Frontline plc Q1 FY2024 Earnings Call

Dear all. Thank you for dialing in to Frontline’s First Quarter Earnings Call. The first quarter of 2024 was to a large degree tainted by the security situation for the passage between the Red Sea and the Gulf of Aden. There are still charters insisting and owners willing to ignore the security for the seafarers, but we, Frontline, simply don't. The highlights of Q1 of 2024 were that all the Euronav vessels are now sailing under the Frontline flag. As we progress into 2024, we will take full advantage of having a fleet of 41 modern, low consuming VLCCs in addition to our efficient Suezmax and LR2 fleets. Utilization seems to be edging higher on all asset classes, but again, the LR2s are the ones to shine. Before I give the word to Inger, please see the numbers on Slide 3 in the deck. In the first quarter of 2024, Frontline achieved $41,100 per day on our VLCC fleet, $45,800 per day on our Suezmax fleet, and $54,300 per day on our LR2/Aframax fleet. LR2s have been yielding VLCC numbers in the quarter, as this segment has been affected the most by the disruptions in the Suez Canal passages. The Suezmax is actually called out for a reason. Hence, the change in flows has forced new trading patterns during the quarter. So far in the second quarter of 2024, 78% of our VLCC days are booked at $60,400 per day; 73% of our Suezmax days are booked at $46,400 per day, and 72% of our LR2/Aframax days at a very firm $64,700 per day. All these numbers in the table are on a low to discharge basis, and they will be affected by the amount of balance days we end up having at the end of Q2. I'll now let Inger provide the financial highlights.

Thank you, Lars, and good morning and good afternoon, ladies and gentlemen. Let's then turn to Slide 4 and look at the profit statement. In the first quarter, we reported profit of $180.8 million or $0.81 per share, and we also report an adjusted profit of $137.9 million or $0.62 per share. Adjusted profit in this quarter increased by $35.8 million compared with the previous quarter, and that was primarily due to an increase in our TCE earnings. This was also again due to the delivery of the 24 VLCCs from Euronav in the previous quarter and also in this quarter, as well as to higher TCE rates. Again, this is partially offset by an increase in ship operating expenses, depreciation, and finance expenses due to the delivery of the 24 VLCCs from Euronav. Looking at some balance sheet highlights in Slide 5, the balance sheet movements this quarter relate to taking delivery of the remaining 13 of the 24 VLCCs acquired from Euronav last year. Frontline has strong liquidity of $404 million in cash and cash equivalents, including the undrawn amounts of the senior unsecured revolving credit facility, marketable securities, and minimum cash requirements to the bank as of March 31, 2024. We have no remaining newbuilding commitments and no meaningful debt maturities until 2027. Now, if we then look at Slide 6, following the delivery of all the 24 VLCCs we acquired from Euronav and the sale of the seven older vessels in the first and second quarter of 2024, our fleet consists of 41 VLCCs; 23 Suezmaxes; and 18 LR2 tankers. The fleet has an average age of 5.9 years and consists of 99% ECO vessels, where 56% is scrubber fitted. We estimate average cash cost for the breakeven rates for the remainder of 2024 to be approximately $31,200 per day for VLCCs, $23,500 per day for Suezmax tankers, and $22,200 per day for LR2 tankers. The fleet average estimate is about $27,100 per day. This is slightly up from the previous quarter due to financings and refinancings done. The fleet average estimate includes dry dock for two Suezmax tankers and five VLCCs in 2024, where over two Suezmaxes and two VLCCs will be docked in the second quarter, one VLCC in the third quarter, and two VLCCs in the fourth quarter. We recorded OpEx expenses, including dry dock in the first quarter of $8,100 per day for VLCCs, $8,800 per day for Suezmax tankers, and $7,400 per day for LR2 tankers. This includes startup of two Suezmax tankers. The first quarter fleet average of OpEx excluding dry dock was $7,700. Moving on to Slide 7, Frontline has about 30,000 earnings days annually, of which about 28,000 are spot-based. The cash generation potential at current fleet and spot market earnings, from Clarkson Research as of May 29, of $55,900 per day for VLCC, $50,000 per day for Suezmax tankers, and $65,500 for LR2 tankers is $835 million a year or $3.75 per share. An increase of 10% from the current spot market will increase the potential cash generation by about 19%. With this, I will hand it back to Lars.

Thank you very much, Inger. Let's move to Slide 8 and look at the current market narrative. We're still in a situation where the conflict between Israel and Hamas and the tensions between Israel and Iran persist. We are in an environment with growing political risk. We're also seeing increased sanction evasion scrutiny from the U.S. and the EU. This causes what I refer to as a grey fleet to move further into this evolving environment, which is growing as we move forward. On the positive side, global oil demand is now estimated by the EIA to reach an all-time high in June at 103.76 million barrels per day. We need to recognize that, although we are transitioning into greener fuels and are part of the green transition, the overall global energy demand continues to grow, and oil and hydrocarbons remain part of that growth. What's particularly interesting in Q1 and following into Q2 is that the period markets have started to show some strength. Looking now at VLCC three-year time charters for ECO vessels, we're closing in on $55,000 per day. This puts the time charter market into a contango position where one-year, two-year, and three-year time charters for VLCCs are priced differently. Additionally, you should note that the LR2 and Suezmax market are now more or less priced equally. Another exciting development is the TMX pipeline expansion that is becoming a reality. We will soon learn how that oil output will affect utilization in that region. The TMX pipeline's output is only suited for Aframaxes, which cannot support STS operations and virtually no storage exists there. As a result, we will see trading patterns evolve depending on where the oil is heading, ultimately either utilizing Aframaxes to transport oil to a suitable STS location or sending it into the U.S. refining system. Lastly, I mentioned the Dangote refinery, which is about to start operations in Nigeria after extensive planning. They are also acquiring feedstock from the U.S. Gulf, which is unexpected given their proximity to Nigerian crude supply. Order books continue to grow. However, with increased deliveries, we will see further interruptions down the line. The chart at the bottom of this slide shows that the VLCC market appears to be in a positive trend where bottom levels are rising after every cycle. The Suezmax market, as previously mentioned, remains range-bound around the $40,000 mark and lacks momentum. The LR2s, on the other hand, continue to excel, particularly due to disruptions in the Suez Canal passages, increasing volatility. Frontline has participated in cleaning up Suezmaxes to compete in specific trades, particularly gasoline moving from the Middle East Gulf to the West. Let's move to Slide 9 to discuss some developments in flows. OPEC continues to maintain its cuts, primarily focused on the Middle East Gulf. Non-OPEC supply has been given an opportunity to grow, and we anticipate this growth to continue. You can see in the top left-hand side of the slide the ton-miles generated from Americas oil exports, which shows a continued high volume. The VLCCs are beginning to gain favor, especially in May, indicating that a lot of this volume is being transported long-haul. Meanwhile, Europe continues to draw oil from much longer distances, avoiding Russian crude. Finally, it's noteworthy that the acceleration of demand reflects broader growth trends; it's likely the short-term benefits could be concentrated in the Middle East. Moving to Slide 10, the order books continue to expand. We're currently addressing a growing need for new vessels to perform efficiently. As older LR2s age beyond 15 years, they transition into Aframax vessels, a factor that must be considered when evaluating the Aframax size class. This makes understanding the overall Aframax numbers essential to truly reflect this aspect of the market. We continue to see order books grow, but at a reduced rate, shifting now to 2028. Moving on to Slide 11, from 2024 onwards, we are approaching a wall of replacement needs due to an impending phasing out of tonnage aged between 20 and 25 years, based on asset class. Notably, the peak year of new building was 2011, during which 519 shipyards operated globally; the current number stands at just 247. The reduction in the number of shipyards globally is significant, by 52%. While some shipyards have varying capacities, the overall reduction remains around 40%. South Korean and Japanese shipyards are struggling to expand due to demographic issues, including attracting skilled laborers. In South Korea, workers are even being brought in from the Philippines to meet capacity needs. Japan faces its own challenges, wherein the average age of a welder is around 56 years. China, however, has greater potential for capacity. This presents a structural supply issue. If we focus solely on the tanker replacement needs over the next ten years, we will require close to 400 VLCCs, 300 Suezmaxes, 187 LR2s, and nearly 400 Aframaxes built. This creates a considerable and structural problem that is not easily resolved. While market intelligence indicates that oil demand will continue to grow, supply growth within shipping appears to be challenged. Let's proceed to Slide 12 and review the summary. The highlights of Q1 for Frontline include having a fully delivered VLCC fleet operating under the Frontline flag. We have completed the sale of older vessels and now have one of the most fuel-efficient fleets in the market. Our expansion financing has been finalized, completing our strategy of releveraging the existing fleet. The security situation in the Red Sea, Gulf of Aden, and the broader Middle East remains a concern. We are observing a continued contraction in tanker markets as building capacities come into question, with delivery dates shifting to 2028. However, the short- and medium-term oil demand outlook remains firm, and market alerts indicate OPEC+ will play a significant role in the second half of 2024. Liquidity in the period market has increased, with long-term time charter rates on the rise, reflecting intelligent investment in the market. I would like to open the floor for questions.

Thank you. The question comes from Omar Nokta from Jefferies.

Thank you. Hi, Lars and Inger. Good afternoon. Thanks for the presentation. Always very detailed and informative across different elements of the market. I have a couple of questions. First, on the financing. As you highlighted, you finalized and inked the expansion financing. You've unlocked a good amount of cash recently, and it looks like $417 million has been unlocked, which will essentially repay the Hemen Holding borrowings of $395 million, used initially for the Euronav deal. But what about the seven tankers you sold? Those unlocked $275 million after paying down the debt. Is that cash earmarked for anything particular, or will it go towards further debt reduction?

You have to remember that we used more cash to finance the Euronav transaction and spent $395 million drawn under the Sterna facility, alongside the Hemen shareholder loan. We used some operational cash until we sold the older vessels, which provides context to your question.

Okay. Yes. So just as simple as that then. And sticking with Lars, you talked about the market, with LR2s shining and also the TMX pipeline. How are you thinking about the LR2 fleet and its current trading dynamics? How are you balancing the LR2s between dirty and clean products given the inefficiencies in the Suez market?

Yes, it's a good question. This is a time when we probably would have wanted some Aframaxes in our fleet, to be quite honest. Your question about LR2s shining is connected to the Suez Canal's virtual closure. Products moving from East to West are growing, but West to East has little material movement. To incentivize an owner to balance the ship going East, the rates actually have to increase. The utilization of the LR2 fleet is increasing significantly due to this inefficiency. Furthermore, significant efforts have been made to clean Suezmaxes for this trade. While Suezmaxes can clean, they cannot handle all cargoes; they mostly work with gas and oil. As we see it, we will witness trade emerge where Aframaxes will travel up and down the coast to certain STS locations in places such as the U.S., Mexico, and Ecuador. Tankages for oil collected from TMX are being conducted by Aframaxes. Although we are seeing increased utilization of Aframaxes, it's not to the full extent as if they were traveling all the way to China. We still need to monitor this trade for a few more months to fully understand how it will develop.

Thanks, Lars. That's helpful. I have a final question regarding VLCC performance in Q1. There seems to be a divergence between what your initial fleet earned and what the Euronav ships have done. Should we expect further repositioning dynamics in Q2? Will Q3 be the first sort of true quarter of ongoing operations for the deal?

Yes, you have a few points I'd like to make. First, the Euronav fleet has lower scrubber penetration than our existing Frontline fleet prior to the acquisition, which affects earnings. Initially, all the vessels were delivered around Singapore, and we encountered a narrow window in the Middle East, which was the weak spot in Q1. As we move forward, we will spread the fleet more evenly worldwide, and the Euronav vessels will blend in better. We will not comment on distinguishing between the two fleets going forward in our reporting. These ships have completed long voyages, and it will take time before they fully integrate into our total fleet. While Q2 might be affected to some extent, Q3 should reflect a more normalized operational performance.

Okay. Very good.

Yes, to a lesser degree in Q2 than Q1, obviously.

Okay. All right. So Q2 will be better, and then Q3 is full operations. Excellent. Thanks, Lars, thanks, Inger.

The question comes from Greg Lewis from BTIG. Please ask your question.

Hey. Thank you and good afternoon. Thanks for taking my questions. Lars, it looks like the depth of the time charter market is picking up. You're obviously taking advantage of that. Looking at the second half of the year and the outlook for rates and the spread between the curve and spot market, I’m curious how you're thinking about opportunities to continue putting some vessels on term charters.

We're constantly evaluating opportunities. However, we believe we're set for a longer trend here. Although I hate to say it, we used the expression 'stronger for longer' back in 2020, which didn’t turn out as anticipated. Now we are closely observing the market. We have a rule of thumb to cover 30% of our largest exposures in revenues, interest rates, and bunkers. We’re quite close on interest rate swaps, fantastic timing; on the bunker side, we’re slightly below; and in terms of revenue, we have virtually no secured revenue for the time being, apart from the LR2s. While we want to lean into the opportunities, we are not rushing as we believe this size issue is gradually improving. Regarding the structural supply issue and resilient oil demand, it will take some time. When we become more confident in the market's recovery, we do want to ensure we have proper coverage, but we are not aggressively pursuing this right now.

That's great. I also wanted to ask about asset sales. You’ve sold 16 vessels since the Frontline acquisition was announced. Do you see this cycle differing from previous cycles where older vessels have historically outperformed? Will there be discrimination against older vessels that could prevent the traditional spread from converging during these up cycles?

That’s a complex question. Our analysis suggests a move towards more emphasis on efficient vessels. We notice scrutiny preferences from clients favoring modern tonnage. Regulatory frameworks have shifted over the last year, which has impacted the narrative surrounding older vessels. It’s conceivable that, in retrospect, we might wish we had focused on the 12 to 15-year-old vessels for better returns, but we remain committed to building a long-term strategy involving vessels that will serve us for 20 to 30 years.

Thank you very much. That's super helpful.

The question comes from the line of Petter Haugen from ABG Sundal Collier. Please ask your question.

Good afternoon, guys. Thank you for taking my question. Lars, regarding the longer-term time charter markets, who is driving these requirements? Are they traders, or are they fundamental cargo owners requesting longer periods? Also, have we seen interest for sort of five to seven-year charters for new builds set for delivery in 2027/2028?

Thank you, Petter. The first point is absolutely correct; it is the oil majors and national oil companies entering the market who have transportation needs. Regarding the second question, there is indeed interest for longer-term business in the market, potentially not as much for 10-year terms, but we’re seeing definitively five to seven-year charters emerging. Keep in mind our proposition to investors is to provide spot exposure, so these longer commitments may not align with our current strategy.

If I could follow up, what sort of rates would you expect for a new build with a 2027 delivery under a five-year time charter deal?

That's a tough question to answer. However, the curve appears fairly flat, and we are considering rates that would provide a decent return on equity for the owners. You're looking at rates around $50,000 per day, which may excite some but not everyone, especially given the capital costs associated with new builds.

Thank you. One last question regarding dividends. You've adopted a discretionary policy, and in this instance, you’ve opted to pay out everything, which most seem to appreciate. How should we think about the payout ratio going forward, especially for Q2 and potentially Q3, which might be less favorable?

You should keep a rule of thumb of 80% of adjusted net income in mind. We opted for a 100% payout this time due to good visibility on cash flow and liquidity. Our goal is to reward shareholders fairly based on market conditions. It's essential to emphasize that payout ratios may vary depending on the market environment, but we aim for transparency in our approach. If the market stays firm or improves, we would have room to increase distribution, but sharp downturns would lead to adjustments.

Thank you for your insights, Lars. That would be all for me.

We have no further questions at this time. I will now hand it back to you, Mr. Barstad for closing remarks. Thank you.

Thank you very much, and thank you all for listening in. These are exciting times, although we're still missing some of the volatility we wished for. Let's just monitor how these markets develop. Thank you very much.