Frontline plc Q2 FY2022 Earnings Call

Good morning and good afternoon to everyone. Welcome to Frontline’s Second Quarter Earnings Call. As mentioned in our release, this is the quarter where the LR2s took center stage. The market tends to forget that close to a third of our vessel days come from this asset class. We started to see the displacement of Russian crude and products also affecting the Suezmaxes during the second quarter. And finally, the VLCC got a pulse as the second quarter came to an end. Before we get to the Q2 financials and what lies ahead, let’s have a look at the highlights on Slide 3 in the deck. So in the second quarter, Frontline achieved $16,400 per day on our VLCC, $6,500 per day on our Suezmax fleet, and a very impressive $38,600 per day on our LR2/Aframax fleet. So far, in the first quarter of 2022, we have booked 73% of our VLCC days at $28,100 per day, 73% of our Suezmax days at a solid $45,000 per day, and 62% of our LR2/Aframax days at an even more impressive $46,200 per day. All numbers in this table are on a load to discharge basis and may be affected by the amount of ballast days we end up having at the end of Q3. This is more relevant to the VLCCs that normally tend to go on the longer voyages. It occasionally affects Suezmaxes and to a lesser degree, LR2s. With that, I will now let Inger take you through the financial highlights.

Thanks, Lars, and good morning and good afternoon, ladies and gentlemen. Let’s turn to Slide 5 and look at the income statement. This quarter, Frontline achieved total operating revenues of $159 million and adjusted EBITDA of $98 million. We reported net income of $47.1 million or $0.23 per share and adjusted net income of $42.5 million or $0.21 per share in this quarter. On the right-hand side of the slide, we show the adjustments made this quarter, which consists of an $8.9 million gain on derivatives, a $6.1 million share of results from associated companies, a $1.3 million amortization of acquired time charters, an $0.8 million gain on insurance claims, a $12 million loss on marketable securities, and a $0.4 million loss on the termination of leases. The adjusted net income in the second quarter increased $44.1 million compared with the first quarter. The increase in adjusted net income was driven by an increase in our time charter equivalent earnings due to the higher TCE rates in the quarter, but it was partly offset by an increase in ship operating expenses of $7.5 million, mainly as a result of higher drydocking costs and other movements in income and expenses. Then let’s take a look at the balance sheet on Slide 6. Total balance sheet numbers have increased by $304 million in the second quarter compared to the first quarter. The balance sheet movements in the quarter are primarily related to taking delivery of the 2 new buildings, VLCCs, Front Alta and Front Tweed, together with the acquisition of Euronav shares in exchange for Frontline shares, in addition to ordinary debt repayments and depreciation. As of June 30, Frontline had $351 million in cash and cash equivalents, including the undrawn amount under our senior unsecured loan facility, marketable securities, and minimum cash requirements. Let’s then take a closer look at Slide 7. Keeping costs down has always been in Frontline’s DNA and core values of the Frontline platform is keeping it simple and focused and maintaining lean and efficient management teams. This slide shows that Frontline has been performing well on OpEx, G&A, and interest expense. And this, together with outperformance of peers on revenues for at least two out of three segments this quarter explains the superior operational performance of Frontline in the second quarter of 2022. Then I think we should look at Slide 8. That is the cash breakeven and cash generation potential. We estimate average cash cost breakeven rates for the remainder of 2022 of approximately $24,900 per day for the VLCCs, $20,000 per day for the Suezmax tankers, and $17,200 per day for the LR2 tankers. This gives a fleet average estimate of about $20,700 per day. The fleet average estimate includes the drydock of 6 vessels in the remainder of 2022, with an impact of about $530 per day. The distribution of these 6 vessels is 2 VLCCs, 1 Suezmax tanker, and 3 LR2 tankers. In the second quarter, we recorded OpEx expenses, including drydock of $8,100 per day for the VLCCs, $10,400 per day for the Suezmax tankers, and $8,400 per day for the LR2 tankers. And in the second quarter, we have drydocked 6 vessels, 4 Suezmax tankers and 2 LR2 tankers. The graph on the right-hand side of this slide shows the free cash flow per share after debt service and free cash flow yield based on current fleet and share price, August 24 alternative TCE rates. Based on historic Clarkson TCE rates for non-eco vessels in the period 2021, adjusted for premiums on scrubber and eco vessels, Frontline has a free cash flow per share of $2.34 and a free cash flow yield of 20%. Free cash flow yield potential increases with higher assumed TCE rates on a fully delivered basis. With this, I’ll leave the word to Lars again.

Thank you, Inger. So let’s move on and have a look at Slide 9 and recap the second quarter. I have basically made a title here called a 'pivotal point for tankers.' Q2 is normally a soft quarter, also referred to as a shoulder quarter. But as we see on the graph at the bottom left, something happened as we went into Q2 this year. So global oil demand came in 700,000 barrels per day lower in Q2 compared to Q1, averaging up to 98.4 million barrels. Supply came in at 99.1 million barrels per day, up a modest 0.2 million barrels per day in the quarter. It’s basically the volatility we’ve seen in the market in Q2, and first and foremost, on the LR2s, is a ton-mile story. We are currently reaping the benefits of that story that started during the second quarter. We are seeing highly inefficient trading patterns developing, and this is to the benefit of oil in transit and utilization, as you can see on the graph at the bottom right. Towards the end of the second quarter, we saw all Frontline asset classes, including the VLCC, start to move up. Asian and, in particular, Chinese demand was still subdued, but the current level of activity paints an interesting picture for future starts to come. Let’s move then to Slide 10. So global exports, and what we’re looking at here are two charts depicting the tracked output of oil and products, split from every producing country in the world and every producing product region in the world. We have seen a dramatic change in demand and trading patterns for refined products developing during Q2 this year. I think people tend to forget and it’s a bit overshadowed by the situation in Ukraine that most of the Western world has actually fully come out of COVID – of the COVID-19 pandemic with the effects that it has had on demand. At the same time, refining capacity, particularly in Europe and to some extent, in the U.S. was reduced quite dramatically during the pandemic, where these regions experienced horrific refining margins. In addition to that, we’ve had the situation with sanctions on Russia, making Russian oil and products more difficult to move. So basically, what we see is that global clean product exports are actually approaching the highest levels we’ve seen, taking us back to 2017. If you go further back, AIS tracking is not as efficient as it has been in this period. We are reaching all-time highs on clean products exports globally. Global crude oil exports are improving, lagging though on the product side. This appreciation in the global crude oil exports is primarily caused by U.S. SPR releases and U.S. production and their export capabilities are growing. U.S. production has increased by 1.4 million barrels year-to-date, according to EIA. As most of you would know, the U.S. is releasing what’s equivalent to almost 1 million barrels per day from the SPR. Currently, we see very high demand for tonnage, both in the Middle East and in the U.S. Gulf, indicating that this positive development for freight looks to continue. Let’s move then to Slide 11. And the order book continues to dwindle, particularly on the crude side. There have been no orders for VLCCs or Suezmaxes in the last 12 months. I have to correct myself there a little bit because I saw reports this morning that there were VLCCs ordered or rumored to be ordered in Japan, but we will get back to that. In order to get a significant change to this picture, we need far more. On the VLCC side, we have seen 27 vessels delivered year-to-date, and there are still 21 to come. Some of those will obviously move into ’23. But the total order book is at 41 vessels. We have a fleet of 861 vessels, of which 81 during this year will be over 20 years old. Once this order book is fully delivered, 114 VLCCs will be above 20 years old. On the Suezmaxes, it’s even more pronounced. We’ve seen 25 Suezmaxes delivered this year. There are eight more to come, six next year, and two in 2024. That makes a total of 16 in the order book, and we have 65 Suezmaxes that will pass the 20-year threshold this year. Looking at the time the order book delivers, there will be a total of 111 Suezmaxes that would effectively be disqualified from the commercial trading oil market. On the LR2s, we have seen some orders placed this year. The broker varies, but we’ve identified 13 orders. Still, I would argue that that’s not an alarming development. There are 20 LR2s or at least vessels registered as LR2s that are going over 20 years this year. However, if we heighten the threshold a little bit and put it at 15 years, which is a more relevant yardstick for anyone that trades clean products, we have more than 70 LR2s built prior to 2008. So basically, when this order book has been delivered, this will come to age. We’re not really alarmed about the development on LR2s either. If we look at the chart at the top left side here, this has become quite repetitive over the quarterly presentations that we have had. The blue line is the absolute deadweight size of the tanker order book, and the yellow one is as a percentage of the fleet. As we can see in absolute deadweight, we’re back to 2000-2001 period. We all know that the oil market is much larger now than it was in 2000. In terms of the percentage of the fleet, it’s even more pronounced, where we need to go back to 1996 and even before. I don’t have history prior to 1996 on this, so it’s difficult for me to gauge if we are in the early-90s, mid-90s, or in the ‘80s. But this is an alarming development, and we’re starting to see the early signs that tankers could become a bottleneck in the energy logistical chain. I’d like to add, though, for those of you not familiar with freight and tankers that not every country in the world is blessed with oil. There is also an asymmetrical relationship between population growth and oil resources. So this transportation need is real. Let’s see how this develops. Moving over to Slide 12, I find this quite exciting. The time charter market has almost erupted over the last month. The time charter of the period market is an old-school bellwether for large oil transporters' expectations. These are, as we refer to them, the big guys, including Shell, Equinor, BP, Chevron, and others who have substantial transportation needs in the market and are looking for up to 3-year commitments on time charters. Even for them, a 3-year commitment is significant. Earlier in the reporting season, we saw even 5-year charters being concluded. This is extremely interesting and encouraging. This is in line with the spot market, but it’s not often that you see this kind of activity in the long-term time charter market following a relatively short period of firm spot markets. This means that our analysis might be in line with some of these companies' analysis. Frontline will remain a spot-focused owner with the objective to offer our investors stock-market returns. However, a certain degree of secured revenue and margin plays a part of our long-term vision. We are actively looking at the time charter market for some of our asset classes. Let’s move over to Slide 13. Although it’s been fairly quiet from Frontline in this respect for the last month, I would say that the Frontline and Euronav combination is on track. We are moving forward. The part of the process we are in now is led by legal, focusing on regulatory requirements. We’re working towards a Frontline relocation filing for the shift from the platform in Bermuda to Cyprus. This will be followed by a tender offer, which we expect to happen in Q4 this year. There have also been discussions around various outcomes of this tender offer. I’ve left out the scenario of achieving less than 50% acceptance, as we don’t believe it will happen. We think this is an industrial solution that the market wants. If we achieve above 75% acceptance among the Euronav shareholders, we will go directly to a merger with Euronav. Should we, in the end, find ourselves between 50.1% and 75%, the outcome is more or less the same. Frontline gains control of Euronav, and a combination of the two complementary platforms will be created that will operate as one company, although Euronav will remain a subsidiary of Frontline. Let’s move to Slide 14 and conclude. So Q2 ‘22 was a shoulder quarter, in terms of oil demand. And in fact, Q3 should have been the same if we follow normal seasonal patterns. This is currently a turbulent story, with sanctions on Russia being a catalyst, but we may face structural catalysts regarding products. I mentioned earlier the dislocation between refining capacity and demand. Global crude oil exports are approaching pre-COVID levels, and oil in transit is already there. The order books continue to dwindle, and there are currently no incentives to invest in new capacity yet. Also, there is a question of when this capacity can be brought to market if ordering starts now. The other question is, are we starting to feel the structural bottlenecks of oil transportation that may come? Frontline has a modern, efficient, spot-exposed fleet, and the stars are looking to align, and I might add, winter is coming. I’d like to draw your attention to the chart at the bottom, which is different from the last three quarters. It’s a seasonal chart of the average weighted earnings of all tankers, not just Frontline tanks, it covers all tanker indices. As you might notice, there’s a very unusual seasonal pattern evolving. With that, I’ll open up for questions.

The first question comes from Jonathan Chappell from Evercore ISI. Please proceed.

Thank you. Good afternoon. Lars, two quick questions on capital allocation. First of all, it’s good to see the dividend renewed for the first time. If we do the math, it looks like maybe a 70% payout ratio has just been so long. Just want to get confirmation on a rough range? And then the second part to that question is, as we’re going through the final steps of consummating the Euronav transaction, are there any restrictions on the amount of dividends or any other corporate actions you can take until that process?

First of all, Inger just handed me a note here. I believe it’s up 79%.

Yes, because we need to calculate the dividend basis to 222.6 million shares outstanding at the end of the second quarter, I mean. So when you do that, it comes out to 79%.

Yes, and back to your other question, the combination agreement was made public in July and the exchange ratio is set. It’s within that exchange ratio that the dividend has been paid. For future dividends, it needs to be adjusted either via the exchange ratio, which is very unlikely, followed by the new shareholders that Frontline will have post-merger.

My second question for you, Lars, is you mentioned in the presentation that you haven’t really seen China come back to the market yet. It feels like Russia is still pretty reliant on – I am sorry, Europe is still pretty reliant on Russian crude and the sanctions clearly haven’t gone into effect yet. Is there any way to quantify or even qualify what’s driven this VLCC spike before you are really seeing the impact of these two potential big catalysts into the market?

Well, first, I would like to say that the European and U.S. sanctions on Russian crude have not affected the Russian flows per se, but they’ve altered the trading pattern. So, what we see right now is that Russian crude oil and Russian products are sailing past Europe and to Asia. At the same time, Europe has had to change its purchase patterns, importing to a much larger degree feedstock and products from the Middle East, West Africa, and the U.S. This has created a highly inefficient trading pattern. It’s kind of like the sanctions stopped Russian crude from entering Europe. Regarding the VLCC, that’s a very recent development. I think it’s more related to U.S. production and the U.S. SPR release and their export capabilities. As you know, I’ve described in previous calls that the oil market is like a toothpaste tube. If you press it, the toothpaste will come out somewhere. U.S. crude oil has priced itself to go far east, with the share price reflecting that volume being offered. So, I think that’s the game changer here. I also think that the flattening of the oil curves in a steep backwardated market makes it quite expensive to hold large volumes of crude oil over a long voyage, which is essentially unhedgeable. With the flat structure in the crude oil market, it’s easier to hedge your exposure over the 60 days necessary to transport crude from say the U.S. Gulf to China.

Okay. That’s all very helpful. Thank you, Lars, and thanks, Inger.

Thank you for your question. We are now taking our next question. The next question is from Chris Tsung from Webber Research.

Hi. Good afternoon. How are you?

Thank you. Very good.

Thanks. Yes. Just to follow up on that last question. So, are you saying that you will continue to see VLCCs/Suezmaxes for the near-term, is that right?

Basically, what we are seeing is that at least VLCC, when these large trade lanes open up as we have seen U.S. Gulf to Asia or North Asia. You utilize the vessels for a very long period of time. So, it takes away capacity for a long time. We also see the activity continue. When we fix VLCCs now, we fix them for late-September, so the oil will be lifted in September and delivered to China sometime in late-October to early November. We see this continue as October dates are already being addressed. This does, however, create a bit of a hole in the Suezmax program because they are fixed closer to the loading dates. At the same time, the Suezmax has a lot of support from the flow of crude from both Middle East, and primarily West Africa, into Europe. We basically see this continuing, or maybe even firming.

Okay. Great. Yes. Thanks for that color. That’s really helpful. Just on to your fleet mix, I know in the presentation, you guys are not looking at new capacity to ship, but with these deliveries into early next year and the potential merger with Euronav fleet, which is heavily be-weighted. I just wanted to understand, is there a desire to rebalance your fleet mix, or how should we think about that?

You are absolutely correct. There is a desire to rebalance our fleet mix. Historically, Frontline has been predominantly a VLCC company, secondary having Suezmaxes. The LR2 additions to our fleet are actually relatively new in the long term. We do see them as very efficient trading vehicles, as this quarter’s story shows. It’s simple analysis, which we have repeated a few times, but I am happy to repeat it again. If you look at the average cash breakeven Frontline has per vessel class and consider the economies of scale in oil transportation, you will find that the lid on VLCC peaks is much higher compared to Suezmax or LR2. This is where the value in a good market lies. This has been our client's philosophy all along. We are also quite good at running VLCCs and have a solid client base in that segment. Hence, the Euronav transaction is aligned with our continuing story.

Got it. Great. Thank you. And just if I can squeeze one last modeling question just noticing your admin costs have inched up a bit this quarter. Is this a one-time thing associated with the time merger with Euronav versus something else?

Yes, you are right. We do have higher professional fees relating to the merger this quarter than usual.

Okay. So, it wouldn’t be like the run rate going forward is just slightly elevated this quarter and maybe into next?

As long as we are in the process of combining the companies, you could assume that we will have higher professional fees and legal expenses in the next quarters to come.

Alright. It makes sense. Thank you, Inger. Thank you, Lars.

Thank you.

Thank you for your question. We are now taking our next question. Please stand by. The next question is from Omar Nokta。

Hi there. Hey guys. I have a couple of questions for you just on the Euronav transaction. Obviously, in the second quarter, you did a few share deals that took your stake up to around 20% in Euronav. Is there anything that prohibits you from doing more, assuming the opportunity exists to take your position higher ahead of the tender offer?

It is in fact limited. There is a regulatory mechanism called the creeping tender offer. If you continue this, at least U.S. legislators don’t deem it the correct way of going about this. That’s why we stopped there. There are limitations when you become a related party, but that’s not necessarily a significant issue as we are very much related through the combination agreement already. Still, there’s no incentive for us to continue that path.

Yes. Got it. That makes sense. Appreciate that. And I guess this is maybe sensitive, I understand if you are not able to respond, but are you having any discussions with the Euronav shareholder that has been vocal in his opposition to the deal, maybe reaching an amicable solution, or does it just simply come down to how the tender offer comes about later in the year?

In the end, it comes down to how the tender offer works out and the outcome when we count the shares.

Understood. Okay. Alright. Thanks, Lars.

Thank you.

Thank you for your question. There are no further questions at the moment, so I will return the conference for closing remarks.

Okay. Thank you very much for calling in. Again, these are exciting times. We are quite excited both by the market developments and our ambitions with regards to the combination of Euronav. So, with that, thank you and have a good day.