Earnings Call Transcript - FRO Q3 2021

Operator, Operator

Good day, and thank you for standing by. Welcome to the Q3 2021 Frontline Limited Earnings Conference Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Lars Barstad. Please go ahead.

Lars Barstad, CEO

Thank you very much, and good morning and good afternoon to everyone. And welcome to Frontline's third quarter earnings call. These are indeed volatile times, although maybe not as volatile as we hope for in freight. Q3 '21 marked the bottom of the tankers post COVID-19. This is seasonally a low point in the markets, but everything seems to have been amplified in these times we currently live in. Towards the end of the quarter, we actually started to see a recovery in demand for freight as export volumes grew, which has continued into the fourth quarter. Right now, we are, as the rest of the world, worried about the implications of this new Omicron variant of the COVID-19 virus. What will OPEC+ do in that respect and will something come out of the ongoing Iranian nuclear talks in Vienna? Well, let's start with the facts on Frontline's third quarter and look at the highlights on Slide 3. Q3 '21 performance reflects the challenges the tanker markets faced this quarter. It is, however, proof that our business model, our efficient operations, our modern fleet and very hardworking team managed to outperform most of our peers. In the third quarter, Frontline achieved $10,500 per day on our VLCC fleet; $7,900 per day on our Suezmax fleet; and $10,700 per day on our LR2/Aframax fleet. So far in the fourth quarter, we have booked 79% of our VLCC days at $21,600 per day; 72% of our Suezmax days at $17,900 per day; and 64% of our LR2/Aframax days at $16,000 per day. All numbers in this table are on the load-to-discharge basis but I do think they show that the markets have indeed recovered from the third quarter, although we have yet to see rates reaching for the skies. I'll now let Inger take you through the financial highlights.

Inger Klemp, CFO

Thanks, Lars, and good morning and good afternoon, ladies and gentlemen. Following the acquisition that we did of the 8 VLCCs in the first half of the year, we have been active on the financing side. In the third and the fourth quarter, we have entered into term loan facilities and obtained financing commitments for a total amount of up to $507 million to partially finance the acquisition of the two 2019 built VLCCs and also the six VLCC newbuilding contracts. These facilities will finance 65% of market value and they will carry an interest rate of LIBOR plus a margin of 170 basis points. And they will have an amortization profile of mostly 20 years but also 18 months commencing from the delivery date from the yard. When we factor in $33.4 million available under the term loan facility entered into in November 2020 to partially finance the delivery of the last LR2 tanker, we have established bank debt of up to $540.4 million. The company has also raised gross proceeds of $51.2 million under the equity distribution agreement and also net cash proceeds of approximately $67 million through the sale of four LR2 tankers. Following these remaining commitments, as of September 30th, for Frontline's newbuilding program consisting of one LR2 tanker and the six VLCCs and for the acquisition of the two 2019 built VLCCs is fully funded. Through these new financings, we reduced our borrowing costs and we also reduced our industry-leading cash breakeven base, providing significant operating leverage and sizable returns during periods of market strength while helping to protect our cash flows during periods of market weakness. Frontline has also extended the terms of the senior unsecured revolving credit facility of up to $275 million by 12 months to May 2023, leaving Frontline with no loan maturities until 2023. Then let's turn to Slide 4 and look at the income statement. Frontline achieved total operating revenues net of voyage expenses of $69 million and adjusted EBITDA of $17 million in the third quarter of 2021. We reported a net loss of $33.2 million or $0.17 per share and an adjusted net loss of $35.9 million or $0.18 per share in the third quarter. The adjustments consist of a $1.2 million gain on derivatives, a $0.2 million gain on marketable securities, and $1.3 million amortization of acquired time charters. The adjusted net loss in the third quarter increased by $12.7 million compared with the second quarter. This increase in loss was driven by a decrease in our time charter equivalent earnings due to lower TCE rates and the recognition of a gain on the marketable securities sold in the second quarter of $4 million. This was partly offset by a decrease in ship operating expenses of $3.2 million, primarily as a result of lower dry docking costs. Then let us take a look at the balance sheet on Slide 5. The total balance sheet numbers have increased by $6 million in the third quarter, and the balance sheet movements in the quarter are primarily related to taking delivery of the LR2 tanker Front Favour, along with ordinary debt repayments and depreciation. As of September 30, 2021, Frontline has $190 million in cash and cash equivalents, including undrawn amounts under our senior unsecured loan facility, marketable securities, and minimum cash requirements. Frontline's remaining newbuilding and vessel acquisition CapEx of $659.4 million as of September 30, 2021 is fully funded by $540.4 million in estimated debt capacity and also the $118.2 million in cash raised with the ATM and the sale of the four LR2 tankers, which I mentioned. The company has also no debt maturities until 2023, as I also mentioned. Let's take a closer look at cash breakeven rates and OpEx on Slide 6. We estimate an average cash cost breakeven base for the remainder of 2021 of approximately $21,400 per day for the VLCCs, $17,800 per day for the Suezmax tankers, and $14,100 per day for the LR2 tankers. The fleet average estimate is about $17,600 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, TC and bareboat hires, installments on loans, and G&A expenses. We recorded OpEx expenses in the third quarter of $8,200 per day for the VLCCs, $7,200 per day for the Suezmax tankers, and $8,800 per day for the LR2 tankers. We dry docked two LR2 tankers in the third quarter and expect to dry dock one VLCC and one Suezmax tanker in the fourth quarter. Then the graph on the right-hand side of the slide shows free cash flow per share and free cash flow yield based on the current fleet and share price of November 26th as alternative TCE rates. For example, if we assume historic Clarkson TCE rates for non-ECO vessels from 2000 to November 2021, and adjusted them for Frontline fleet scrubber and ECO vessels, Frontline would have a free cash flow yield of 38%. The free cash flow yield potential increases with higher assumed TCE rates and also on a fully delivered basis. With this, I leave the word to Lars again.

Lars Barstad, CEO

Thank you very much, Inger. Let's move over to Slide 7 and look at the third quarter tanker market. So tanker rates bottomed during Q3 and this is seasonally the normal weakest moment of the year. But I think it's safe to say that this is not a normal year. We actually haven't had any normal year since 2019. So global oil consumption averaged 98.6 million barrels per day; that's up 1.9 million barrels from the second quarter. Supply averaged 96.8 million, also increasing by close to 2 million barrels per day. But we continue to grow then kind of very close to 1.8 million barrels per day of inventories. OPEC+ supply rose an average of 1.4 million barrels per day. It's important to note that many of the key OPEC suppliers came out of their peak demand period, which is when they burn fuel for electricity generation and basically for cooling, and this normally happens in September, towards the end of the quarter. We saw strong demand growth in North America and in Europe, whilst the Asian demand recovery was muted during the third quarter, similar to the second quarter. What was special about the quarter we went through was that oil and energy prices were extremely volatile. We saw natural gas prices, coal prices, and other commodities affected by energy prices rise rapidly during the quarter. All the markets kind of performed strongly as we approached the end of the quarter. I think it's important to note here, if you look at the graph on the left-hand side at the bottom of the slide, total world consumption is now actually not that far off from where we started in January 2020, before the pandemic hit us. In December, some market commentators are actually arguing for us to end up at or around 100 million barrels per day. What we've seen, which is illustrated on this slide, is that oil in transit has developed quite well during the last couple of months. We saw that during Q3, we remained at depressed levels where oil in transit increased, then decreased again, and then increased, resulting in this choppy movement. However, as we moved into November, we started to see that oil and water, which is essentially a picture of demand or utilization in the tanker fleet, increased rapidly to where we are now. So let's move to Slide 8 and have a look at the order books. Tanker ordering was obviously muted during the third quarter. We saw one Suezmax order and eight LR2 Aframax orders, while no VLCCs were reported ordered during the quarter. What did happen, however, is that the delivery window for ordering any meaningful number of tankers is now starting to get limited for 2024, even. 2023 is destined to show very few VLCC and Suezmax deliveries. Newbuilding prices are indicated at very high levels. There hasn't been much price discovery in this market, particularly for the VLCCs, as no new builds have been ordered in the last four to five months. This situation is governed by a combination of high steel prices and low availability. The considerations that shipowners need to make now, if they are to go into the market and order a VLCC, let’s say at $110 million or $115 million or $120 million depending on whom you speak to, would be a bet on steel prices in 2023. This is obviously a bet that many are hesitant to make at this point. The VLCC order book stands at 71 units, which is a little bit over 8% of the existing fleet. However, we still have a situation where 113 VLCCs will exceed or pass the 20-year mark as the current order book delivers. For Suezmax, there are 41 units in the order book while 116 will be turning 20 years old using the same metrics. One thing that changed a little bit during the third quarter is that recycling has started to show some promise. Let's move to Slide 9. With record high recycled steel prices, activity is finally accelerating. As you see in the chart at the top, 2017 and 2018 were the last significant periods for vessel retirement. In Q3 alone, we saw close to 0.76% of the global tanker fleet sold for recycling. We are in a situation now where alternative uses for tankers are extremely limited. As most of you may know, in earlier markets, there was an opportunity to either convert a ship for storage or even change it into a production unit, but such markets are currently closed. Additionally, during the pandemic, the capacity for recycling has been substantially reduced. The COVID pandemic has affected countries like India, Pakistan, and Bangladesh significantly. Year-to-date, we have seen 15 VLCCs, 11 Suezmaxes, 18 Aframax, and eight LR2s reported sold for demolition. Broadly speaking, this amounts to almost 2% of the existing fleet. We believe that this may accelerate going forward as the recycling values remain strong. Moving to Slide 10, a lot of noise currently exists in the market, particularly regarding the potential impact from the Omicron virus. However, we believe we'll need a few weeks to learn more about this variant to truly understand where we're heading. What we do know is that in recent weeks, we've had a note regarding the US releasing oil from their strategic petroleum reserve. Other extraneous factors are also at play; however, let’s focus on this one. The US has released oil volumes from their SPR a few times over the last 18 months. Despite US inventories being below five-year averages, the country is not particularly short of crude oil. After the recent releases, we have observed slightly higher exports with a significant part of the volume going to Asia, particularly in October and November this year. It’s worth noting that it's not the SPR volume itself heading to the Gulf Coast but rather ample supply of oil in the US. An SPR release depresses local prices for crude, making that crude attractive to Chinese or Asian buyers. China, India, South Korea, and Japan have pledged to join the US effort in releasing oil from their SPRs, but apart from India, none have been very specific on volume. We must remember that these Asian countries are highly sensitive to severe supply disruptions due to their limited domestic production capacity. The Northern Asian region is facing record high energy prices as they head into winter. Whether oil will be released from the SPR following a $10 drop in oil prices is uncertain. If it does, it could trigger an increase in ton miles. In summary, demand and supply of oil continues to rise, but the latest variant of the virus is clouding the outlook. The tanker markets have recovered since Q3 '21, but they are still challenged by oil supply and not fully at pre-pandemic levels. Tanker recycling, which has finally started to impact vessel supply, is crucial to note. Additionally, we are facing numerous external factors that remain uncertain. The US SPR release, upcoming OpEx strategy changes, recent delays in meetings to gather more information on the virus outbreak, and the resumption of Iranian nuclear talks in Vienna all add complexity. Oil in transit keeps rising, and energy prices are at record highs as the Northern Hemisphere heads into winter. The most important takeaway is that Frontline's financial commitments are now fully funded, with reduced overall funding costs, and we are indeed well-positioned as the story of this market unfolds. Finally, I have used this graph before, showing year-on-year performance in various segments. We observed that tankers are now showing a growth of 3.8% year-on-year in October compared to October 2020. Tankers have lagged behind other shipping asset classes for a while, but we are beginning to catch up. So with that, I'll open up for questions.

Operator, Operator

Your first question today comes from the line of Chris Tsung from Webber Research.

Chris Tsung, Analyst

I wanted to just ask about the four LR2s that were sold. Were they clean prior to the sale or are they still relatively dirty?

Lars Barstad, CEO

No, they were trading clean.

Chris Tsung, Analyst

And then I think last quarter, there were seven dirty and then 13 clean. What's the composition of your fleet now?

Lars Barstad, CEO

It's actually 35% trading dirty and 65% trading clean.

Chris Tsung, Analyst

And to dry docking, I think Inger, you said one VLCC and one Suezmax in Q4, roughly, how many days would you estimate for these two?

Inger Klemp, CFO

How many days? Around 20 days, that's the standard.

Chris Tsung, Analyst

20 days for each, so 40 in total?

Inger Klemp, CFO

Yes.

Chris Tsung, Analyst

And lastly, a quick one from me. How much is remaining under the equity distribution agreement?

Inger Klemp, CFO

The equity distribution agreement is a total of $100 million. So now that we have raised $41.2 million, the difference is $48.8 million remaining.

Operator, Operator

Your next question comes from the line of Greg Lewis from BTIG.

Greg Lewis, Analyst

I guess I wanted to discuss a little bit more about the decision to sell the LR2s. What was it about those vessels that made them more attractive than some of the other vessels in the fleet? Is it more of realizing the acquisition from last year on the Suezmaxes? Was the function of those vessels being in the sale leaseback transaction really the fact that those were product vessels versus crude? Or what I'm wondering is I think we're all optimistic that we're going to see a recovery in tanker rates in '22. But could we see more of those similar types of transactions with some of your crude vessels?

Lars Barstad, CEO

Over the last year, we've obviously expanded our exposure in the VLCC market significantly. This is something we've communicated for a long time that this has been our ambition. Historically, we have found that the best return for our shareholders comes from the larger vessels. In that process, we've worked hard to grow that fleet substantially. This year, the asset class that has appreciated the most is, in fact, LR2s. While all asset prices have risen, the LR2s have demonstrated tremendous strength. Therefore, we saw this as an opportunity to capture value at this point in the curve. We may divest other vessels in the future, but our focus remains on growing and maintaining our VLCC position, where we believe we can achieve the best returns. The LR2 segment is very interesting and we believe in that market. We thought it prudent to capture this value as we saw the price we could achieve on those four units, the oldest four in our fleet, Chinese built, provided a strong opportunity to realize value.

Greg Lewis, Analyst

Thank you for the presentation and discussing the VLCC market. You referenced historical prices. What I'm trying to understand is regarding the modern VLCC fleet today. Do we have any sense of how much of that fleet is scrubber fitted?

Lars Barstad, CEO

Actually, I don't have that number in front of me. However, I can say that roughly half of the VLCC fleet is scrubber fitted. I would assume the most modern vessels are fitted as they come from the yard. Most scrubber investments have likely occurred on the non-ECO, more thirsty units, as that’s where it makes the most economic sense. But I don't have the exact split up front, just that about half is currently sailing with a scrubber.

Greg Lewis, Analyst

I just have one more question. Let me think for a moment; it slipped my mind.

Operator, Operator

Your next question comes from the line of Jon Chappell from Evercore.

Jon Chappell, Analyst

Inger, I’ll ask Greg's question for him. You got a lot done on the financing side in Q3, and it seems like you're all squared away now, which checks a significant box in terms of meeting the newbuild commitments. I'm curious about the equity distribution. Why did you feel it was necessary to issue equity at that amount given all the financing you had lined up and the fact that you’re basically covered now even without the more expensive equity?

Inger Klemp, CFO

The timing of that issuance was accretive to the company since the NAV of the Frontline shares was significantly below the share price at that time. We felt it was a wise move for the company.

Jon Chappell, Analyst

On the macro side, Lars, clearly, there are many things we can't identify right now. This question was likely more fitting two weeks ago before more factors emerged. Everyone's presented a very optimistic view, ourselves included, on why things should improve. The spring is coiling, inventories are low, production is increasing, demand is rising, and the fleet is shrinking. Yet we still find ourselves at these very low levels where we occasionally see a slight increase, and just as quickly it pulls back again. Aside from OPEC being somewhat stingy with their releases, what has been the limiting factor in allowing the recovery from the third quarter trough to gain traction? Are there any additional concerns about sustainability going into early '22 beyond what you've already addressed?

Lars Barstad, CEO

There is probably not one definitive answer to that question. Our experience suggests that in some market segments, there is suddenly an opportunity to push rates higher, but other segments might experience challenges. Recently, we have seen strong demand in the VLCC space, with the Middle East exporting according to the OPEC program. However, prior to this, we suspected that other countries were consuming or retaining significant volumes domestically. Compounding this, West Africa has faced production issues, causing a tapering off of volume. Additionally, for long-haul oil, the arbs need to be open to incentivize shipping from Atlantic Basin to Asia. That has not been the situation as demand has risen rapidly, particularly in Europe and the US. We are still shy of a few million barrels of production to reach pre-COVID levels. Furthermore, new ships have been delivered throughout the year, contributing to the complexity of the situation. In essence, it is a confluence of these three factors. As for pricing and crude pricing dynamics, they can shift quickly based on regional markets. Regarding production increases, the risk lies with whether OPEC will increase volumes into Q1. However, we are very close to equilibrium. We need to fire on all cylinders for traction, but regrettably, one cylinder seems to be misfiring sometimes while others are in play.

Jon Chappell, Analyst

If I can follow up on that point. All eyes will be on OPEC this week. They have been drivers of sentiment in the tanker markets more recently. Based on what you noted about the arbs and the SPR release in the US leading to lower domestic prices here, which could enhance exports and thus longer-haul shipments, does OPEC retain the same level of influence in the tanker markets that it once did, or is its role more about sentiment than fundamentals now?

Lars Barstad, CEO

I would say OPEC now plays more of a role in shaping sentiment than actual fundamentals. Take, for instance, the past year where OPEC has oscillated between adding supply and hesitating to do so. Their relatively minor production increases have been reflected in their exports. We see OPEC producers compliant but facing production challenges. In our scope of global crude oil transportation, we observe volumes gradually increasing. If OPEC decides against increasing production in January, we could witness market reactions and swings in prices, causing Atlantic barrels to become more attractive to Asia. Thus, our focus is on volumes, which matter more to us than OPEC's month-to-month decisions.

Operator, Operator

Your next question comes from the line of Randy Giveans from Jefferies.

Chris Robertson, Analyst

This is Chris Robertson on for Randy. Just to follow up on the ATM issuance there. Can you talk about how you decided on the amount that was issued in October? And if rates remain weak in 2022, would you consider utilizing it again with a further issuance?

Inger Klemp, CFO

Based on the current share price, we will not consider utilizing the ATM further.

Lars Barstad, CEO

I would like to add that Frontline has had ATM programs previously, and we've always been extremely disciplined, acting only when it's accretive and when market conditions are favorable for such actions. That should further inform your question.

Chris Robertson, Analyst

Yes, definitely. Thanks for the additional information.

Operator, Operator

Thank you. There are currently no further questions. I will hand back for any remarks.

Lars Barstad, CEO

Yes. Thank you very much for calling in and for your time. Also, thank you to the entire Frontline team who's done a fantastic job again this quarter. Stay safe.

Operator, Operator

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