the charter coverage is not included in the breakeven level. So I was wondering, would that mean the breakeven levels excluding the time charters would show a slightly higher breakeven for the fleet?

No, I mean the cash breakeven rates that we disclose are the total costs that our fleet has divided by the different number of days for each segment, shown on a gross basis. If you have contract coverage above the breakeven rates, that would obviously lower the cash breakeven rates for the spot vessels. So they do not increase them.

So if the contract coverage decreases, would excluding it result in an increase, and you're saying the answer is no?

Yes.

Okay. All right. I just wanted to clarify. And I kind of wanted to just ask about your investment in Clean Marine. I guess when the investment was made back in October of 2019, it seemed like it would be a smart hedge for IMO 2020 and scrubbers in general. Fast forward 10, 11 months now, COVID, OPEC, and market volatility, what are your plans for this investment going forward?

Well, we'll see how this develops. We own about 17%, and the company has a production facility which is owned in Indonesia. It's got its stocks and so forth. We only have a very small loan to the company, so we don't really have any risk there. We don't see the need to put any money into the company. I think there will be some positive news going down the road. It's not turning out to be as lucrative as we hoped, but the downside was so the risk was always controlled and limited.

Right. I see, okay. Makes sense. And just last question. Given the news about the voluntary cuts from several key OPEC members, the congestion that's happening around Chinese ports and Hurricane Laura in the U.S. Gulf, I'm just curious about how you guys are choosing to position your fleet in the near term?

What we're doing now is that this is an extremely difficult market to predict. I've been in this industry for a few years, and my intuition suggests we are moving towards a more normal market. Volumes are significantly down as we know. According to the latest statistics, world production is 3 to 4 million barrels below consumption, which is negatively impacting freight. However, this might set up a better scenario as we approach winter, and the fourth quarter typically performs well. My understanding, although not with high conviction, is that conditions may improve as we near the year's end. We are trying to reposition the Suezmax in the Atlantic Basin. If we have to choose between a long voyage at current rates or a shorter one, we prefer the shorter option. There are potential triggers we are monitoring closely. We sense that things might get better. Nonetheless, volumes remain low, so everything hinges on the number of cargoes. This summer, in the Middle East, we saw one out of three cargoes vanish, which has clearly affected earnings, but we hope demand will gradually return, suggesting better times ahead. I remain cautious and am not ready to adopt a bullish outlook just yet.

Your next question comes from the line of J. Mintzmyer from Value Investor's.

Thanks for taking my questions. I do excellent. Thanks. So, first of all, congrats on a good quarter. As we're looking towards the shifting interest rate environment, I know you've done a few swaps and hedges in the past on some of your debt profiles. I know you also have a new debt profile coming up with the new builds. Is there any plan to expand or extend those interest rate swaps? Is any of that in the works? Are you going to maintain some floating exposure?

So we have entered into quite a lot of interest rate hedges recently. At the moment, we have no further plans for entering into additional interest rate hedges, but we had $550 million of all the hedges now at the moment and have a short additional portion of about $100 million that will soon mature. But at the moment, I think we are happy with that.

Okay, that makes sense. I noticed you had about one-third or so hedged. I was curious if those plans have changed. Jon inquired earlier about cash plans and whether you've considered expanding or new builds or anything like that. Frontline has a strong premium compared to some of your tanker peers. I believe Frontline is likely one of the few tanker companies that has a respectable valuation in today’s market. Is there any chance for Frontline to act as an equity consolidator? I know there are some competitors in the Norwegian market that are trading at a significant discount to NAV. Is there an opportunity for consolidation there, or is that idea off the table?

No. There are opportunities, and as you say, we have the pricing. We're well below the premium we normally have, and that premium is there for obvious reasons. We do have a main shareholder who remains hugely supportive, and that will remain so. In terms of consolidation, yes, we are a potential consolidator, but we are happy with what we have now. We will keep tracking opportunities. So let's see what comes up and what makes sense. Our size already gives us earning potential, which you can clearly see from the Q2 numbers.

Excellent. You'll have to forgive me for this one, Robert; the parting question here, but we talked back in April and you had kind of a fun bet on whether rates would come back down. Unsurprisingly, you'd be walking across Norway. I just wanted to check in on that and see when the trip is planned, and maybe it's after COVID we can get a group together.

Yes. I'll tell you what; you would probably enjoy the walk. Of course, it's a beautiful walk as long as you start from the east side and then walk towards my hometown. Then you're going the right way. But J, you settled the bet so it ended up being a dinner; I must say that with the confidence I had, the bet was high, and they did come very close. Fortunately for me, I got away with it.

Your next question comes from the line of an unidentified analyst.

Hello, Robert and Inger. Hey, I'm calling from Pittsburgh, which is the home of the steel industry that a good Scotsman named Andrew Carnegie made famous. I was curious, what effect do scrap steel rates have on the retirement of vessels?

Sorry, so did you scrap steel price?

Well, the decision to retire vessels; I know it has to do with the five-year intervals and so forth and the market, you know, but do high or lower scrap prices affect your decisions in the industry to retire ships? I just wondered if the rate of scrap steel would go up, if that would result in more retirements, which would be beneficial for your industry.

That's an interesting question. Yes, it does. For example, our oldest ship is from 2009, so we don't have many candidates for retirement. However, as I mentioned earlier, there is an increasing number of older ships in the market. Over the last 18 months, the value of steel has varied between $11 million and $18 million, and it's currently at the lower end. This price is an important factor in deciding whether to scrap a ship since it constitutes a significant portion of the contract's value.

Well, maybe you could talk some of these shipbuilders into offering bonuses to the scrappers to tie in a sale of the new vessel to scrapping a ship.

Yes. That could be a way of doing it or combining, making a pool of all the old ships and getting the balance back quicker that way.

We have no further questions coming from the phone lines. Please continue.

Okay. I think we'll round off. So I'd just like to thank everyone for calling in, and also to my colleagues and everyone at Frontline. Thank you very much for all your efforts.

Ladies and gentlemen, this does include our conference call for today. Thank you for participating. You may all disconnect.