Frontline plc Q1 FY2023 Earnings Call

Good day, and thank you for standing by. Welcome to the Q1 2023 Frontline PLC Earnings Conference Call. At this time, all participants are in a listen-only mode. I would now like to hand the conference over to the CEO, Mr. Lars Barstad. Please go ahead.

Thank you very much dear all, and thank you for tuning into Frontline's first-quarter earnings call. We’re a bit late, but we’re expressing what we are. We’ve had a seasonally strong first quarter of the year. Russia still has an impact on the market due to sanctions, but the key part of the action in Q1 was related to China. The strong Q1 has given us the ability to book quite strong numbers into Q2, as well as the Frontline team relentlessly growing to create shareholder value. Before I give the word to Inger, let’s look at the TCE numbers on Slide 3 in the deck. In the first quarter, Frontline achieved $52,500 per day on our VLCC fleet, $64,000 per day on our Suezmax fleet, and $56,300 per day on our LR2/Aframax fleet. In fact, we are back to a somewhat reverted earnings relationship between our segments, with the Suezmaxes outperforming the VLCCs and the same for LR2s. We have secured quite firm numbers as we progressed into Q2, with 78% of our VLCC booked at $75,000 per day, 71% of our Suezmax days booked at $65,000 per day, and 63% of our LR2/Aframax days at a very respectable $65,700 per day. Again, all these numbers in the table are on a load-to-discharge basis, and they will be affected by the amount of ballast days we end up having at the end of Q2. And mind you, this is Q2, which is supposed to be the weak point in the market. With that, I'll give Inger the word. She will take you through the financial highlights.

Thanks, Lars. Good morning and good afternoon ladies and gentlemen. Then let's turn to Slide 4 to the profit statement and look at some highlights. As Lars already stated, Q1 2023 is the highest first-quarter profit since 2008. Q1 2023 is also the first interim financial information presented by the company on IFRS. Following the transition to IFRS, one important thing is that drydocking costs will be capitalized and subsequently depreciated over the period to the next scheduled drydocking, which ranges from 2.5 years to 5 years. Q1 2023 drydocking costs were $3.6 million that have been capitalized, and 3 vessels were drydocked in the quarter. I will also mention that the company has revised the estimated useful life of its vessels from 25 years to 20 years, effective January 1, 2023, which resulted in an increase in depreciation expense of $12.7 million in Q1 compared to Q4 2022. Now, let's move to Slide 5 and look at some balance sheet highlights. The company has no remaining newbuilding commitments in Q1 2023, as we completed the delivery of the last two business unit buildings, Front Orkla and Front Tyne, in January 2023. The company has a strong liquidity position of $584 million in cash and cash equivalents, including the undrawn amount of unsecured facility, marketable securities, and minimum cash requirements. Lastly, the company has a healthy leverage ratio of 52.9%. Let's look at the cash flow potential of the company next. We estimate industry-leading cash break-even rates fleet average that includes drydocking costs for 8 Suezmax tankers in 2023. Four of them are expected to be drydocked in the third quarter, and 4 are expected to be drydocked in the fourth quarter. The Q1 2023 average OpEx, excluding drydock, was $7,300 per day. The free cash flow indicates strong potential return for the company, as shown in the table on the right-hand side. Assuming received rates of $75,000 per day, with the 5-year historic spread to be received for Suezmax and LR2 tankers, the annual free cash flow potential is about $1.4 billion or $6.29 per share, representing a free cash flow yield of 42%. And with this, I will hand it back to Lars.

Thank you very much, Inger. Let’s have a quick look back at the Q1 2023 tanker market. I already mentioned that it was typically seasonally strong. Normally in Q1, we kind of sober up after the Q4 hype, and markets will fairly quickly start to deteriorate into February. What happened this time around was that we had a second peak in the market in March, and the segment was performing very, very strong. If you look at the chart at the bottom left here, you will find how elevated the average weighted market earnings are. The reason for this is that not only VLCC and Suezmax, but also Aframax and LR2 are very strong. If you compare it to the period we like to look back on from 2003 to 2009, we are actually quite high up on the earnings side, as the markets are performing very well. Chinese imports moved to all-time highs; we also saw the highest number of VLCC shipments to China. As I said, Russian sanctions continue to yield inefficient trading patterns, but it is more about China as that situation seems to have stabilized. However, we had a mild winter in the Northern Hemisphere during Q4 and Q1, which muted oil demand to some extent. Moving to Slide 8, we received an OPEC cut or a voluntary cut. The volumes are indeed down for May, but what about ton miles? Russia continues to export. With the current oil price scenario, the G7 cap is not an obstacle to Russian oil exports, and we see Russia pumping relentlessly. This is quite interesting ahead of the OPEC meeting on June 4. Both OPEC+ and non-OPEC volumes were down in May, but we need to remember this is the seasonal slow point of the year with high refinery turnarounds. Global oil demand is expected to rise by around 2 million barrels per day in the second half of 2023. The overall global exports are indeed back to pre-COVID levels, albeit a bit slow in May. It will be exciting to see what the U.S., Brazil, and West Africa can do post-summer, as those three countries may have the ability to export more volume as we move into winter. Now, let's move on to Slide 9. Vessel utilization remains high but is volatile. We see this data from Signal Ocean, which records every fixture done on various asset classes and measures the number of days that vessels are laden. If you look at the chart at the bottom left, you will see that VLCC utilization is quite elevated, compared to historical patterns. It has corrected down; it might be a bit muted right now, but VLCC is still affected by the rally in Q1 and the mini rally we just experienced. If you look at the Suezmaxes, they are high relative to previous years but have also corrected a bit in the past couple of months. LR2s are back to trend, although high in the trend. The key takeaway from these three charts is to observe the overall direction of utilization and ton-mile demand throughout the year. We are currently at the low point in the cycle, and the direction towards the end of the year, based on historical patterns, could be very interesting. Now let's move to Slide 10 and have a quick discussion on the order book. I'm not going to delve too deeply into these charts; they tell their own story. It’s quite remarkable that by the end of this year, we will have 111 VLCCs still operating in the market that are over 20 years old, which amounts to 12.6% of the current trading fleet. The order book stands at 16 vessels yet to be delivered, amounting to 1.8% of the fleet. For Suezmax, about 14% of the fleet will be above 20 years old as this year ends, and the order book stands at about 3% of the existing fleet. For LR2/Aframax, the global fleet is only 415 vessels. Twenty-five of those are over 20 years old; it’s more relevant to look at 15 years to be conservative. The order book there is growing and significant, currently standing at 12.8% of the existing fleet. Overall, for the segments we’re exposed to, close to 12% of those fleets will be over 20 years old, with an order book at 4.6%. It's very challenging to foresee a scenario on the supply side that will disrupt the tanker story until well into 2026. To sum up, Frontline delivered the highest Q1 profit since 2008 at $193 million, with a cash dividend of $0.72 per share. We continue to capture value at a time charter analysis at an advantageous point in the cycle. New orders are occurring for Suezmax and LR2, with 2025 now firmly sold out and you can build in 2026 in China. In Korea, you probably need to look to 2027. We also see only two orders year-to-date, though more are being discussed, and 12% of the tanker fleet we are exposed to will be over 20 years old by the end of this year. The OPEC transactions have had limited impacts so far in May, and it looks like they are being countered. Again, China will be the X factor as we progress through the summer low. Lastly, I’d like to explain a bit on the chart below. I just presented for a group of students from Denmark, explaining the long-term picture in oil and tankers. The blue line represents oil demand, which tends to grow with population growth, and the yellow graph shows annual fleet growth as we approach 2025. Although this is a bit of apples and pears, it simply doesn’t add up. With that, I would like to open it up for questions.

And the first question is from Jon Chappell from Evercore ISI. Please go ahead. Your line is open.

Thank you. Good morning, Lars or good afternoon. First question is on strategy, some interesting developments since the end of the quarter with the sale of the vessel and the two time charters on the LR2s. Are you at the point in the cycle now where you're looking at harvesting some of the older tonnage that may not be core? I think there are 10 ships that are over 8 years old. Also, are you considering doing more time charters on the LR2s and keeping the larger crude ships available for spot?

Yes. First of all, when we look at the fleet and which vessels could be potential sales candidates, we look at efficiency primarily. We are preparing for a tighter regulatory framework for CII and ETF and other regulations. It is with that in mind that we evaluate this. Certainly, we also consider the values that are achievable. So far, the time charter side has seen elevated values on the Aframax/LR2, and there has been notable price action on the second-hand Suezmax side. Thus, it feels natural to capitalize on these opportunities. Yes, we are willing to tap into the markets when we see values that meet our internal benchmarks for significant gain on certain asset classes over a sustained period. We must keep in mind that the average breakeven cost on our Aframaxes/LR2s is about $46,500 per day, against which the cash breakeven is $16,800, making it an opportunity we can't pass up. On the asset side, while we are not publicly offering all our vessels as a strategy, we will consider selling less efficient vessels if the opportunity arises.

If I could just follow up on both of those topics, there seems to be more skittishness regarding the OPEC cut, global recession, and weak oil prices, etc. Although you laid out a framework where the next two years should remain robust, have you noticed any slowdown in transaction activity regarding older vessels, which have been quite active over the last 12 months? Additionally, have you experienced any slowdown in the willingness of charterers to commit for a 2- to 3-year duration?

I would be lying if I said no. As you well know, given your long experience in this industry, our focus tends to shift towards big deals when the spot market is strong rather than the opposite. Right now, we are experiencing volatility, along with some weakness in segments, which indeed changes sentiment a bit. However, I don’t consider this a long-term event. I don’t foresee a situation where global oil demand falls significantly. Such fluctuations are typical for Q2, to be quite honest.

Yes, that makes complete sense. Thank you, Lars.

Thank you.

Thank you for your question. We are now taking the next question. Please stand by. The next question is from Amit Mehrotra from Deutsche Bank. Please go ahead. Your line is open.

Hey, good morning and good afternoon. This is Chris Robertson on behalf of Amit. Thank you for taking our questions. I wanted to touch on the LR2 fleet for a moment. How many of those are currently trading dirty at the Frontline level, and do you have a general sense across the fleet of how many LR2s are engaged in dirty trades at the moment?

Thank you, Chris. That’s a very good question because the switch between trading dirty and clean has become increasingly effective over the last half year. As for our own fleet, I can say we are quite comfortable, but it’s challenging to follow what happens out there in the global market. To provide some context, you can quickly switch a dirty vessel to clean by doing a few short trips. From our fleet that we still control, which are not under time charter, we currently have 14 vessels trading dirty. However, the market has been pricing a hefty premium for this ability.

Okay, got it. Switching gears here, looking at shipyard capacity, you mentioned limitations for Chinese yards for 2025 delivery and Korea in 2026, but do you have a sense of how much mothballed capacity could come back online over the next few years? Is the limitation more due to labor issues or can the yards resolve the real estate aspects?

We’ve seen not new players on the block, but we've noted yards in China with significantly reduced capacity that are getting revitalized and willing to accept orders. This is obviously a risky exercise for any owner looking to contract with these yards. However, quantifying it is difficult. Some new kids can't take orders until 2025 or even 2026 because it takes time to get those yards back up and running. From a labor perspective, it appears China does not have issues, while in Japan and Korea, it is indeed a challenge. Although tankers are complicated ships to build, they tend to focus on less labor-intensive technology. So, they are pricing themselves out of the market. However, it’s hard to gauge the overall potential volume until it starts in 2026.

Okay. Yes, that’s great color. Last question for me relates to your expectations around the upcoming OPEC meeting. With Brent prices trending well below $80 a barrel, which we see as a threshold price, there’s been market commentary around speculators in oil pricing. Are you concerned there could be additional cuts on the table going into this meeting? How are you thinking about that?

I can’t provide much more than what you read. However, I must say that when you enforce a cut starting in May and then contemplate an additional cut in June, it does seem a bit peculiar because demand is typically low during this period. It’s essential to exercise patience when making significant moves as OPEC strategists. The real concern in this situation is that while Russia claims to adhere to voluntary cuts, they are not physically doing so. It’s quite an intriguing scenario, and giving a qualified guess is nearly impossible at this point. What I will say is that any demand increase resulting from this voluntary cut will be reversed quickly once demand picks up.

Yes, I think that’s fair. It seems more like a compliance enforcement issue in the short-term, and then they can ramp back up over time, as you said. Thank you very much for taking the questions.

Thank you, Chris.

Thank you for your question. We are now taking the next question. The next question is from Omar Nokta for Jefferies. Please go ahead.

Thank you. Hi, Lars. Hi, Inger. Good afternoon. I wanted to check back on the new building discussion. Clearly, the charts on Slide 11 reflect the disparity between oil consumption growth and fleet growth. Lars, previously in your last call, you mentioned new buildings weren't that interesting for Frontline. Has there been an update? You highlighted that we are looking firmly into 2026 and perhaps 2027 for deliveries. Is this something you are reconsidering?

Yes. It's a good question, but regrettably, or not regretfully, my answer remains the same. When we look at the newbuilding market, we consider three factors. The first is the technology we will adopt; second is the delivery time until we can start generating cash flow from that investment; and lastly, the price of the asset. I hear the argument that inflation has yet to hit asset prices because, adjusted for inflation, a long-dated VLCC equivalent from 2008 or 2009 would be around $70 million today. However, for that to hold true, we need inflation to also reflect in rates we see, alongside a significant uptick in the long-term time charter market. With this in mind, it just doesn’t appear compelling for Frontline at this moment. I also note that many orders we’re witnessing are tied to long-term charter commitments, which isn't aligned with our strategy to provide spot exposure. Furthermore, those not linked to long-term charters appear somewhat opportunistic, as they involve down payments for a market that may only become interesting by 2026.

That makes sense, Lars. Thanks for that. Clearly, you're highlighting that inflation impacts charter rates to incentivize ordering. How do you perceive opportunities in the current capital allocation environment? Given your commitment to paying dividends, do you see potential in the sale and purchase market, particularly regarding younger or undervalued older tonnage, particularly in light of the green transition?

Yes. I think the best-in-class side would be to consider acquiring LR2/Aframax, Suezmax, or VLCCs below 5 years old. However, the visibility and offerings in that market segment are virtually zero. A lot of modern VLCCs delivered in recent years are currently on time charters and relet to operators or traders. Thus, notable sales candidates from this age group are scarce. With this in mind, we'd rather remain patient and generate the best return until we decide to make an investment.

Sure, that makes sense. Thank you. Also, if you have any public comments about the situation at Euronav regarding management and board shifts, and any thoughts on the back and forth with International Seaways?

I understand the question but it’s not really for me to comment. I’m observing from a distance, just like you are concerning both situations. While we are shareholders, that’s about as far as I can go. The same applies to International Seaways; thus, I’ve been reading the same news as you.

That’s good enough. Thanks, Lars. I’ll turn it over.

Thank you.

Thank you for your question. We are now taking the next question. The next question is from Chris Tsung from Webber Research. Please go ahead.

Hey, good afternoon, Lars. How are you?

I'm good. Thank you. And yourself?

Good. Good. Thanks. I wanted to ask, in your deck, you highlighted the Russian sanctions and the inefficient trading patterns that have been a tailwind for several tanker owners. Do you believe these inefficiencies could be corrected, or are they more structural in nature until the war ends and sanctions are lifted?

What I can say is that if you look at the Suezmax and Aframax fleets and how many are calling on Russia, approximately 30% of the Aframax and 30% of the Suezmax fleet is still calling on Russia. This suggests a high level of interconnection between what we might call the gray fleet and the compliant or non-Russian trading market. While there are inefficiencies present, they may not be as pronounced because we haven't lost 30% of the ships in the non-Russian trading market. So the situation might be more balanced. However, vessels of lower quality or those outside age restrictions will struggle to access the compliant market. The interconnectivity is surprisingly efficient, which could mean that when the situation reverses, the negative impact on ton miles won’t be as severe.

Thank you. Just one more follow-up regarding arbitration. Are there notable milestones we should anticipate from now until June 2024?

No, not at the moment.

Okay. Fair enough. I'll turn it over. Thank you.

Thank you.

Thank you for your question. There are no further questions at the moment. I will hand back the conference over to management for closing remarks, please.

Well, thank you very much for dialing in. It's been a pleasure to report another good quarter. Hopefully, we will continue to do that and look forward to what's to come. Thank you.

And that concludes the conference for today. Thank you for participating. You can all disconnect.