Frontline plc Q1 FY2021 Earnings Call

Good day, and thank you for standing by. Welcome to the Q1 2021 Frontline Earnings Conference Call. At this time, all participants are in a listen-only mode. After the presentation, there will be a question-and-answer session. I must advise you that this conference is being recorded today on Thursday, the 27 of May, 2021. And now without any further delay, I'd like to hand the conference over to your speaker today, Lars Barstad, Interim CEO. Please go ahead.

Thank you very much. Thank you, and good morning and good afternoon to everyone. Welcome to Frontline's first quarter earnings call for 2021. We're obviously quite content to be able to provide positive numbers, maybe to the surprise of many of you. Q1 2021 was a fairly quiet quarter corporate-wise, as we are in a good position financially and no major transactions were concluded during the quarter. We continue to focus on the well-being of our seafarers as they are exposed to the global ebb and flow of COVID-19 infections. Our technical and operations team are doing a fantastic job in mitigating the challenges that arise. And I'm very happy to report that we are well underway in vaccinating our crew. Let's now move to Slide 3 and have a look at the highlights. The Q1 2021 performance is very much a testament to keeping true to our strategy, being mostly spot exposed and not expecting an imminent recovery in the market. Our chartering desk has remained true to trading the ships in a month where we allow our vessels to commit to long voyages, securing income but potentially giving away upside. Our modern fuel-efficient fleet is built for this purpose, and it also gives us this flexibility. This proved to be the right call. In the first quarter of 2021, we made $19,000 per day on our VLCC fleet, $15,200 per day on our Suezmax fleet, and $12,000 per day on our LR2/Aframax fleet. So far in Q1, we have booked 70% of our VLCC days at $18,100 per day, 63% of our Suezmax days at $13,600 per day, and 59% of our LR2/Aframax days at $14,200 per day. All these numbers in the table are on the load to charter basis. Before Inger takes you through the financial highlights, let me quickly comment on the fleet development as well. We took delivery of two of our four LR2s coming this year from Fusion and from Future in March and April, respectively, bringing our number of LR2s on the water to 20. Further, subsequently, we confirmed acquisition through resale of six high-spec ECO scrubber-fitted VLCCs to be delivered from Hyundai Heavy Industries in Korea, five in 2022 and one early in 2023. I'll now let Inger take you through the financial highlights.

Thank you, Lars, and good morning and good afternoon to all of you. And let's then turn to Slide 4 and look at the income statement. As Lars said, we are happy to report numbers in black. Frontline achieved total operating revenues net voyage expenses of $107 million in the first quarter. We also had an adjusted EBITDA of $59 million and we report net income of $28.9 million or $0.15 per share. Further, we have an adjusted net income of $8.8 million or $0.04 per share. The adjustments consist of a $15.7 million gain on derivatives, a $3.1 million unrealized gain on marketable securities, a $1.2 million amortization of acquired time charters, and a $0.1 million share of results of associated companies. The adjusted net income in the first quarter has increased by $21 million compared with the previous quarter. And the increase was driven by a decrease in ship operating expenses of $11 million, mainly as a result of $6.4 million lower drydocking costs. We also had an increase in time charter equivalent earnings of $6.8 million, which is due to the higher TCE rates, as well as we had an $11.2 million decrease in other costs. Let's then take a look at the balance sheet on Slide 5. The total balance sheet numbers increased by $10 million in the first quarter. The balance sheet movements in the quarter were primarily related to taking delivery of the LR2 tanker Front Fusion in addition to ordinary debt repayments and depreciation. As of March 31, 2021, Frontline had $380 million in cash and cash equivalents, including undrawn amounts under our senior unsecured loan facility, marketable securities, and minimum cash requirements. Let's then take a closer look on Slide 6 on the cash break-even rates and the OpEx. We estimate the risk cash cost break-even rates for the remainder of 2021 to be approximately $21,500 per day for VLCCs, $17,700 per day for Suezmax tankers, and $15,900 per day for LR2 tankers. This gives a fleet average asset of about $18,100 per day. These rates are the all-in day rates that our vessels need to cover budgeted operating costs and drydock, estimated interest expenses, TC and bareboat hire, installments on loans, and G&A expenses. In the quarter, we recorded OpEx expenses of $7,300 per day for the VLCCs, $7,100 per day for the Suezmax tankers, and $7,200 per day for the LR2 tankers. We did drydock one Suezmax tanker in the first quarter only, and we expect to drydock two Suezmax tankers and four LR2 tankers in the second quarter. Let's then look at the graph on the right-hand side of the slide. As usual, we show the incremental cash flow after debt service per year and per share, assuming $10,000, $20,000, $30,000, or $40,000 per day achieved rates in excess of our cash break-even rates. The numbers include vessels' time charter equivalents that are adjusted from newbuilding deliveries, and we're looking at a period of 365 days from April 1, 2021. So in this graph, as an example, with a fleet average cash cost break-even rate of $18,100 per day and assuming $30,000 on top of the average fleet earnings, the TCE rate would be $48,100 per day. Frontline would then generate a cash flow per share after the service of $3.45. With this, I leave the word to Lars again.

Thank you very much, Inger. Let's move to Slide 7 and have a look here at a recap of the Q1 2021 tanker market. It goes without saying that it's been somewhat demanding. Total oil consumption rose by 4.3 million barrels from January to March and reached 96.5 million barrels per day. On the other hand, supply fell by 0.5 million barrels. This was mostly fueled by the actions from Saudi Arabia and their voluntary cuts, which ended up at 93.5 million barrels per day at the end of the quarter. As we continue to draw on inventory, tanker demand remained basically unchanged. We did, during the quarter, see a return of Libyan volumes. We also experienced, towards the end of the quarter, the U.S. cold snap that created a lot of volatility. So tanker rates firmed towards the end of the quarter, and this is viewed quite positively because it indicates a thinner balance than what may be perceived. To wrap up Q1, we see that demand or consumption is running ahead of supply, and the drawn inventories are mitigating that volume. If you look at the chart on the right-hand side, you see what I refer to as a ripple rather than a very strong market. However, we see how quickly rates react, as we saw the Aframax market move in line with Libya opening up, and secondly, the Suezmax market reacted, fueled by the U.S. cold snap impacting volumes from the U.S. So let's move on to Slide 8 and look at the tanker orderbooks. Across all asset classes, we are observing delayed recycling. We see very little support for keeping older tonnage in this market, but they remain in the fleet list. Recycling prices are up 30% year-to-date and are now being negotiated around $550 per long ton or $23 million for a VLCC. This is, to some extent, being outcompeted by the demand for vintage tonnage from undisclosed price buyers at relatively firm prices. The overall tanker order book has shrunk year-to-date by approximately 4%. The asset vessel deliveries and new ordering has been fairly muted. We've seen on the VLCCs 28 new orders placed, but as 25 vessels are delivered at the same time, the order book remains fairly flat. The VLCC order book stands at around 9% of the existing fleet, and the overall order book for tankers is around 7% of the existing fleet. Let's move to Slide 9 and look at the asset prices. The prices are on the move. Over the last six months, we have seen more than 170 new orders for containerships. We've also seen quite firm ordering on LPG and confirmation of LNG orders, further contributing to the activity. In line with the entire commodity space, steel prices have depreciated sharply. The fundamentals of the tanker market suggest the tightening of capacity over the coming years, with regulatory tightening concerning greenhouse gas emissions further supporting the case of investing in modern fuel-efficient ships. Right now, the driver is not propulsion but the lack of yard capacity, which is driving prices together with this activity. So let's move to Slide 10 and look at the short-term outlook. We are currently in the middle of OPEC plus production increases. They are increasing somewhat slowly but are adding to transportation demand. Presently, Asia, and in particular, China, are coming out of refinery maintenance, and oil demand continues to recover. Inventories, both on land and floating, have now normalized to pre-COVID-19 levels. According to EIA, oil supply is expected to grow by 6 million barrels by year-end. Most of these increases are expected to happen from where we stand now and over the summer. The key to the demand balances in 2021 can be found in our expectations for gasoline, jet, and diesel demands, which include a recovery of 1.8 million barrels per day for gasoline and 1.3 million barrels per day for jet fuel in 2021. Essentially, all key macro indicators point towards a firm recovery. Global GDP is expected to rise by 6% this year. Prices are on the move as capacity tightens and steel prices are increasing. As I've just mentioned, the COVID-19 vaccination pace in developed countries is very encouraging, and countries are opening up. We can see on the graph below, which indicates activity within the various key segments of the shipping sector, that the cyclical recovery has started. All key shipping sectors are firm, though tankers are lagging. Frontline is ideally positioned to capitalize on the anticipated recovery in tanker markets with our modern spot exposed fuel-efficient fleet. And with that, I would like to open up for questions and answers.

Thank you. Your first question today comes from the line of Jon Chappell of Evercore. Please ask your question. Your line is now open.

Thank you. Good afternoon.

Hi, Jon.

As I'd say, that's a pretty balanced outlook on the market, maybe a bit more balanced than some of the optimism out there. Yet, obviously, the press release last week on the six new VLCCs indicates, I think, a lot of optimism about where the market is going. I think I asked this three months ago, but at this stage in the cycle, based on what you see for the next 12 months or so, do you think you're a more aggressive acquirer of assets? And if so, how much of this fuel propulsion question plays into whether you're doing more new builds like you announced last week versus maybe the traditional Frontline activity in the secondhand market?

Well, it's all a question of opportunity. First of all, I would say that we're always aggressive, but the right opportunity has to come our way. Our overall view of the market has firmed over the last couple of months, and we have more conviction now that we are moving in the right direction. Regarding resale versus modern vessels on the water, we obviously have to look at the current spot markets when we weigh whether to take a ship that's sailing in this market or a ship that will be delivered at a point in time when we're expected to be at full throttle again. This is a part of the consideration. Secondly, it's actually not that many vessels for sale that meet our investment criteria. So while the activity in dry bulk has been tremendous and the activity on ordering containerships and LPG has been excellent, the VLCC asset market has been fairly muted year-to-date.

Okay. Now that makes complete sense. And then just a follow-on to that regarding financing, I understand you're going to almost certainly get financing for these ships ordered or announced last week. I was a bit curious that for the down payment, given the cash you have on your balance sheet, you still drew down $50 million from the Hemen facility. So what's the thought process around the amount of liquidity you want to keep, taking debt to pay down payments, and not resuming the dividend despite a profitable quarter? I understand that the second quarter is weak, and we have a kind of near-term choppy outlook. But should we think about just drawdowns of debt to finance new builds going forward and maybe retain the cash for a stronger market when you can think about capital returns again?

I think we have flexibility with respect to this facility that we are drawing on. We will establish the debt financing for the first vessel probably in the second half of 2021, depending on opportunities that arise. With respect to equity and repayment of this facility, we will have flexibility going forward to decide how to handle that and when we would like to potentially use the ATM. That will depend on the share price and timing for raising equity.

Okay. All right. Thank you, Inger. Thanks, Lars.

Thank you.

Thank you. Your next question today comes from the line of Randy Giveans of Jefferies. Please ask your question.

Team Frontline, how is it going?

It's good, Randy. How is it for you?

All right. I guess, question: you talked a lot about the crude markets. Just looking also at the product tankers, how do you view those two and maybe the timing of an inflection where you really start to see some rate improvement? And then with that, are you using any of this soft patch to clean up some of your LR2s that were trading dirty and transitioning to trading clean going forward?

To start with the first one, we are obviously in a recovery phase. I think we've probably just finished drawing on inventories. That’s at least some of the information I'm seeing, which is relatively current, which means that we are also in a refinery turnaround, a relatively heavy one. I was quite hopeful for the product market to start to run already in March, but that faded. I think in order for the product market to properly move, we need to see a significant portion of the lost jet demand return. There is always a product market to be had around arbitrages opening up. However, we need to see the refineries coming out of turnaround, which creates a chicken-and-egg discussion. To be quite honest, I'm still not sure which will come first: increased demand for crude oil pushing the VLCC market or the demand increase for product pulling the LR2s as product is transported. It's difficult to say. Regarding cleaning up, we have cleaned one vessel and used this opportunity in the market. It’s not really an opportunity because it always comes with some degree of cost. We have to remind ourselves that we also had a lot of incremental income while doing this. Accordingly, we should gradually look at utilizing our vessels as LR2s because that's what they are intended for.

Yes, that makes sense. All right. And then, I guess, second question for me: You've shown some impressive expense control here with the market downturn, specifically more recently, a sharp reduction in vessel OpEx and G&A. So going forward, what's a good run rate for those two line items?

As I mentioned, for this quarter that we are into now, we will have a drydocking cost, which is higher than we had in the first quarter. We only had less than $600,000 in drydocking costs in the first quarter. For the second quarter, we estimate around 7% or probably a bit more. So in that sense, of course, the operating expenses will increase in the next quarter. However, it will vary significantly between quarters depending on how many vessels are undergoing dry dock. In the third quarter, we are planning to drydock three vessels instead of six, meaning that it will be about half of the costs I mentioned for the second quarter. Regarding admin expenses, I would say that G&A in the first quarter is not the expected run rate. It will probably be a couple of million dollars on top of that, making it around $8.5 million or so going forward.

A couple of million on top of the $6 million, okay. So is $9 million a good run rate going forward?

That's probably a bit too high, but a couple of dollars on top of what was reported. That gets something around $8.3 or $8.5, whatever, in that respect.

Your next question today comes from the line of Magnus Fyhr of HC Wainwright.

Yes. Just most of my questions have been answered. But just going back to Jon's question regarding your thoughts on ordering or buying more ships: Do you think there's an opportunity here? Many operators seem a bit hesitant to buy or order ships at these levels due to uncertainty regarding propulsion technology. But just curious if you think there are further opportunities there, new building versus acquiring resales.

We will remain true to our strategy and try not to add to the order book. To be quite honest, where the current order book stands, it is quite difficult to gauge. You would struggle tremendously to order VLCCs for delivery in Q4 2023, and if you should locate a slot there, the prices are likely north of $100 million. Rather than focusing on new orders, we might concentrate on acquiring either resales or modern ECO vessels on the water. It's important to note that there has been frantic activity with yards, and Inger and I draw comparisons to outlook periods in 2002 and 2003. At that time, we had much more yard capacity coming. Right now, we don’t have that, so yards are starting to look at 2025 due to the current situation.

And you have a really modern fleet. You mentioned that scrapping prices are picking up. What do you see as far as older ships finally heading to scrap? Current spot prices are very challenging for these older ships, and I'm just curious if you expect to see that scrapping finally increase during the summer?

Our count stands at 8 VLCCs sold for scrap year-to-date, and I think there are 3 Suezmaxes. However, we have to remember that there have been disruptions in the capacity for recycling yards to accept vessels due to COVID. This pandemic has affected operational efficiency. With current recycling steel prices, we should definitely see some action. However, we still face competition in the market for vintage secondhand tonnage from undisclosed parties involved in what I refer to as the dark web of oil—transporting either Venezuelan or Iranian sanctioned crudes.

So I guess, with the ongoing talks regarding Iran and the potential removal of sanctions, what's your thoughts about those vessels potentially not being able to compete in an open market?

That could be a tremendous boost to the conventional law-abiding tanker market. We all talk about the Costco moment in the tanker industry, and I think you could have that effect. With the nuclear deal between the U.S. and Iran, you could see a significant volume that needs compliant ships to trade within the compliant market.

We will not be doing any drydockings in the fourth quarter. Only in the second and the third.

We do have one more question at this time. This comes from the line of Chris Tsung. Please ask your question.

I wanted to dig in a bit more into a question asked earlier regarding OpEx. I saw that it came down significantly from Q4, roughly around 20%. Looking back at your previous presentation of the OpEx, the daily OpEx for the Suezmaxes was about $9,700 a day, and it's down to $7,100 now. Maybe if you can help explain how that is received.

The OpEx will vary between quarters, as I mention, due to dry dock transitions. In the quarter you referred to, the Suezmaxes had a high OpEx due to dry dockings. Currently, we only have a small drydock expense that doesn't significantly impact the OpEx.

To clarify, we actually expense the actual dry docking costs in the quarter rather than capitalizing, as many of our peers do. This is why we see volatility in our expenses.

Yes.

Understood. I guess just following up on another question about the six VLCC resales starting delivery in 2022. Could you expand on the cadence of the delivery? Is it more front-loaded or back-loaded?

The delivery will be fairly smooth. The first vessel will deliver very early in 2022, and we have a degree of flexibility in the deliveries at this stage, with the last one arriving very early in 2023.

I noticed in the presentation or in your press release, there was a decision to purchase shares in Golden Ocean for around $400,000. While it's not material, I wanted to know more about the decision to purchase shares in Golden Ocean.

This is related to a forward contract we have for Golden Ocean shares. We participated in their right issue, which was in-the-money.

There are no further questions at this time. Inger, Lars, back to you.

Thank you very much for hosting. Also, thank you for listening in. Thank you to the entire Frontline team for their fantastic efforts in Q1, and stay safe, everyone.

That does conclude our conference for today. Thank you all for participating.