Frontline plc Q2 FY2024 Earnings Call

Good day and thank you for standing by. Welcome to the Second Quarter 2024 Frontline plc Earnings Conference Call. At this time all participants are in a listen-only mode. After the speakers’ presentation there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Lars Barstad, CEO of Frontline Management AS. Please go ahead.

Thank you very much for that introduction. Dear all, thank you for dialing into Frontline's Quarterly Earnings Call. The second quarter of 2024 ended up very much in line with the first with volatility but ending up on softer notes, as we entered the seasonal summer lull. Complications around war risk in the Middle East and tightening sanctions against Russia have regrettably become the norm. And I will be touching on that later in the call. It's important to remember, though, that we are at the seasonal lows, and I would like to say that all shareholders have a very exciting fall ahead, as Frontline has not had this number of potential money-making days going into the winter for decades. Before I give the word to Inger, I'll run through our TCE numbers on Slide 3 in the deck. In the second quarter of 2024, Frontline achieved $49,600 per day on our VLCC fleet, $45,600 per day on our Suezmax fleet, and $53,100 per day on our LR2 / Aframax fleet. So far in the third quarter, 79% of our VLCC days are booked at $47,400, 85% of our Suezmax days are booked at $49,900, and 65% of our LR2 / Aframax days are booked at $50,100 per day. Again, all these numbers are on the load-to-discharge basis, meaning they will be affected by the amount of ballast days we end up having at the end of the third quarter. Although Q3 bookings came in somewhat short of market expectations, please do keep in mind the binary characteristics of our market, especially as we come out of the seasonal lows. And then I'll let Inger take you through the financial highlights.

Thanks, Lars, and good morning and good afternoon, ladies and gentlemen. Let's then turn to Slide 4 and look at the profit statement and highlights. We report a profit of $187.6 million or $0.84 per share this quarter and adjusted profit of $138.2 million or $0.62 per share. The adjusted profit in the second quarter was comparable to the first quarter, as you can see from the slide, and the decrease in our TCE earnings with $12.4 million, as a result of the disposal of two VLCC fleets and two Suezmax tankers was offset by a decrease in ship operating expenses, administrative expenses, depreciation and finance expense, as well as an increase in interest income of $12.6 million making up the $0.2 million increase in the quarter. Let's then move to Slide 5 and look at the balance sheet. The balance sheet movements in this quarter are mainly related to the sale of four vessels in the second quarter, of which one VLCC was held for sale in the first quarter. And also to re-leveraging part of the existing fleet used to repay debt drawn to partly finance the acquisition of the 24 VLCCs from Euronav. Frontline has strong liquidity of $567 million in cash and cash equivalents, including an undrawn amount of the senior unsecured revolving credit facility, the marketable securities, and minimum cash requirements to the bank as of June 30, 2024. We have no remaining newbuilding commitments and we have no meaningful debt maturities until 2027. Then we can look at slide 6. In the second and third quarters of 2024, we completed our strategy of freeing up capital by deleveraging part of the existing fleet and also divesting older vessels, which enabled us to repay an aggregate of $395 million, which was strong under the Hemen shareholder loan and also under our revolving credit facility with an affiliate of Hemen to partly finance the acquisition of the 24 VLCCs from Euronav earlier. From this slide, we can see that this has involved optimizing the capital structure through refinancing of 36 vessels and divesting eight older vessels. Total recent and ongoing refinancing in a total amount of $1.55 billion have secured long-term financing at highly attractive terms with a maturity of about eight years and improved debt margins by about 30 basis points on a weighted average basis. The net expected cash proceeds from the refinancings is $548 million, and $311 million from divesting older vessels. Let's then look at Slide 7. Our fleet consists of 41 VLCCs, 23 Suezmax tankers, and 8 LR2 tankers. It has an average age of six years and consists of 99% ECO vessels, of which 56% are scrubber-fitted. We estimate average cash breakeven rates for the next 12 months of approximately $29,600 per day for VLCC, $22,300 per day for Suezmax tankers, and $21,200 per day for the LR2 tankers, with a fleet average estimate of about $25,700 per day. It is slightly down from the previous quarter, mainly as a result of the financings and refinancings loans. The fleet average estimate includes dry dock of two Suezmax tankers and four VLCCs in the next 12 months, of which two VLCCs in the third quarter of '24, one VLCC in the fourth quarter of '24, one Suezmax in the first quarter of 2025, and one VLCC and one Suezmax in the second quarter of 2025. We recorded OpEx expenses, including dry dock in the second quarter of $8,600 per day for VLCC, $9,300 per day for Suezmax tankers, and $7,600 per day for LR2 tankers. This includes startup of two Suezmax tankers and two VLCCs in the quarter. The Q2 '24 fleet average OpEx excluding dry dock was $7,600 per day. Then let's move to Slide 8. And look at cash generation potential. Frontline has about 30 earnings days annually. We have about 28,000 spot days. Even in this week's spot market that we are experiencing now, the cash generation potential at current fleet and spot market earnings from Clarksons Research as of August 29 is over $33,500 per day for VLCC, $36,600 for Suezmax tankers, and $28,700 for LR2 tankers, which is $242 million or $1.09 per share. The sensitivity is high from these spot market levels that you see now, and a 30% decrease from the current spot market will increase the potential cash generation by about 116%. Note that the spot market earnings at the 30% increase is $43,600 for VLCCs, $47,500 for Suezmax, and $37,300 for LR2 tankers. And the upside potential should be much higher going forward when the party begins. With this, I leave the word to Lars again.

Thank you very much, Inger. Let's then go to Slide 9 and start the discussion on the current market narrative. You will notice that there is a new theme we are focusing on at Frontline, as we've been trying to explain the developments in the current market. We all sit on more or less the same supply and demand models. The unknown is basically how oil trades. There is a development of a two-tier market between what we would refer to as a compliant and non-compliant market. This divide has grown over the last 12 to 18 months. Currently, and this is quite surprising to some, I would assume, 23% of the global fleet is expected to be involved in sanction trade. And in these numbers, it's not necessarily a ship that has lifted Russian crude because the molecule is still not sanctioned, but it is vessels that have adverse activities surrounding their trade, whether it is with Russian crude or other sanctioned crudes. And so basically, what these numbers tell you is that 17% of the VLCC fleet is currently under some service scrutiny, either by OFAC, UANI, or they have red flags attached to their activities. Likewise, if you move to the Suezmaxes, you have 21% of the fleet under the same type of scrutiny. And we have 28% of the Aframax / LR2 fleet exhibiting the same characteristics. This is obviously related to the rise in sanction scrutiny and also the volumes trading, and I'll come back to that later in the following slide. Geopolitical risk linked to the Middle East is ever increasing. It is also quite surprising to us to see the somewhat moderate oil movements of volatility, considering this explosive backdrop. Chinese imports are in question after soft July. But as far as we can see, August tracking implies an increase of 1.2 million barrels month-over-month to China. So although that doesn't really make this story fantastic, at least you should not base China on the July observation. Global oil demand is on track, at least looking at the numbers we see. Oil in transit is on a rising trend. World inventories are at historical lows. And there is a limited cushion for adverse events, which also could be related to weather. The order book expansion in our industry is slowing, and the available delivery window for tankers has moved into 2028 for any substantial order that is. Other asset classes are starting to take center stage. Let's move to Slide 10 and discuss a little bit more about the sanctions-exposed trade growth. So there has been, over the last months, increased scrutiny on Russian trade, basically exposing more vessels to being sanctioned by either G7 or EU in their operations surrounding Russian trade. We've also seen a steep growth in Iranian exports, which has basically increased the need for tonnage for transportation. What we've ended up seeing is that we have a two-tier market, which is kind of developing in front of our eyes. We have what we would refer to as a compliant market, which involves 80% of the tanker fleets or thereabouts. And then you have the dark or grey fleet, which involves 20% of the tanker fleet or even up to 23% of the tanker fleet. The interesting part here is that you're not building vessels to enter the dark or grey fleets. So basically, they get their fleet supply from the compliant fleet. So the compliance fleet is shrinking, whilst this kind of dark or grey fleet is growing. It's supplied by the aging of the overall tanker fleet basically. And over 20-year old vessels still do not trade in what we regard as the conventional market. It creates an interesting dynamic because unless non-conventional trade continues to grow, the illicit market will soon be oversupplied as the fleet aging accelerates. So basically, vessels moving from the compliant market due to age and basically because we have zero scrapping, will at some point here start to overcrowd the dark or grey fleet. One should expect scrapping to start to happen in the end. The parallel oil trade carries an increasing risk to any reversal of sanctions as well, and that needs to be kept close in mind. The implications here lead to questions about where sanctions enforcement fits into this picture and also where the IMO is in respect of safety and reducing emissions, etc. I can assure you this fleet is not spending too much CapEx on reducing their carbon footprint. At the bottom right-hand side of this slide, you will see kind of how this development is and the red arrows indicate this divide. The overall fleet continues to grow, as basically no ships are being recycled, but the compliant fleet vessels under 20 years of age are gradually shrinking as we proceed. This includes the newbuildings coming into the market. With that harsh message, I'm going to move to Slide 11, and let's look at the upside potential here in the compliant market. We have tanker seasonality, and it's extremely pronounced. Ninety percent of the global population lives in the Northern Hemisphere, where most of us on this call live, and EIA expects oil consumption to increase by 1.5 million barrels by December, basically due to temperatures turning. On average, looking back, the winter market sees an increase of consumption by 1.5 million to 2 million barrels in the period from August to December. This is a long-term pattern, and we see it both in oil in transit and obviously in freight earnings. If you look at the bottom right-hand slide chart, that's we were basically just taking the last 34 years and looked at the seasonal trend. We are basically in the weeks where this market starts to come into action. It's also quite encouraging to see oil in transit, actually dipping out of the long-term trend. And to top it off, we have to keep in mind that the inventories within OECD and we've added China and India as well, are at historical lows. Again, I would like to emphasize that it offers a very limited cushion in the event of unexpected events. OPEC is still supposed to increase supply from October. The question is whether they will do it at the current oil trading levels, but 2.2 million barrels are said to be returned between October and the end of 2025. And again, as per the previous slide, the shrinking compliant tanker fleet capacity to serve conventional oil demand growth makes this a very interesting picture. Also, I think we need to keep in mind that although the market is sluggish currently, the balance is fairly thin. Only two weeks ago, we had VLCC rates moving up 25%. It doesn't take much to move the needle. Let's then have a look at the order books. The overarching theme here is that the ordering we saw in the beginning or the first half of the year has been muted over the last month, 1.5 months. Basically, virtually zero tankers have been ordered in the last 1.5 months and at the same time, we've seen other asset classes move in to contract vessels, in particular, we have seen big orders being placed on the container side for 2028 delivery. We think that for VLCC and Suezmax, the order book looks still very low for VLCC, medium low for Suezmax, and high for LR2. But with LR2s, as I mentioned before, we need to consider that there are virtually no Aframaxes on order, so if you take that percentage and apply it to the overall LR2/Aframax fleet, we come in at 13%, which is still not alarming. We also need to keep in mind that we're heading into a generation of ships that came post-2008 for VLCC and Suezmax and post-2007 for LR2s, which are sizable generations of vessels that will come to age in 2027, 2028, and onwards. To sum this up before we open up for questions, Frontline has decades high earnings capacity as we move into the second half. We have a strong balance sheet with sensible leverage on our modern fleet. There is, as mentioned, a growing divide between the compliant and sanction trade, which can create interesting volatility going forward. The security situation in the Red Sea, Gulf of Aden, and Middle East is ever-increasing, as delivery slots for new building move into 2028. We have seen that container ordering has accelerated again. Short and medium term oil demand looks on track, but China is, of course, a question. The seasonal play is on. And I know a few people below this call, let us say it again, winter is coming. So with that, we will open up for questions.

Thank you. We will now take our first question. And the first question comes from the line of Jonathan Chappell from Evercore ISI. Please go ahead, your line is now open.

Thank you, good afternoon. Inger, first question is for you. Slide six says you've completed the re-leveraging and the divesting of older vessels. I want to be clear, there are no more big refinancings that we should expect before 2027 and the divestiture of the older vessels is mainly complete at this point?

Your first question was that there were no more refinancings until 2027. Was that correct?

Correct.

We don't have any significant refinancings expected before 2027. We do have a few smaller ones planned for 2025. What was your next question?

Was around the divesting of the older vessels. Is that process completed as well?

Yes, that is also completed, yeah.

Okay. Good. And then just a follow-up question on this latest refinancing with the sale and leaseback. It is interesting that sale and leasebacks were kind of a thing of the prior tanker markets when rates were weak and maybe financing wasn't as available or attractive. You've done most of your refinancing through traditional credit facilities. What was the thought process of doing another sale and leaseback at this point in the cycle to refinance that prior one?

This new sale leaseback arrangement is refinancing a current sale leaseback arrangement. We are not increasing the number of vessels; it’s the same 10 vessels we have today, which we are simply replacing. It's not a typical sale-leaseback arrangement; it can be viewed more like a bank facility because the leverage is only 60% loan-to-value, and the terms resemble those of a bank facility. That's why.

Okay. That's very helpful. Thank you for that, Inger. And then, Lars, just one for you. I mean I think the seasonality slide is pretty clear and many of us who've been around understand this very well. I guess there is some concern about China; you noted in your prepared remarks, let's not extrapolate July. But is there any way to take that inventory slide that you did for Slide 11 and isolate China? And is there a reason that China may be a lot more aggressive in the back half of the year? Or is it more of an OECD-depleted inventory and maybe China doesn't have that type of panic going into their winter season where they need to be more aggressive on the imports?

That's a valid observation. If we were to examine the chart specifically for China, it would suggest that inventory levels have increased, although the details of their strategic inventories are not publicly available. Since the end of COVID, China has managed to maintain a relatively high level of inventory. As you may recall, they took advantage of the low oil prices during that period to restock. Regarding China, it's clear that growth is not occurring at the pace we would like. However, our nearby neighbors in the dry bulk market present a different scenario. It's important to acknowledge that understanding the situation in China is quite challenging right now. Additionally, nearly 20% of China's imports come from Iran, Venezuela, or Russia, making it hard to track these supplies accurately. We do know they are importing more crude from Russia in the north. So, China remains an unpredictable factor. Presently, the outlook isn't very promising, but other countries in the region typically see higher demand during the winter months, with India being a prime example. However, I don't foresee a weak performance from China in Q4 or heading into Q1, although I question whether there will be year-on-year growth. Nevertheless, with other countries likely to increase their demand during the winter, I believe we should be in a decent position.

Okay, great. Thank you very much, Lars, thanks Inger.

Thank you. We will now take our next question from the line of Omar Nokta from Jefferies. Please go ahead, your line is now open.

Thank you. Hi Lars and Inger. Good afternoon. I have a couple of questions about the market, but I also wanted to discuss the VLCC performance you've reported so far in the third quarter. You've booked 79% of Q3 at just over $47,000, which is a bit lower than the first half, but still quite impressive when considering the market averages since June, including ECO and Scrubber premiums. I wanted to ask what you believe has contributed to this outperformance.

First of all, Omar, it's important to remember that we report on a load-to-discharge basis, which is different from how many of our peers report. This can create some confusion, so don't expect us to book too much near the end of the quarter since we can only recognize income when the vessels load the cargo. In Q1, we received a significant new fleet from Euronav, mostly delivered in the Middle East. Throughout the quarter, we've integrated this fleet into our operations while limiting our exposure to any single region. Recently, the Middle East has been challenging; ironically, the VLCC benchmark and major indices are influenced by trades in the Atlantic Basin, West Africa, the US Gulf, and Brazil, resulting in a lot of short hauls since oil hasn't traveled far in the latter part of Q2 and into Q3. This explains the weakness in this segment and its effect on Suezmaxes to some degree. That said, there's no specific figure to highlight here. We are pleased with our performance, especially considering we've decreased our scrubber usage in the fleet. It's also worth noting that the spread between high and low sulfur fuel has been quite narrow lately, indicating that the benefits of scrubbers haven't been as significant in recent months.

Okay. Thanks Lars, appreciate that. And just a quick follow-up just on that point or just generally on the VLCCs. Have you played into the whole product cargo lifting in your fleet?

Not on the VLCCs, but on the Suezmaxes, yes. So basically cannibalizing our own LR2s.

Okay. And then just kind of more on the market here. One, we've seen the recent pullback in Libyan exports or at least production volumes. It seems like they’re may be still able to export from inventory. But if this is prolonged and that volume is away from the market, how do you think that affects the different dynamics within the crude trade at this point? Obviously, Aframax has seemed more exposed to that. But how do you think the VLCCs and Suezmax react in that type of environment?

Had you asked me before the disruption started in the Suez Canal or Red Sea Gulf of Aden, I would have said that this is kind of material. What's happened since those events started to occur is that Libya used to go east by way of either Suez or actually rarely all the way around, but at least through Suez. With the disruptions in Suez, we've seen that oil trade local. So you're right that it affects the Aframaxes. It might have a limited impact on Suezmaxes but I would say virtually no impact on the VLCCs. Again, if you take one crude out of the equation, another one comes up.

And I guess in that situation, if you lose that crude from Libya and that gets made up potentially from the Middle East, does that become a VLCC trade?

Potentially, but it could also be replenished from Latin America or US Gulf or West Africa. Because Libyan oil is now predominantly going into Europe and not to this due to the disruptions in Suez.

Okay, I understand. I have one more question for you. You mentioned the sanctions and the dark fleet, as well as the grey fleet. I would like to know your thoughts on how the market might react if there is increased scrutiny on Iranian crude exports, causing them to decline to levels seen a few years ago. Do you think that the grey and dark fleet would return to the regular market fleet? How do you view this situation in terms of needing to replace those barrels?

No, I think this development has been occurring for much longer than I expected. It's making it increasingly unlikely that the vessels servicing this market will return to compliance. Any change in the sanction regime against Iran, even if unlikely, would positively impact the compliant market. This is a frequent topic of discussion. We find it hard to understand how this trade continues. However, if you are from a crude-short nation that needs to refine petrol, you will seize any opportunity for available barrels. Unfortunately, we can't do much about this trade. As the compliant fleet ages, its supply will decline, and this aging is accelerating. Unless Iran can significantly boost oil production, which is also true for Russia and Venezuela, we risk facing an overcrowded, oversupplied sanctioned market. My faith in enforcing sanctions has diminished. For example, a tanker explosion outside Singapore recently received little attention. Currently, there is a Suezmax burning in the Red Sea that is also flying under the radar outside the shipping community. I've lost confidence in this area. However, I believe the fleet will continue to grow because there are incentives for older ships to enter this market. Once the margins in this market erode, we will start to see recycling. I apologize for the lengthy response to your question.

No, no, it did. Very interesting. I appreciate that perspective, somewhat sobering. But yes, Thanks, Lars. I'll turn it over.

Thank you, Omar.

Thank you. We will now take our next question from the line of Deven Sangoi from TEJ Investments. Please go ahead, your line is now open.

Yes, Lars, I just want to ask you a question that you mentioned about the oil spillage in Red Sea, which happened, and there were several other instances. How do you see this dark fleet insurance getting covered because that's, again, the amount of crude is moving on and you don't have global insurance companies who are willing to underwrite?

It's a very good question. Prior to this, we conducted an exercise to assess how many ships are operating in the sanctioned or illicit Russian trade, as some owners are finding ways to trade Russian oil despite the price cap. To determine how much of that oil is under sanction, we looked at how many of these vessels are not insured by any recognized P&I club. The picture is quite concerning if an incident occurs. The Suezmax currently burning in the Gulf of Aden does have insurance from a recognized club, but the tanker that exploded outside Singapore has raised questions about who actually owns it. This scenario paints a very bleak outlook if we continue to see events like these.

Thank you. My second question is regarding the uncertainty surrounding a potential soft landing for the U.S. economy and the possibility of it entering a mild recession. Additionally, with the Chinese economy not showing signs of recovery, do you foresee that if both of these economies do not bounce back next year, global oil demand could decrease?

I don't think we'll have lower global oil demand, but the expected oil demand growth will be limited. Coupling that with the fact that the tanker fleet is presumably shrinking, at least the efficient fleet is shrinking, we're not too worried about that from a tanker demand perspective.

Any other factor which can affect the ton mile because we've seen a significant change in ton miles over the last 12 months? So do you see any other factor which affects mile positively or negatively?

No, there is nothing really that comes to mind. We are moving into a weather-exposed period of the year, which partly explains the volatility we normally see towards winter. That could obviously change things up. Sudden supply changes like Libya were mentioned, where we're losing 660 million barrels per day or thereabouts. That is actually enough to trigger certain changes. But there is nothing apparent I see. We see the TMX pipeline, which is the new flow out of Canada on the US West Coast. That is kind of developing, but it doesn't seem to have altered trading lanes materially. One thing to watch is the production growth in Guyana, Brazil, and the US Gulf. There is not a lot of export growth expected out of the US Gulf for next year, but everybody has been wrong every year in quite a long time. There is also an election over there, which might affect the willingness to invest in production, which will impact exports. There are numerous interesting spots to look at, but nothing material that I think will happen very, very soon.

Okay. As you've seen, you've been paying out handsomely in dividends, but if your call on the bull market goes right, you will be flush with so much cash. What do you do with the cash?

We pay it to our dear investors, then you can decide what to do. That was jokingly said, but that's basically how we operate unless we see an investment opportunity that we think will yield our investors a better return on equity. We will pay it all out.

You don't see any good asset acquisition opportunities, or are we done with that after taking all the ships out from the yard, including the half-completed VLCC, and now leveraging your balance sheet?

I think and I hope that we are in line with the rest of the markets that we need to see confirmation in the rates in our markets before we have the conviction to do anything on the asset side. Right now, we are content with the fleet composition we have. But if the market is going to continue to only pay us $40,000 to $45,000 per day, there is no sense to either buy or order a ship at these price levels.

Thank you Lars, and all the best.

Thank you very much.

Thank you. As there are no further questions, I would like to hand back to Lars Barstad for any closing remarks.

Thank you, and thank you for listening in. Thank you for all the very, very good questions. We'll just keep our fingers crossed for the normal seasonal pattern to begin. Thank you.

This concludes today's conference call. Thank you for participating. You may now disconnect.