Earnings Call Transcript - FRO Q2 2021

Operator, Operator

Thank you all for standing by and welcome to today's Q2 2021 Frontline Ltd. Earnings Conference Call. Please be advised the call is being recorded. And I would now like to hand the call over to your speaker, Lars Barstad. Thank you.

Lars Barstad, CEO

Thank you. Good morning and good afternoon. Welcome to Frontline's second quarter earnings call. Different from the first quarter this year, the second quarter ended up being quite inevitable. As many of you have asked quite a few times now, will Frontline try and exploit the weakness in this market to grow further? And I guess we have answered that now during Q2. We are in some way a three-legged shipping platform with VLCCs, Suezmax, and LR2s. Our VLCC leg has been a bit shorter than the others. Now we're amending that somewhat. Parts of the challenges in the market this quarter have been the continuous flare-ups of COVID infections in various locations around the world. Vaccination has come far in the Western parts, but other parts of the globe are not so fortunate. We remain vigilant towards our seafarers' well-being and are happy to share that our efforts to arrange vaccines for them are going well. In addition, I'd like to mention we are very grateful certain port states are being extremely generous offering vaccines to seafarers literally for free. So, let's move on and have a look at the highlights on Slide 3. Q2 2021 performance reflects the challenges the market faced this quarter. It is, however, further proof that our business model, efficient operations, modern fleet, and a very hardworking chartering team manage to outperform the key benchmarks. To put this in perspective, an average weighted earnings index I checked recently for oil tankers came in just over $6,000 per day in Q2 2021, the lowest print in more than 20 years. In order to outperform this, the owners and in particular the owners' charters must fight for every cent and know their position well to be able to play their hands as best as possible. Regrettably, this is not always the case as far as we can observe. Anyway, at Frontline we do the hard work and have achieved $15,000 per day on our VLCC fleet; $11,000 per day on our Suezmax fleet; and $10,600 per day on our LR2/Aframax fleet in the second quarter of this year. So far in Q3, we have booked 70% of our VLCC days at $14,000 per day; 64% of our Suezmax days at $9,800 per day; and 63% of our LR2/Aframax days at $11,800 per day. All numbers in this table are on a load-to-discharge basis. Before Inger takes you through the financial highlights, let me quickly comment on the acquisitions in the quarter. During Q2, we acquired through resale six latest-generation ECO-type VLCCs currently under construction at Hyundai in Korea. In addition, we acquired two modern ECO-type VLCCs built in 2019 at the same shipyard. We have for a period of time followed the VLCC asset market closely to look for opportunities. As we didn't expect an imminent recovery in tanker markets, delivery was a key bargaining chip. The rallying steel prices and high activity around us for non-tanker assets pushing potentially delivery slots way forward added to our conviction in making these investments. I'll now let Inger take you through the financial highlights.

Inger Klemp, CFO

Okay. Thanks, Lars, and good morning and good afternoon ladies and gentlemen. Yes, following the acquisition of the VLCCs, as Lars mentioned, we have progressed on the loan financing. In August this year, we obtained financing commitments subject to final documentation for three senior secured term loan facilities. They are in a total amount of just $247 million, and they will partially finance the acquisitions of the two VLCCs built in 2019 and three of the six VLCC newbuilding contracts. All facilities will finance 65% of market value. They will carry an interest rate of LIBOR plus a margin of 170 basis points. They will have an amortization profile of 20 years starting from the delivery date from the yard. We intend to establish long-term financing for the remaining four resale VLCC newbuilding contracts, closer to the delivery of the vessels. Let us then move to Slide 4 and look at the income statement. Frontline achieved total operating revenues, net of voyage expenses of $80 million and adjusted EBITDA of $28 million in this quarter. We reported a net loss of $26.6 million or $0.13 per share and an adjusted net loss of $23.2 million or $0.12 per share. The adjustments this quarter consisted of a $4.7 million loss on derivatives; a $0.8 million gain on marketable securities; a $1.3 million amortization of acquired time charters; and lastly a $0.8 million share of losses of associated companies. The adjusted net loss in the second quarter decreased by $32 million compared with the first quarter, and the decrease was driven by a drop in our time charter equivalent earnings due to the lower TCE rates as Lars mentioned, an increase in ship operating expenses of $9.3 million, mainly as a result of higher dry-docking costs; offset by a gain on marketable securities sold in the quarter of $4 million. Let us then look at the balance sheet on Slide 5. The total balance sheet numbers have increased by $64 million in this quarter. The balance sheet movements in the quarter are primarily related to taking delivery of the LR2 tanker from Future and the acquisition of six VLCC newbuilding contracts in addition to ordinary debt repayments and depreciation. As of June 30, Frontline has $257 million in cash and cash equivalents, including undrawn amounts under our senior unsecured loan facilities, marketable securities, and minimum cash requirements. Then, let us take a closer look at cash breakeven rates on Slide 6. We estimate risk cash cost per daily rate for the remainder of 2021 of approximately $21,800 per day for the VLCCs; $7,500 per day for the Suezmax tankers; and $15,400 per day for the LR2 tankers. The fleet average estimate is about $18,000 per day. These rates are the all-in daily rates that our vessels must earn to cover the budgeted operating costs and dry-dock estimated interest expenses, TCE, bareboat hire, installments on loans, and G&A expenses. The highly attractive terms on the updated financing commitments on four of the acquired VLCCs, which I mentioned earlier, decrease the daily cash breakeven rates by approximately $1,400 per vessel per day compared to existing financing terms of similar vessels. In the quarter, we recorded OpEx expenses of $7,600 per day for VLCCs; $8,500 per day for Suezmax; and $9,000 per day for LR2. We dry-docked three Suezmax tankers in this quarter and four LR2 tankers, and we expect to dry-dock one VLCC and two LR2 tankers in the third quarter and none in the fourth quarter. The graph on the right-hand side of this slide shows that if we assume $30,000 on top of the daily fleet average cash cost per daily rate of $18,000, Frontline will generate a cash flow per share after the service cost of $3.51 per year. The cash generation potential will increase after the acquisition of the eight VLCCs. With this, I leave the word to Lars again.

Lars Barstad, CEO

Thank you, Inger. Let's review the second quarter tanker market based on slide seven. Global oil consumption averaged 96.7 million barrels per day in Q2 2021, which is an increase of 2.1 million barrels per day compared to Q1 2021. Production averaged 94.9 million barrels per day, resulting in a draw of about 1.8 million barrels from inventories. To illustrate this, drawing from inventories means less demand for transportation. Typically, it requires about 30 VLCC equivalents to transport 1 million barrels of oil per day, indicating a loss of 30 to 35 VLCC equivalents in demand. Throughout the quarter, tanker rates gradually declined, and volatility decreased. OPEC+ increased its supply by over 1 million barrels per day in Q2 2021. Key OPEC producers also entered high demand periods, especially in the Middle East due to summer energy needs. The US and Brazil contributed an additional 900,000 barrels per day, mostly from Brazilian exports. However, the US saw robust demand growth, leading to fewer exports from the US Gulf. Demand surged in North America and Greater Europe, while Asia's recovery was more subdued in the second quarter. As shown in the charts below, North America, Europe, and Eurasia saw a significant rise in demand during Q2, unlike the rest of the world, particularly Asia, which did not perform as well in the first half of the year. Moving to slide eight, the tanker order books reveal that new orders were limited in Q2 2021. We noted that the delivery timeline for significant numbers of VLCCs or Suezmaxes has shifted to 2024 due to increased ordering in other asset classes. The tanker order book for VLCCs, Suezmaxes, and LR2 has decreased by 10% year-to-date, with the total order book for tankers exceeding 10,000 deadweight tons now at 8% of the existing fleet. This level is similar to what was observed in Q1 1997. Currently, in absolute deadweight terms, we are at a 20-year low. To put this into perspective, global oil consumption was approximately 76 million barrels per day two decades ago, whereas a normalized market is closer to or above 100 million now, indicating that the oil market is 30% larger than in the early 2000s, with an order book of similar size. The VLCC order book currently stands at around 81 units, while we have 124 VLCCs that will be over 20 years old soon. For Suezmax, we have 41 units and 123 that are also reaching 20 years. On slide nine, we examine oil in transit, which is a crucial indicator we monitor monthly. Oil in transit refers to oil being transported, excluding what is in storage. As I pointed out, 2020 was a volatile year for oil transportation marked by the Saudi-Russian price war in the early year, a massive production boost, and later a demand shock due to the pandemic. In Q3 and Q4, transportation needs fell back to 2017 levels, with floating storage helping maintain tank utilization. In the first half of 2021, tanker volumes and transportation grew, but we faced increased fleet supply from vessels returning from storage and new builds, alongside significant inventory draws. Currently, in July and August, we have returned to Q4 2019 levels, and OECD commercial inventories have dropped to 2019 levels, which we believe is a fair proxy for global inventories. Notably, when inventory draws cease, there will be a need for transported oil. For instance, the EIA estimates a building of 1 million barrels per day for September, followed by a 0.5 million barrel per day draw in October, indicating a delta of 1.5 million barrels that needs transport—equivalent to the demand for 45 to 48 VLCC equivalents. This illustrates how rapidly conditions can change. Now let's proceed to slide 10, where I focus on what I call the VLCC fleet paradox, reflecting similar trends for Suezmaxes. The challenges faced by older VLCCs are evident as very few charters accept 20-year-old vessels based solely on age. With the trading environment being tough in the first half of this year, earnings on non-ECO vessels have been zero or negative. Currently, 61 vessels exceed 20 years old. So far this year, eight VLCCs have been reported sold for recycling, with average recycling prices in Asia increasing by 70%, now close to $25.5 million for a VLCC. One common exit strategy for older vessels previously included crude oil storage; however, with crude oil curves entering backwardation in Q4 last year, floating storage options have diminished. This year, only three VLCC spot fixtures have been reported for vessels 20 years or older, out of 660 VLCC fixtures recorded. This highlights that effective tonnage hasn't grown over the past few years, positioning us closer to balance than we may expect. This distortion in the picture must be addressed. To summarize on slide 11, oil supply and demand are on the rise, though the Delta variant is creating uncertainty, particularly in Asia. Asset prices remain strong, steel prices are climbing, and yard activities are robust, especially for non-tanker assets. Meanwhile, the tanker fleet continues to age, the overall order book is shrinking, and the potential delivery timeline extends further out as demand for tankers increases. OPEC+ plans to add around 400,000 barrels per day each month until year-end, leading to a total increase of 2 million barrels per day. With that growth, we would require 60 to 65 VLCC equivalents by year-end. Oil in transit is rising, and the crucial question is when we will hit inflection points. I encourage you to look at the chart at the bottom of the slide, which I showed last quarter. It depicts our shift from negative to positive year-on-year growth in global oil trade, and since last time, Frontline has significantly expanded its position. We have secured attractive financing and are prepared to capitalize as we progress towards the anticipated recovery. Thank you very much, and I would like to open the floor for questions.

Operator, Operator

Thank you. We’ll now begin the question-and-answer session. The question is from the line of Randy Giveans from Jefferies. Your line is now open.

Lars Barstad, CEO

Howdy Randy.

Operator, Operator

Mr. Giveans, your line is now open. You may ask your questions. The question is from the line of Magnus Fyhr from H.C. Wainwright. Thank you.

Magnus Fyhr, Analyst

Yeah, good afternoon. Looking at the performance in the fleet in the third quarter, I mean compared to some of the peers, it looks like you had a little bit better performance. I know it's hard to compare quarter-to-quarter, but you've been consistently outperforming the peers. So was there anything else in the quarter, or is there any other flavor you can give on the performance in the third quarter?

Lars Barstad, CEO

Well, it's a good question. This is one of the things that we, obviously, try to analyze. Well, obviously, when you compare to peers there is an aspect of fleet composition and the age of your fleet, and so that does play a part. But it doesn't account for all the comp out-performance. It's also staying true to the fact that we are shipowners, we have assets we need to protect. We need to try as hard as we can to get our clients to understand that and not give in. It's also about a modern fleet in addition to the economics; it also gives you more opportunities to trade around. You basically have all options. So that's an important fact as well as you try to triangulate your vessels in order to achieve higher utilization and better returns. I hope that's a good answer to your question.

Magnus Fyhr, Analyst

Yes. No, that’s helpful. Thank you for the color. Also, I mean you're painting a picture of wanting to avoid going into the abyss here; rates are very weak. We're in the weakest part of the year. You mentioned that the fleet growth may not be as high if you adjust for the age composition of the fleet. But do you have any visibility into the winter market? I mean, we're still in August, I know it's a little bit early. But I was just curious your outlook here for a recovery in the fourth quarter.

Lars Barstad, CEO

The share volatility of the freight market indicates that we have limited visibility, to be frank. However, we do secure contracts well in advance, which allows us to gauge demand early. Currently, we are fixing contracts for September in the Middle East and West Africa, and the volume outlook appears quite positive. We've noticed Suezmax rates trying to rise slightly. We're also arranging contracts for early October out of the US Gulf, and the initial outlook there seems relatively busy as well. While I can't provide any guarantees, the overall situation looks a bit more favorable than it did a couple of weeks ago.

Magnus Fyhr, Analyst

Okay, that's good. Just one last question about the S&P market. You've been actively purchasing some resales, and I'm curious if you see any opportunities in the second-hand market. There was a non-ECO 2012-built vessel reported last week at a significant discount. I'm not sure if that was just an isolated transaction or if it indicates potential weakness in the second-hand market. Can you provide any insight on that?

Lars Barstad, CEO

I think if there is a curve on values, I think the softer spot is kind of the middle-aged generation, particularly if it doesn't have a scrubber. Because the older vessels like the really old ones have been held up by this artificial demand from undisclosed accounts that want to use the vessel for various purposes. The modern vessels are obviously the ones everyone wants to own as we go into a tightening regulatory framework and face all sorts of efficiency demands going forward. That keeps these vessels in the middle a little bit out of fashion. I'm not too worried about that transaction because, basically, from what I see on the market, you could argue that a very modern vessel or a resale or a new build is more correlated to asset prices themselves and eventually to the steel price. As long as that is holding up, I'm not too worried about the modern part of the fleet.

Magnus Fyhr, Analyst

Okay. Thank you very much for answering my questions.

Lars Barstad, CEO

Thank you.

Operator, Operator

Thank you. Next question is from the line of Jon Chappell from Evercore.

Jon Chappell, Analyst

Thank you. Good afternoon.

Lars Barstad, CEO

Hi.

Inger Klemp, CFO

Hi.

Jon Chappell, Analyst

Inger, so you've lined up $130 million for two of the six VLCC newbuilds. Should we assume that you're looking for a similar percent about – by my math around 70% financing, so another $260 million to be taken down for the remaining four?

Inger Klemp, CFO

Yes, I will be looking for that. Yes, I see that.

Jon Chappell, Analyst

Okay. So if we take that $390 million plus the drawdown on the Hemen facility, that's the majority of the payment on this. I think that only leaves like $74 million in cash outlay for the six newbuilds. Is that the type of financing in total you're looking for, or when you get the bank facilities for the remaining four ships, would you have to pay that back to the Hemen facility immediately?

Inger Klemp, CFO

We will use this Hemen facility as bridge financing at the moment. Then we will continue or we will consider in a way a bit further down the road our options on the long-term financing for the equity portion of these vessels.

Jon Chappell, Analyst

Okay. And then in addition to the Hemen facility expiring in May of 2022, which obviously you pushed that back several times, and it's probably a safe bet to assume you could push it back further if you'd like. Are there any other big bullet payments or amortization profiles coming up in the next let's call it 12 to 18 months as we kind of bridge to the recovery that Lars talked about?

Inger Klemp, CFO

No, there is nothing until 2023.

Jon Chappell, Analyst

Okay, great. So generally speaking, you feel good about the liquidity profile, it's now just finalizing the debt on the last four newbuilds and kind of holding on until the market recovers. Is that correct?

Inger Klemp, CFO

Yes, that is correct, yes.

Jon Chappell, Analyst

All right, great. Well, that's all I had. I think liquidity is important to getting you there. Thanks for moving that out, Inger.

Inger Klemp, CFO

Thanks, Jon.

Operator, Operator

Thank you. Our next question is from Randy Giveans from Jefferies.

Randy Giveans, Analyst

Lars and Inger, can you hear me now?

Lars Barstad, CEO

Yes, we can, Randy.

Inger Klemp, CFO

Yes, we can.

Randy Giveans, Analyst

Excellent. I could hear you earlier; you just didn’t hear me. Congrats obviously Lars on the official promotion to CEO, so exciting times for that.

Lars Barstad, CEO

Thank you very much.

Randy Giveans, Analyst

Two questions. Clearly, Frontline has been pretty active in acquiring tonnage. Is this strategy to continue to grow the fleet that way, or will you now maybe look to sell some older assets?

Lars Barstad, CEO

Well after – almost every time we speak, it's difficult to kind of give you the playbook here on the air, if at all. But we obviously keep all options open. So, I'm not going to dismiss it nor confirm it. But we will always look at our fleet composition. And we favor the more modern units. So that could be a part of our strategy going forward, yes.

Randy Giveans, Analyst

Okay. That's fair. And then looking at your quarter-to-date rates, they are pretty good relative, right? Do those include any recently signed time charters? Have you signed any of those this summer? And then we start to see some rates ticking up on the product side. Is that maybe the start of a recovery or still too early to tell?

Lars Barstad, CEO

The first question first. So, we haven't done any time charters. And it's a very good question because short-term time charters we record as spot, and we haven't done any of those. Secondly, on the LR2 market you're referring to, yes, it's firming out in Asia, and it's actually quite strong. We like to think it has legs, but we've been disappointed a few times now when it's had wrong freight happened back in April as well. So let's say the jury is out. What we have done in the meantime is actually cleaning up one of our LR2s. So we're kind of the balance is more tilted towards the cleanup with seven of the 20 vessels trading dirty, and then obviously, 13 clean and ready to rumble in that market.

Randy Giveans, Analyst

Perfect. Dirty and 13 clean. All right. Well, hey, sorry for the difficulties here earlier. But thanks for getting me back on.

Lars Barstad, CEO

Oh, thank you.

Inger Klemp, CFO

Thank you.

Operator, Operator

And there are no further questions at this time, please continue.

Lars Barstad, CEO

Okay. If that was all, thank you very much for listening in on a busy day on reporting, and we will soldier on at Frontline. Hopefully next quarter, we can report a completely different situation in the market. Thank you.

Operator, Operator

That concludes our conference for today. You may all disconnect. Thank you all for participating.