Earnings Call Transcript - FRO Q1 2022

Operator, Operator

Good day and thank you for standing by. Welcome to the Frontline Q1 2022 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, today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Lars Barstad. Please, go ahead.

Lars Barstad, CEO

Thank you very much. Good morning, and good afternoon, everyone, welcome to Frontline's first quarter’s earnings call. I think I'll start off by saying it's safe to say that this has been a busy quarter in many respects. The conflict in Ukraine has been demanding on our organization. First of all, in order to support our crude, both Ukrainian and Russian nationals, in some instances, working together on our ships. Our legal and compliance team have worked relentlessly in an ever-changing sanctions environment, making sure we are staying compliant. But it's also very satisfactory to see Frontline has managed to maneuver through all these challenges and traded our ships very competitively at the same time. To top it all, we announced the proposed combination with Euronav in early April, and we’ve since then been working diligently together to finalize an appropriate transaction structure for this combination. So let's move to slide three and look at the highlights. In the fourth quarter, Frontline achieved $15,700 per day on our VLCC fleet. We achieved $16,900 per day on our Suezmax fleet and $19,000 per day on our LR2/Aframax fleet. So far, in the first quarter of 2022, we booked 74% of our VLCC days at $22,600 per day. We booked 70% of our Suezmax days at $32,700 per day and 58% of our LR2/Aframax days at $46,300 per day. All numbers in this table are on the load to discharge basis as usual for Frontline. Also, this quarter, I would like to draw your attention to slide four to explain the differences in returns depending on the vessel characteristics. You can clearly see on the figures on the right-hand side of this slide that the earnings differentiate a lot with respect to what type of ship we're trading. As you can see on the left-hand side, Frontline has a young fleet, 88% of our fleet is regarded as ECO vessels, and we have 53% scrubber penetration. And as you also can see, all the scrubbers are focused on the VLCC and Suezmax assets that have the highest consumption. But we're up now to $17,100 per day premium for a VLCC between an ECO with scrubber compared to a traditional non-ECO VLCC or vessel. For the Suezmaxes, the premium is $9,500 compared to non-ECO, and for the LR2s it's an $8,500 a day premium compared to a non-ECO. So, basically, this high oil price environment is affecting us a lot. This does not tell the full story, though, as the technical, operational, and commercial performance we managed to achieve is also very much dependent on our talented team. We work more like asset managers, optimizing a portfolio of multi-million dollar investments than traditional ship owners. With that, I'll let Inger take you through the financial highlights.

Inger Klemp, CFO

Thanks Lars and good morning and good afternoon, ladies and gentlemen. Let's then turn to slide number five and look at the income statement. Frontline achieved total operating revenues of $104 million and adjusted EBITDA of $53 million in the first quarter of 2022. We reported net income of $31.1 million or $0.15 per share, and the adjusted net loss was $1.6 million or $0.01 per share in the first quarter. The adjustments that we have made this quarter consist of a $24.9 million gain on derivatives, a $0.3 million gain on marketable securities, a $6.1 million gain on the sale of vessels, a $0.4 million gain on insurance claims, and a $1.3 million amortization of acquired time charters, partially offset by a $0.1 million share of losses of associated companies. The adjusted net loss in this quarter decreased by $3.1 million compared to the fourth quarter and the decrease in adjusted net loss was driven by an increase in our time charter equivalent earnings due to the higher TCE rates in the quarter, partly offset by other movements in operating gains and expenses. Then let's take a look at the balance sheet at slide six. Total balance sheet numbers have decreased by $56 million in the first quarter compared with the fourth quarter 2021. The balance sheet movement in this quarter is primarily related to the sale of the LR2 tankers from Frontline and Front Panther in addition to ordinary debt repayments and depreciation. As of March 31st, 2022, Frontline has $179 million in cash and cash equivalents including undrawn amounts under our senior unsecured loan facility, marketable securities, and minimum cash requirements. Short-term debt includes total balloon payments of $267.1 million for two existing loan facilities with maturity in the first quarter of 2023, which is expected to be refinanced prior to maturity. Let's then take a closer look at slide six. Keeping costs down has always been in Frontline's DNA, and core values of the Frontline platform is keeping it simple and focused and maintaining a lean and efficient management team. This slide shows that Frontline outperformed peers in the first quarter of 2022 on OpEx, G&A, and interest expense. This, together with our performance compared to peers on revenues this quarter, explains the superior operational performance of Frontline in the first quarter of 2022. Then, I think you should take a look at slide 8. We estimate average cash cost breakeven rates for the remainder of 2022 of approximately $23,700 per day for the VLCC segment, $19,800 per day for the Suezmax tankers and $16,600 per day for the LR2 tankers. The fleet average estimate is about $20,100 per day and includes drydocking of 13 vessels in the period from the second quarter to the fourth quarter of 2022 with an impact of $750 per day. The distribution of the 13 vessels is three VLCCs, five Suezmax tankers, and five LR2 tankers. We recorded OpEx expenses including drydock in the first quarter of $8,200 per day for VLCCs, $7,000 per day for the Suezmax tankers, and $7,900 per day for the LR2 tankers. In the first quarter with drydock to one VLCC, which was completed in the second quarter and two LR2 tankers where one was completed in the second quarter. The graph on the right-hand side of the slide shows free cash flow per share after debt service and free cash flow yield based on current fleet and share price as of 23rd of May at alternative TCE base. Based on historic tracks in TCE rates for non-ECO vessels in the period 2000 to 2021, adjusted for premiums on scrubber and ECO vessels, Frontline has a free cash flow per share of $2.43 and a free cash flow yield of 27%. The free cash flow yield potential increases with higher assumed TCE rates and on a fully delivered basis. With that, I leave the word to Lars again.

Lars Barstad, CEO

Thank you, Inger. So the headline for my Q1 tanker market report is basically that volatility is back. And if you look at the graph on the bottom left side on slide 9, you'll see that after coming through a period of almost 18 months, where we've been hovering between $10,000 and $30,000 on a good day, we're suddenly rocketing up. The quarter was fairly quiet as global oil demand was estimated to have averaged around 98.8 million barrels. Q1 is historically our seasonally shoulder quarter and the demand was down 1.7 million barrels compared to Q4. Supply came in at the same number, in fact. So this is the first quarter for a long time we've not grown significantly on inventories. But if you compare it to Q1 last year, we start to see some significant changes. Demand was, in fact, up 4.5 million barrels per day compared to last year, and supply had increased by a whopping 6.3 million barrels per day. As we enter the year, oil in transit stabilized around one billion barrels, and as I mentioned, inventory draws dwindled. The invasion of Ukraine sparked volatility as trade lanes started to change. What we saw towards the end of the quarter and into Q2 is high product demand growth in both the US and Europe starting to open arbs from Asia. COVID-19 continues to affect, in particular, Chinese demand, more so due to their zero tolerance policy and full lockdowns. This is predominantly what's affecting VLCC utilization. Let's move to Slide 10, and I'll try to do some explanations regarding the Russian flows. So, new trading patterns are evolving. And Russian oil and product exports from the Black Sea and the Baltic were, in fact, not down more than 360,000 barrels per day since February 2022 compared to May. European imports from Russia are down by 1.4 million barrels per day in the same period. This has been replaced by imports from Asia, Africa, and the Americas to Europe. Asia has increased their imports from Russia by about 850,000 barrels per day, and an unknown element, which is seen on the top right corner of the graph, is another 1.1 million barrels. Unknown is basically cargo that is tracking, and the vessels have yet to reach their destination port. So as we move forward, this will become more and more known to fill that gap. In essence, 2 million barrels of oil per day are diverted compared to what's regarded as the global trade of oil, or seaborne oil, which is around 38 million barrels per day. This amounts to 6%, and 6% of oil is now traveling at least 50% longer, if not twice the distance, and some even argue 2.5 times the old distance. Geographically, Europe is obviously close to Russia, and now significant amounts of crude oil and products are selling from Europe to clients predominantly in Asia. Europe now needs to replace those same barrels from either the Middle East, West Africa, or the US. The only way to kind of stop this trend would be a blockade of Russian exports or direct sanctions on oil itself. This I'll leave you to discuss. In addition, we have an element of the US now arguing to or indicating to lift sanctions on Venezuelan crude for exports to the US and Europe. So basically, this diversion or disruption is now causing both, particularly Aframaxes but also LR2s and Suezmaxes to have much tighter market conditions than we had prior to the Ukraine invasion. If we move to Slide 11, there's another thing going on in our markets as well, and look at the products market. We are, in fact, in what is regarded or you can read the headlines coming out more and more on diesel shortages. This is causing record refining margins and arbs to open up. The jury is still out whether it's all due to disrupted diesel flows or middle-distance flows from Russia because there is also an element of quite strong demand, particularly in Europe as well. So, basically, what's happened is that refining margins have literally exploded. As you can see on the top graph on the left-hand side, this is Northwest Europe, spot refinery margins coming back from May 2020 until now. These margins are partly due to lack of feedstock, but also due to the high demand. This has basically opened up, for the first time in quite a while, wide other charges from the Middle East and Asia. The longevity of the current situation is very hard to call, but this is a structural challenge. Refining capacity in both the US and Europe was reduced during the COVID-19 pandemic when they were suffering disastrous refining margins. There is ample refining capacity in the Middle East and Asia, and this is growing as well. Then let's move to slide 12 and the tanker order books. This is the first time since 2018 that we've seen fleet growth turning negative. What we've done in this top left chart is basically to look at the net fleet growth in deadweight terms, year-on-year change and the net recycling of tankers during the same period. As we can see, we started this development late in Q4 and throughout Q1, the net tanker fleet growth has actually turned negative. The last few times we've experienced this, first in 2013-2014, and secondly, towards the end of 2018, it was followed by a period of high volatility and fairly good market rates. We expect this to continue, just looking at the various order books. We continue to be in the same situation if you look at the VLCCs first, where there is a large portion of that fleet that should have been retired and still is floating on the Seven Seas. In total, 82 VLCCs will come to age, either they are already above 20 years, or they will become above 20 years in 2022. For the Suezmaxes, this end number is 67, and for the LR2s, it's a whopping 22. As the order book, as the audience would know, is dwindling. There are no new orders being placed. In fact, for the VLCC and Suezmax segment, we haven't seen a single order placed since September last year. For the LR2s, there is a bit of activity, and 6 LR2s have been ordered so far this year, but it's still not putting a dent into basically the outlook for that sector either. With regards to when you can expect to receive a vessel should you go out and order now? I think 2024 is more or less out of the question, and you need to look into 2025. It's still the case that for the main yards that build tankers, they're far more interested in building other asset classes as that yields them better margins. So, to sum it all up, oil demand continues to rise, but global oil supply issues are swelling with the Russian exports curtailing. We got volatility in tankers back in Q1 2022. As I said a few times through media and with the analysts now, it's too early to call a big cyclical upswing, but we have hopes. The tanker fleet across the globe is now in negative territory, and that's expected to continue at an accelerating pace as long as no new orders are being placed. Ton miles are expanding significantly, particularly for Suezmax and Aframax as Russian flows are diverted. There is high product demand and record refinery margins in Europe, and this is very supportive of our LR2s, which we refer to as the VLCCs of the product market. It is expected that with these refinery margins, one should see increased refinery runs, which in the end would support the VLCC. We're very happy that Frontline is able to quickly capture volatility with what we regard an efficient, diversified fleet, low-cost base, and agile approach to the market. Lastly, before Q&A, let me make a few points on the Frontline and Euronav combination. As I mentioned initially, since we went public with this in April, we have been working diligently together. What we want to achieve is a combined company with a $4.2 billion market cap. This would incur a wider index inclusion. We believe it will attract share liquidity and, of course, broker coverage. We also believe it could improve access to capital restricted finance resources. Frontline and Euronav alone are actually regarded as small cap or borderline small cap. Now, we're moving firmly into the mid-cap if you look at the New York Exchange. We believe that the combination would give enhanced commercial offering. The significant size would create significant size in all relevant trading experience, and this would yield efficiency and utilization. There are also significant synergies discovered between the two companies, both on OpEx, G&A, and financing. Finally, both companies regard themselves as leading on the ESG, and this will obviously strengthen our position in that respect in the industry. With that, I would like to open up for questions.

Operator, Operator

Thank you. Your first question today is from the line of Jon Chappell from Evercore. Please go ahead.

Jon Chappell, Analyst

Thank you. Good afternoon. Just want to start where you left off, and I understand that there's probably some limitations around what you can say regarding the potential transaction. But Frontline has obviously historically been a very active company, sale and purchase, et cetera. Also based on your quarter-to-date rates, it looks like you would return to a dividend per your formulaic policy as soon as the next quarter. I just wanted to know, as you're finalizing the terms of this transaction and you're waiting for more clarity or a potential close, are there any restrictions on your normal strategic activity, whether that's operational or financial as it relates to capital return to shareholders?

Lars Barstad, CEO

Not at this point. It's in fact.

Jon Chappell, Analyst

Okay. And then, I guess, we'll have to wait to see the terms to see if it changes not at this point. I wanted to ask a market question. You did a very thorough job explaining all the different pros and cons of the market. The VLCCs have, obviously, been a pretty big laggard. I just wanted your view on what may have the Vs catch up to the rest of the segments? And is it just a function of China opening up from its lockdowns and renewing the import growth of that nation? Is it that combined with kind of the secondary and tertiary fallout of redrawing the crude map, because of what's going on in Russia and Ukraine, or is there a chance that it's just a much stronger market given the geopolitical backdrop for midsize and product carriers and the Vs, although they'll do well, may not return to their top of the leaderboard across the asset classes?

Lars Barstad, CEO

I believe that if you examine history, it has presented many challenges over the years. One constant is that all asset classes are closely interconnected. Therefore, I find it hard to believe that this time will be different, with an unusual prolonged period where earnings relationships flip, with Suezmax performing well in the middle and VLCC lagging at the bottom. The main issue here, which I mentioned in my summary, is the global oil supply situation, which poses a challenge. The oil price indicates that we are struggling to produce or at least to export enough oil. This, combined with the situation in China, is what is holding back the VLCCs from my perspective. There are a few sources of additional crude, one of which is the U.S. If production increases, they are currently releasing oil from the Strategic Petroleum Reserve. I'm uncertain if we've felt the full impact of that in the market yet. If China rebounds, that could become clearer. Additionally, Iran is still not fully active. I'm not overly optimistic about that situation, having been more hopeful in previous quarters. However, I am quite positive about Venezuela and there are developments there that could alter the landscape. Although Venezuela may be limited to exporting to Europe, this could shift risks towards China, which would also benefit the shipping sector. I don't see this as a long-term issue. We are already observing VLCCs competing for Suezmax cargoes and Suezmax ships going after Aframax cargoes, indicating a trend towards balance. The key question now is what will trigger this change. It will be interesting to see if Beijing avoids major lockdowns and if China re-emerges robustly; that could reveal more potential in the market.

Jon Chappell, Analyst

Okay. Thank you very much, Lars.

Operator, Operator

Thank you. The next question comes from the line of Chris Tsung from Webber Research. Please go ahead.

Chris Tsung, Analyst

Hi. Good afternoon. How are you?

Lars Barstad, CEO

Hi. Good afternoon.

Inger Klemp, CFO

Good afternoon.

Chris Tsung, Analyst

Hi. I noticed in the report that I wanted to ask for more details about the decision to end the time charters with SFL, and whether the termination loss of $600,000 is in addition to the $4.5 million.

Lars Barstad, CEO

Those are the adjustments to the balance.

Inger Klemp, CFO

Okay. That's something we have had every quarter for, yes, how many years? It's actually an adjustment we have to make in order to align with what happened back in 2015 when the merger between Frontline and Frontline 2012 happened. At that point in time, Frontline 2012 was the accounting acquirer, and Frontline Limited was acquired and needed to be fair valued. At that point, we took on the balance sheet and a valuation with relation to these Ship Finance leases. This is the kind of adjustment we need to do compared to what we thought at that point in time was the profit share that we should pay in connection with these leases. So this means, in a way, that we took too much profit share on the balance sheet compared to what we actually paid then. So that's why we had to do this. Sorry about the long explanation, but.

Chris Tsung, Analyst

Okay.

Inger Klemp, CFO

Yes, Chris.

Chris Tsung, Analyst

Thank you. Regarding the earlier question about any restrictions related to the merger, I know there are about four vessels under commercial management. Will that continue if the merger goes through? That’s my question. Thank you.

Lars Barstad, CEO

Yes, that's a fair question. The answer is yes. The merger wouldn't change any of our commercial arrangements.

Chris Tsung, Analyst

All right. That's it. Thanks, Lars. Thanks, Inger.

Lars Barstad, CEO

Welcome. Thank you.

Inger Klemp, CFO

Thank you.

Operator, Operator

Thank you. Your next question is from the line of Chris Robertson from Jefferies. Please go ahead.

Chris Robertson, Analyst

Hey, good morning and thanks for taking my questions.

Lars Barstad, CEO

Hi, good morning.

Inger Klemp, CFO

Good morning.

Chris Robertson, Analyst

So on the 12% of the fleet that's non-ECO, I guess, how are you thinking about these vessels in context of IMO 2023 and beyond? But then in context of the merger with Euronav that's pending, are these sales candidates in your minds, or are they more likely to be incrementally upgraded to comply with the new regulations?

Lars Barstad, CEO

It's a good question. To be honest, we don't view them as sales candidates. This perspective is more related to our position on the curve. We firmly believe we are entering a phase where global tanker carrying capacity will decrease while we anticipate oil supply and demand will at least remain stable. Therefore, having such assets at sea will have value moving forward. Our main thesis is that the non-ECO vessels require minimal capital expenditure to meet energy efficiency standards from 2023. You may be familiar with the concept of de-rating, which involves reducing engine power capacity to comply, and there are other low-capex adjustments that can be made as well. As I've mentioned in previous quarters, the Frontline fleet is well-prepared to meet EEXI and the upcoming CII over the next few years. Our average rating stands at A, and we are confident we can maintain this for an extended period due to the vessels' ability to reduce power and output.

Chris Robertson, Analyst

Okay. Yes. Thanks for the color on that. That was really in-depth. My second question is related to the strong quarter-to-date rates that Frontline has booked here. It seems that you have come in above some of your peers. I was wondering if you could talk about whether it is just due to the way Frontline accounts for these, or is there an operational or maybe positional advantage that you had during the quarter that allowed you to outperform?

Lars Barstad, CEO

Well, we obviously report according to US GAAP on a load-to-discharge basis. Over time, this basically makes no difference from a reporting on a discharge-to-discharge basis. But when we guide, one should assume a certain portion of open days at the end of the quarter where no income can be accounted for. I think what we've seen over the last few quarters post-guiding, yes, the earnings have reduced, but maybe more so on the bigger vessel classes that have longer voyages than on the smaller vessel classes. I would expect, or we can at least cross our fingers that the LR2s and Suezmaxes will fall more in line with kind of the guidance. On the VLCCs, there is room for a potential adjustment, depending on what the market does from here.

Chris Robertson, Analyst

Okay. Thank you very much for your time.

Lars Barstad, CEO

In response to your question, most of our peers report on a discharge-to-discharge basis, although at least one reports in a similar way.

Inger Klemp, CFO

At least two, I would say.

Lars Barstad, CEO

Yes.

Inger Klemp, CFO

I mean, load to discharge is actually the US GAAP standard. So this should, in a way, report on that basis. But we know probably that at least one, as you say, does on the discharge-to-discharge basis. Yes.

Chris Robertson, Analyst

All right. Fair enough. Thank you very much.

Operator, Operator

Thank you. There are no other questions at the moment. We have a question from the line of Nick Lenihan from an unknown firm. Please go ahead.

Unidentified Analyst, Analyst

Sorry, I think it was on mute. Thanks for taking my questions. Can you give me some color or maybe concrete examples on where you draw the line between crude that you will transport that has or may have Russian content versus what you won't do? So, I'm assuming you won't do anything in the Black Sea, but would you load any crude in the Baltic? Would you carry crude to Asia that may have been loaded in the Black Sea or Baltic on smaller ships and then wants to STS onto a VLCC? Would you load crude in Fujairah that may or may not have Russian crude blended into it in part? Where do you draw the line? And do you think you're drawing the line in exactly the same places as all the other publicly-listed companies were? I'm basically trying to understand how much of the Russian crude will effectively kind of move to gray market ships or whatever you call them, similar to the way Iranian, Venezuelan crude is carried currently?

Lars Barstad, CEO

It's a challenging question to answer because this has been a recurring theme for our company since the situation began. We have decided to adhere to the sanctions implemented by the EU, US, and UK. We are not taking a moral stance but rather following the directives of the politicians. It's important to note that since the war started, the EU has been importing significant amounts of gas and oil from Russia, which are essential resources. Our position is to operate within the framework that is established for us. However, due to the complex web of sanctions, our ability to conduct business with Russia is significantly restricted. Publicly-listed companies that stand to lose a lot if they violate sanctions have generally avoided any associated risks, and we find ourselves in the same situation. While you mentioned a gray market, Russian crude can still be traded, meaning that owners who do not perceive as much risk may choose to engage in this trade, calculating their risk against the potential premium. However, this has led to inefficient trading patterns, such as navigating long distances to nearby ports, which affects the availability of tonnage for regular non-Russian trade. Consequently, we're experiencing tighter markets in areas like West Africa and the US Gulf, with similar effects in the tank market as if we were handling Russian barrels directly. It's hard to predict how the situation will develop. Currently, we observe that Russian crude is flowing relatively freely into the market, mainly to Asia, despite a slight decrease in certain activities. Most vessels are sailing directly. For those advocating for a halt to Russian exports, a change in the structure of sanctions is necessary, although that has not happened thus far. I mentioned earlier that Russian exports from the Baltic and Black Sea regions have only seen a minor drop of 360,000 barrels per day since February, indicating that this oil continues to move.

Unidentified Analyst, Analyst

Have you picked up any cargoes in the Baltic in the last month?

Lars Barstad, CEO

We have had instances where we were under contract with third parties. In those cases, we have engaged in shipping, but we maintain a strict policy to evaluate all implications. We would never send a Ukrainian vessel to a Russian port and ensure that the crew composition is appropriate. However, all owners have faced challenges during this time because the way sanctions are structured sometimes puts you in a difficult legal position regarding making calls. It's primarily a contractual matter.

Unidentified Analyst, Analyst

Yeah, yeah. Okay. Thanks. Thanks for taking my question.

Operator, Operator

Thank you. We have no further questions from the phone line. So I'll hand back to the speakers.

Lars Barstad, CEO

Thank you. Thank you so much for listening in. And, obviously, I would like to thank my organization for doing a fantastic job this quarter. Thank you.

Operator, Operator

Thank you. This does conclude the conference for today. Thank you for participating, and you may now disconnect.

Lars Barstad, CEO

Thank you.