Frontline plc Q3 FY2022 Earnings Call

Good day. And thank you for standing by. Welcome to the Q3 2022 Frontline Limited Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there'll be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to turn the conference over to your speaker today, CEO, Mr. Lars Barstad. Please go ahead.

Thank you very much. Good morning and good afternoon to everyone. Welcome to Frontline's third quarter earnings call. It's quite satisfying to report from a part of the market that is seeing exceptional earnings right now. I have humorously referred to tankers as a safe haven during market volatility, and this has certainly proven to be true in the last six months. In the third quarter, we noticed all asset classes that Frontline trades beginning to perform. I say beginning because some time has passed since the end of September. There are three important topics I will elaborate on later in this presentation: crude and product displacement due to sanctions on Russia; Chinese imports beginning to recover from the COVID-19 lockdowns; and the situation with U.S. exports. Before we delve into the third quarter financial results and the outlook ahead, let’s review the highlights on slide 3 in the presentation. In the third quarter, Frontline achieved $25,000 per day on our VLCC fleet, $41,100 per day on our Suezmax fleet, and $40,200 per day on our LR2/Aframax fleet. Up to now, in the third quarter of 2022, we have secured 75% of our VLCC days at a solid $77,200 per day, 76% of our Suezmax days at $65,400 per day, and 70% of our LR2/Aframax days at $58,000 per day. All figures mentioned are on a load-to-discharge basis and will be influenced by the ballast we have at the end of the quarter. However, this suggests a decent Q4 ahead. If we quickly move to slide 4 in the presentation, I'll reiterate some key points about the Frontline fleet composition. I want to remind everyone that we continue to maintain one of the youngest and most energy-efficient fleets in the industry. We have received a few newbuildings this year, with two more expected to arrive in January for our VLCC segment. After deliveries and the installation of scrubbers in Q4 and Q1, we will have 21 out of 23 VLCCs equipped with scrubbers; 21 out of 29 Suezmaxes will be fitted with scrubbers; and 4 out of 18 LR2s will have them as well. As indicated on the right side, the average spread between the eco scrubber segments and the non-ecos appears to have narrowed, but this is misleading since the absolute rates have increased. VLCCs fitted with eco scrubbers will earn $24,200 per day compared to their non-eco counterparts; for Suezmaxes, the same relationship applies with $13,500 per day; and $12,300 per day for LR2s. Now, I will hand it over to Inger to discuss the financial highlights.

Thank you, Lars, and good morning and good afternoon, ladies and gentlemen. We can turn to slide 5 and look at the income statement. Frontline achieved total operating revenues net of voyage expenses of $209 million and adjusted EBITDA of $148 million in the third quarter of 2022. We reported net income of $154 million or $0.69 per share and adjusted net income of $82.9 million or $0.37 per share in this quarter. On the right-hand side of this slide, we have shown the adjustments made in this quarter, which consist of a $15.8 million gain on derivatives, a $5.7 million share of results from associate companies, a $0.3 million amortization of acquired time charters, a $2.8 million gain on insurance and other claims, and a $47.1 million gain on multiple securities. Adjusted net income in the third quarter increased by $40.7 million compared with the second quarter. The increase in adjusted net income was driven by an increase in our time charter equivalent earnings due to higher TCE rates in the quarter, partly offset by an increase in interest expense, as a result of higher interest rates and an increase in administrative expenses as a result of costs in relation to the proposed business combination with Euronav. The Board of Directors announces its intention to declare and pay cash dividends in respect of the third quarter of 2022, only after the tender offer has been completed. This dividend is expected to be in the amount of 80% of adjusted net income for the third quarter of ‘22, payable to record holders after completion of the tender offer in 2023. Then let’s move to slide 6 and take a look at the balance sheet. This quarter, the total balance sheet numbers have increased by $184 million. The balance sheet movements in the third quarter are primarily related to taking delivery of one newbuilding VLCC, the Front Tana. The increase in carrying value of the shares held in Euronav, the increase of the current assets due to the increase in voyages in progress and trade accounts receivable and also the net income in the quarter. As of September 30th, Frontline had $406 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 at slide 7. Cost comparison with peers. Keeping costs down has always been in Frontline’s DNA, and the core values of the Frontline platform are to keep it simple and focused and maintain a lean and efficient management team. This slide shows that we outperformed our peers in terms of lower OpEx and interest expense in the third quarter. On G&A, one peer is lower than Frontline this quarter due to increases in administrative expenses, as a result of costs in relation to the proposed business combination with Euronav. Then I think we should move to slide 8, cash breakeven and cash generation potential. We estimate average cash cost breakeven rates for the remainder of 2022 of approximately $25,000 per day for VLCCs; $20,200 per day for Suezmax tankers, and $17,200 per day for LR2 tankers, which brings us to a fleet average estimate of $20,900 per day. The fleet average estimate includes the start-up of two vessels, one VLCC and one LR2 tanker in the remainder of 2022, with an impact of about $380 per day. We reported OpEx expenses, including dry dock, in the third quarter at $8,800 per day for VLCCs, $7,500 per day for Suezmax tankers, and $8,900 per day for LR2 tankers. We dry docked four vessels in the third quarter, one VLCC, one Suezmax tanker, and two LR2 tankers. The graph on the right-hand side of the slide shows free cash flow per share after debt service and free cash flow yield based on current fleet and share price. Based on historic Clarkson TCE rates for non-eco vessels in the period 2000 to year-to-date 2022, adjusted for premiums on scrubbers and eco vessels, Frontline has free cash flow per share of $2.37 and a free cash flow yield of 18%. Free cash flow yield potential increases with higher assumed TCE rates and also on a fully delivered basis. With this, I'll leave the word over to Lars again.

Thank you, Inger. And let's start to dig into the tanker markets. So, if you look at slide 9. The headline I have chosen this time is, 'Is This the Start of a New Bull Market?' Global oil supply is back to 2019 levels, around 100 million barrels per day. The EIA in September reported 101 million barrels per day of production and 100 million barrels per day of consumption. Global crude oil exports reached 40 million barrels per day during the third quarter, and this is approximately 40% of global production that moves to the oceans. And this is a normalized situation for tankers. Oil in transit, though, moved significantly up, reaching the highs of 2020. You can see this on the chart at the bottom left here, where global crude oil exports are around or about 40 million barrels per day, but the yellow line, global oil in transit, is actually flirting with the levels we saw in Q1 2020 when Saudi Arabia and Russia were engaged in a crude oil price war. The explanation for this is largely due to the situation with sanctions on Russia. I would like to note that laden days are only up 10% year-on-year, while the load-to-load businesses, meaning that the distance from when a ship loads a cargo until it gets to its next cargo or engagement, is up 20%. If you look at the chart on the right, this is important, particularly now as we are overwhelmed with news of OPEC, news of Russian sanctions, and news of everything else. People tend to forget that China is actually starting to move. So, Chinese oil imports are on the rise; they are actually up 1 million barrels per day in Q3 alone, and this is a steep trajectory. Preliminary numbers for November tell us that Chinese crude oil imports are in fact up 3 million barrels per day from the bottom in July. As I will come to later in the presentation, time charter markets and asset prices are on the move. Let's move to slide 10 and look at new trading patterns. If you look at that somewhat confusing graph on the bottom left-hand side, you will see that European imports of oil and products from Russia are down 1.4 million barrels per day year-on-year. This is November last year compared to this November. This shortfall is largely replaced by imports from the U.S., Latin America, and Asia. If you look at the two columns on the right, they amounted to 1.3 million barrels per day. The products and oil that come from Asia have three times the travel distance than from Russia. What comes from America or Latin America is at least twice as far as Russia. We have seen exports from Russia sailing past Europe to Asia to the same extent. The orange column on the Russian headline is 1.3 or 1.4 million barrels per day, equating to what Europe is replacing. Mind you, Europe continues to import 3.2 million barrels per day from Russia. We are now facing increased sanctions represented by the price cap. After the 5th of December, the jury is still out on how this will play out, but these flows may change even further. If you look at the chart on the right, the U.S. has played an important role in the last six months of the year by adding volumes to the market through their SPR releases. There's a fear in the market that once this SPR release finishes, how much capacity will we lose out of the U.S.? In the bottom chart on the right-hand side, I've simplified this a bit. The gray area is U.S. net export. It's basically U.S. exports, minus the SPR release. We all know that the SPR is not connected to the ocean, so the SPR feeds the U.S. refining system, which has the capability of exporting more. Despite the SPR release, we have seen the outright net exports from the U.S. increase, particularly lately. The jury is still out on how significant the fall in U.S. exports will be once the SPR stops releasing barrels. If we then move to slide 11 and look at the assets and the TC markets, as the spot markets move, so will the time charter rates and asset prices. There has been and there still is hectic activity in the time charter market for tankers as charters try to seek cover. With the current order book and fundamentals for oil, there is an increasing interest in tonnage. There's almost a fear of not having the capacity to freight oil going into the future. Resale prices are now higher than contracting, and this is due to the timing of available yard space. If you look at the chart on the bottom left here, this is resale values as quoted. The dark blue line is for VLCC resales. It's actually a little below where the actual market is. The last whisper number on the VLCC resale is $130 million for a scrubber fitted prompt delivery. A new order will be delivered in three years at the earliest. This basically creates a gap in the delivery chain of freight capacity, and this is a worry for people who are short on freight. As the conviction in the current rate environment grows, rates will follow. I had an interesting discussion with an investor the other day regarding the current fundamentals, and he realized that this could actually last—what then? Interestingly, if you look at long-term historicals, the weighted tanker sector earnings are now at levels last seen in 2005. The reason for this is that the Aframax and the LR2 segments are making far more money than they have ever previously. This is not a typically unusual market for VLCCs; it’s a high market for Suezmaxes and an astronomical market for Aframax and LR2s. We have not seen current resale prices at these levels for 14 years. Let's move to slide 12 and look at the tanker order books. On the top left-hand chart here, I've lumped together the asset classes that Frontline is exposed to, namely the VLCC, the Suezmax, and LR2s. If you sum up the number of vessels that are currently over 20 years old, where we argue that trading efficiency is not only limited but almost impossible in compliance with the current tanker market, that pile of ships amounts to 163 vessels. The order book for the same segment stands at 92, and that order book is to be delivered over the next two to three years. This relationship does not make sense. To further illustrate, you could add some of the 303 vessels of these asset classes that are currently over 15 years, where almost half of them will reach the 20-year threshold while the existing order book delivers. I think this recycle pool order book ratio is an interesting concept. Let's move from slide 12 to slide 13 and discuss the Frontline and Euronav combination. As you know, anything and everything around this combination is quite sensitive. I just want to go through the steps. The Frontline relocation comes first and is in process. Post that, we will launch the tender offer. A lot of analysts and market players have asked about these delays. These are regulatory delays. The process of moving Frontline from Bermuda to Cyprus has proven complicated. There are many regulatory bodies involved, and they take time. However, we are committed to this process. The tender offer launch has slipped to Q1 next year. The outcome remains the same: depending on the level of support we get in the tender offer, if we get above 75%, we will push forward with a merger. If we are between 50.1% and 75%, we will form a group on Frontline. We will gain controlling interest in both scenarios. Let's then move to slide 14 and sum up what we discussed. The ton-mile story continues, and further inefficiencies are expected post the 5th of December. The global crude oil exports are now at pre-COVID levels, and oil in transit continues to be very firm. The order book to recycling pool ratio is at unprecedented levels. The order book stands at around 5% of the existing fleet, while 9% is in the so-called recycling pool. The markets are pricing in limited free supply in the spot markets, in the TC market, and also on assets. In all this, Frontline has a modern, efficient, spot-exposed fleet. The story unfolds as winter is indeed upon us. So, with that, I'll say thank you and open up for questions.

Thank you. Your first question comes from Omar Nokta from Jefferies. Please go ahead.

Thank you. Hey, guys. Good afternoon. Hi, Lars. Hi, Inger. Thanks for the update. Obviously, very exciting times across the tanker space. I wanted to ask about the latest topic you had in the presentation about the merger, and then maybe just on the redomicile from Bermuda to Cyprus. I know there are regulatory issues there. But does that ultimately require a shareholder vote to do, or can that be done in the ordinary course of business?

No, it will require a shareholder vote.

Okay, that will. All right. When you consider the timing of the tender offer in the first quarter, based on your conversations with various authorities, do you anticipate that occurring? Is it more likely to take place in January, or do you think it will happen in March? Can you provide any insight on that for us?

It's almost impossible to answer. As we've proven, the timing with the filing of relocation has obviously taken an unexpectedly long time. But we remain positive and optimistic, and the documentation has been done in parallel here. So, we do hope that this process will be far more efficient. In fact, we can file documentation for the tender offer before the relocation is effective.

Okay. Thanks for that. And maybe just more about the market. Obviously, you were talking about the Aframaxes and LR2s being at exceptionally high levels, rates we haven't seen before historically. How are you thinking about that segment right now? You’ve got those 18 ships, 2 of them I see around those attractive longer-term contracts, but the remaining 16 or so, how are you trading those? Are those in the clean trades or some of those shifted into dirty?

Well, the majority of them remain in the clean. I think last quarter I mentioned that we had 6 out of 18 trading in dirty; now that number is temporarily 7. Basically, one ship was offered a cargo it couldn't refuse. Overall, you need to look at this in two dimensions. One is the general macro change here where refining capacity has increased further away from key demand centers. The COVID pandemic was a blow to a lot of refining capacity in Europe and some in the U.S. This underpins a fundamental change in trading patterns, which is here to stay. This has been turbocharged by the inefficiencies surrounding the sanctions on Russia. Europe has been dependent on significant product imports from Russia, particularly diesel, which now needs to be sourced from elsewhere. This is causing a refinery margin environment that we haven't really seen before, or at least not in a very long time. I think short-term, we can expect these super inflated clean rates to continue. In the longer term, we have this kind of fundamental change in the dynamics that will help this market going forward, but maybe not to the same elevated state we're seeing right now.

And your next question comes from the line of Chris Robertson from Deutsche Bank. Please go ahead.

I just wanted to talk about the dividend for a moment, not as it stands today, but maybe in the future. Lars, you talked about maybe a stronger-for-longer scenario here with rate strengths. I’m curious about the cash dividend for Q3 at 80% of adjusted net income. How should we think about that going forward as we get closer to 2030, as there's maybe more technological clarity around future fuels, things like that? Would there be a change so that you could have more cash on hand to pursue additional growth opportunities or fleet renewal in the future?

Well, it's a good question. If you look at history, Frontline has a tendency to pay out dividends, then uses other means of financing to finance investments in new tonnage and so forth. The only times we've kept back from paying a handsome dividend have been in situations where the markets have clearly changed fundamentally. I don't know if that answers your question fully. I would like to say, though, that 80% of net income is in line with what Frontline historically pays when we make money. It's our key ambition to give our investors cash we make directly. I think that's the normal conduct of business.

Yes, that's fair. I guess just as a follow-up, that’s a million-dollar question. As you mentioned, what will the market fundamentally be different as we approach 2030 compared to today? There's quite a few years' runway here with the current order book and everything else going on. But then, as we get closer to the end of the decade, that's kind of the question I was trying to get at. How different is that market?

I'm sorry, Chris, but that's a very good question. You call it the million-dollar question. I wish I could answer it. At Frontline, we tend to be late adopters when it comes to new technology and new fuels. We will always try and position ourselves towards regulatory changes and execute best practice as far as we can. The jury is still out. Most of our tonnage is deep ocean, long-traveling ships, and as it stands right now, there isn't really an alternative energy source for these ships. It could be that if gas prices or LNG prices drop significantly, the economics of LNG propulsion could come back to compete, but it's difficult to envision. Keep in mind that the kits are going to be more expensive as we proceed, basically because investments will need to be made to reduce carbon footprints. However, I don’t even dare try to put numbers on that apart from the general direction. In all fairness, we have actually reduced quite a bit of emissions, and we are committed to follow regulatory demands to reduce our emissions. We will do so, but obviously at a certain point, the ships can't go any further.

Yes, thanks for indulging the scenario and walking us through that. It's great color. I'll turn it over. Thanks.

Thank you. And your next question comes from Greg Lewis from BTIG. Please go ahead.

Lars, clearly, you guys have been doing a lot of work. Thank you for the presentation. I did have some questions around the impact of the Russian crude embargo. I have a couple of questions: as these volumes need to go farther field because they got diverted away from Europe, what types of port restrictions are there from these export areas? Can we think about places like the Gulf of Mexico, where there's a lot of wide transfers as smaller vessels then move out to ship oil on larger vessels for their final destination? Is that something we should logistically be thinking about that could tighten the market further?

Yes. First, it's a good question, and this is evolving. I've previously talked about the dark web of oil markets involving Iran and Venezuela. The Russian trade I refer to as a gray market—these are all good vessels sailing in accordance to class, potentially uninsured in markets outside of normal shipping. What you're pointing to is that this largely inefficient trade will likely grow, meaning we might use bigger tonnage to benefit from volume of scale, at least if Asia continues to take Russian crude. Yes, we're already seeing this, not inside the EU territory yet, but we are seeing activity in STS operations. The concerning part is that not all of these areas are suited to assure safety, and pollution risks increase. We've also seen high activity in the sale and purchase market for more vintage tonnage that we expect to see entering this market. I'm talking about 17 to 17.5, or even 15-year-old Suezmaxes that have been bought recently and may appear to make this trade more efficient.

My other question was more around insurance. As I think about a cargo looking for insurance in the gray and the black market, is that cargo generally insurable? Is it something that's usually provided by the buyer or the seller for shipping?

It's—the environmental risk once the cargo is aboard ship is taken care of by the ship owner. But you're pointing to a very good question. Russia has a significant internal insurance market, but if that market can underwrite this type of risk is a big question. The price cap is uncertain, as we still don't know how it's going to be applied. There could be a scenario where oil is sold according to the price cap, and thus the sanctions wouldn't apply. In that case, the western insurance market would be able to assist. But just to reiterate, if this oil continues to trade in a manner where insurance isn't certain, that's a big concern.

Yes, definitely interesting times in the market. This was super helpful. Thank you very much.

Thank you. There are currently no further questions. I will hand the call back to you.

Okay. Thank you. And thank you so much for listening in. Exciting times indeed, and have a very good Christmas when that comes. Thank you.

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect. Speakers, please stand by.