Earnings Call Transcript - FRO Q4 2020

Lars Barstad, CEO

Good morning, and good afternoon. Welcome to Frontline's Fourth Quarter and Full Year Earnings Call. This has been a volatile year and black swans have become a common feature in our market landscape. The COVID-19 pandemic has affected our business on many levels. But most importantly, our seafarers have been safe and our organization has been spared serious human consequences. Tanker markets have been challenging, but the year, as a whole, has been solid business-wise, and we recorded our best full-year result in 2020 since 2008. Let's move to Slide 3 and have a look at the highlights. Frontline came into the fourth quarter of 2020 on a soft note, expecting some degree of normal seasonality to kick in, as the northern hemisphere usually stocks up for winter. This time around the fourth quarter proved to be softer than Q3, actually, for the first time in 10 years. On a low to discharge basis, we made $17,200 per day on our VLCCs, $9,800 per day on our Suezmaxes, and $12,500 per day on our LR2s. So far this third quarter, we have about 78% of our available VLCC days at $22,600, 68% of our available Suezmax days at $17,800, and 65% of our LR2/Aframax days at $12,200 per day. I think it's safe to say our markets in Q4 were challenging. But I will come to that later in this presentation. I'll now let Inger take you through Frontline's financial highlights.

Inger Klemp, CFO

Thanks, Lars. And good morning and good afternoon, ladies and gentlemen. Let’s turn to Slide 4 and look at the income statement. We achieved total operating revenues, less overage expenses, of $101 million in the fourth quarter and an adjusted EBITDA of $31 million. We reported a net loss of $9.2 million, or $0.05 per share. An adjusted net loss of $20 million, or $0.10 per share in the fourth quarter. We have some adjustments in the fourth quarter, which included a gain on the sale of SeaTeam for $6.9 million, a $2.5 million gain on derivatives, a $1.9 million unrealized gain on marketable securities, a $1.3 million amortization of acquired time charters, and a $1.6 million share of losses from associated companies. Adjusted net income in the fourth quarter decreased from the third quarter by $76 million, primarily driven by a $75 million decrease in our time charter equivalent earnings due to the lower reported TCE rates in the fourth quarter, which Lars went through. Frontline reports full year 2020 net income of $413 million, or $2.09 per share, and adjusted net income of $421 million or $2.13 per share. This is the strongest yearly result since 2008. Then let's take a look at the balance sheet on Slide 5. At the end of December 31, 2020, Frontline had $413 million in cash and cash equivalents, including the undrawn amount under our senior unsecured loan facility, marketable securities, and minimum cash requirements. In November 2020, we entered into two terminal facilities in the total amount of $361.5 million to refinance two existing terminal facilities, which matured in the second quarter of 2021, which had total balloon payments of $324.4 million. We also entered into a loan facility in an amount of $133.7 to partially finance the CapEx requirements as of the end of 2020 of $142.4 million for the four LR2 tankers that we had under construction. Further, in February 2021, we extended the terms of our senior unsecured revolving credit facility of up to $275 million by 12 months to May 2022. $60 million of this extended facility has been recorded as long-term debt as of December 31, 2022. $216 million remains available and undrawn under this facility. Following the concluded refinancing and financing, we have no material debt maturities until 2023, and the newbuilding program is fully funded. Then let's take a closer look at the cash breakeven rates and OpEx on Slide 6. We estimate an average cash cost breakeven rate for 2021 of approximately $21,600 per day for the VLCCs, $17,800 per day for the Suezmax tankers, and $15,600 per day for the LR2 tankers. The fleet average estimate is about $18,200 per day. These rates are the all-in daily rates that our vessels must earn to cover the budgeted operating costs, dry dock, estimated interest expenses, TC and bareboat hire, installments on loans, and G&A expenses. We recorded OpEx expenses in the fourth quarter of 2020 of $7,800 per day for the VLCCs, $9,700 per day for the Suezmax, and $8,300 per day for the LR2 tankers. The OpEx expenses were impacted by the dry docking of four Suezmax tankers and one LR2 tanker in the fourth quarter. We will dry dock one Suezmax tanker in the first quarter of 2021. In the graph on the right-hand side of the slide, we have shown incremental cash flow after debt service per year per share, assuming $10,000, $20,000, $30,000, or $40,000 per day in achieved rates in excess of our cash breakeven base, respectively. As an example, with a fleet average cash cost breakeven rate of $18,200 per day, and assuming $30,000 on top, the average fleet TCE rate would be $48,200 per day. Frontline would generate a cash flow per share after debt service of $3.46. With this, I will hand over to Lars again.

Lars Barstad, CEO

Thank you, Inger. So, let's move on to Slide 7 and recap the fourth quarter tank markets. During Q2, oil inventories grew at a record pace to the tune of 2.6 million barrels per day according to EIA. As oil demand continued to rise to levels near 10 million barrels above the Q2 levels, oil prices continued to strengthen further and the structure of the oil market incentivized players to empty tanks, both floating and on land, as the future price was increasingly lower than the prompt price, making it uneconomical to hold stock. A significant number of tankers were employed in storage in the second half of last year, particularly outside China. This inventory draw cycle added pressure to an already oversupplied market as these vessels now return to compete in the spot business. Asia and in particular, China has been the key driver in the recovery so far. This supported the VLCC market for a while as sourced returning oil demand from the Atlantic basin. In the latter part of last year, we saw China also draw on inventories, muting their demand for tankers. By December 2020, Chinese oil consumption reached an all-time high at 16.6 million barrels according to the EIA. Let's move to Slide 8 and look at the crude fleet and order books. The argument that ships older than 20 years struggle to trade in the conventional oil market is undisputed. Oil majors, traders, and national oil companies all practice a hard stop at 20 years. This means that we have a very limited amount of options once the vessel has gone through the 20-year class. With freight rates at zero to negative for non-eco tonnage, we struggle to see the prospects for this portion of the fleet for alternative use. The conversion market for FFOs and SSOs is not very hot at the moment, and there is limited demand for storage as all the curves are in steep decline. We also believe that the upcoming regulatory changes regarding GHG emissions will challenge the fleet going forward. This indicates a limited lifespan even for vessels of 17.5 years of age. Ordering activity is muted and does not match the current age profile of the fleet. We did see some orders towards the end of last year, which lifted the order book slightly. 30% of the overall tanker fleet is about 15 years. After regulations on energy efficiency or the now famous EESI kicks in in 2023, the potential work for a carbon tax regime kicks off. This whole portion of the fleet will either need to invest heavily or face higher costs. Let's move to Slide 9. We want to talk about our clean product tankers. We normally don't mention our clean trading capabilities in these presentations, but we do have 18 modern LR2s and four more to come, which makes us a significant owner in this space. The reduction in jet fuel demand as travel was restricted in 2020 hit refinery margins severely. Refinery margins in Europe and the U.S. have been under pressure for years. Due to bleak prospects, little investment has been made in improving and modernizing these plants. Last year's depressed margins accelerated decisions to permanently close or convert refineries to storage plants or, in some few examples, floating plants. Asia, in general, and in particular, the Middle East and China, over the last three years, expanded refining significantly. Modern refineries can process a wider range of crudes more efficiently, and I can give you an entire presentation on the topic. The key is that they outcompete local refineries, especially in Europe, but also, to some degree, in the U.S. We can see on the slide here that the refining capacity that has permanently closed in Europe is to the tune of 500,000 barrels per day, in the U.S., close to 700,000 barrels per day. There have been some closures in Asia of 705,000 barrels per day, but the new additions are 1.4 million barrels per day. In net terms, we expect trade flows to be affected by this. As product demand normalizes post-COVID-19 pandemic in Europe and the U.S., we have to assume we return to some level of normality over the coming years. Jet fuel and other products are far more likely to be sourced by Asia, and this will incur longer-term miles. Our LR2s offer great economies of scale for the expected developments in the product trade losses. Let's move on to Slide 10 and discuss the market outlook as we see it. I'm focusing on the short-term drivers in this presentation, as that's probably the interesting part considering where the markets are. Saudi Arabia has signaled the reversal of their voluntary one million-barrel per day cut to come in April 2021. That comes in addition to whatever they agreed. The usual cold weather in the Northern Hemisphere distorted usual demand patterns. Gas and LNG in Asia turned on capabilities to – sorry, the gas and LNG spike in Asia and the unknown capabilities regarding our oil for heating dynamics work as we haven't really seen oil for heating in ten years, creates a lot of uncertainty around how much oil has been incrementally consumed during this period. The spike in LNG prices implied oil prices at $260 per day, making incentives to burn oil for heating. We have episodes of similar situations where skiing suddenly became popular in Madrid, and most recently in Texas, we've seen how the cold weather has affected production. Goldman Sachs estimates that this production loss to be close to 700,000 barrels per day for February. Oil demand continues to recover despite extended lockdowns. Oil prices indicate tightening markets. The floating storage is no longer a significant factor weighing on the tanker market as we see it. And in April alone, oil supply is expected to increase by three million barrels according to EIA. So, let's move to Slide 11 and sum all these things up. The global tanker markets have corrected sharply during the second half of 2020 after a significant retraction in world growth. All the leading commodity markets are pricing in a strong recovery in 2021, and global GDP is expected to grow by 5.5% during this year. Oil demand is recovering, but the pace is a little bit unknown. We all know that the analyst agencies are slow to react both on the downside when demand disappears, but also to the upside. Demand is recovering. Global oil production is expected to increase by 5.3 million barrels during 2021. When this recovery starts for tanker Suezmax, we are very low in the cycle, as this chart on the bottom right side indicates. OPEC+ is expected to ease on cuts from Q2 2021 onwards. With all the above, we believe Frontline is well positioned for a recovery in tanker markets with our modern OPEC exposed fleet. I would like to open up for questions from the audience.

Operator, Operator

Thank you. Our first question comes from Jon Chappell from Evercore. Please go ahead with your question. Your line is open.

Jon Chappell, Analyst

Thank you. Good afternoon. Lars, as I was reading your press release in your presentation, it struck me that Frontline has a history of being nimble and inquisitive when others kind of can't. And now that you've been very prudent with your dividend, Inger has done a great job of pushing up the maturities. It seems like you're in a position of financial strength at a time when the markets really still kind of struggling. So how do you think about these next six months and Frontline's willingness and ability to acquire ships before there's the optimistic upturn starts, maybe later in the year or early next year? Or do you sit back and wait to see the whites of the eyes on a recovery before you get more aggressive?

Lars Barstad, CEO

Well, it's a good question and it’s an expected one. I think I would like to emphasize our capabilities – as you mentioned there. Whether we sit back, whether we're looking at something right now, or whether we'll do something in Q2 or later, I am not going to comment on that to be quite honest. The solid answer I believe is we're always looking. Our financials show that we're also ready to move when we see the opportunity.

Jon Chappell, Analyst

Okay. And then the second question is more of an industry one that I've also been thinking about. I think scrapping is kind of important on the margin. It's not the most important part of recovery in this market. That's going to be demand-driven. But it seems like a lot of companies have been talking about the new emission standards and the terrible market environment and the older ships being discriminated against and why that's going to drive scrapping, and you had a whole slide on that yourselves. It just seems like there hasn't been much in the form of scrapping in the last 12 months, where rates have been pretty much as bad as they can be for at least the last six to nine months. Now there's this kind of consensus optimism that OPEC starts producing again, and the world is recovering and everything is going to get better. So why would we see scrapping accelerate when the view is that things can only get better from here, when there really wasn't much to be done at the absolute trough?

Lars Barstad, CEO

Well, I must admit – and I think I mentioned or at least indicated in my presentation that the lack of scrapping in this market is a bit of a mystery to me. I think I pointed out that for all economic reasons, we shouldn't be seeing a lot of scrapping during this month or the last month, and we haven't seen that yet. But I think scrapping will accelerate throughout the year, with regards to the challenging, albeit somewhat hazy outlook with regards to regulatory changes and so forth. I think it's going to be a very important factor to our market going forward. But I wouldn't join the doomsday predictors saying that every vessel that's above ten years needs to scrap. There's a lot to be done for tankers to actually improve their GHG emissions with the existing kits. But for sure, it will affect our market going forward that I think one has to be a little bit critical of all the various analysts’ predictions on the outlook for the tanker fleet.

Jon Chappell, Analyst

Yes, that makes sense. Okay. Thank you, Lars.

Operator, Operator

Thank you. Our next question comes from the line of Chris Tsung from Webber Research. Please ask your question. Your line is open.

Chris Tsung, Analyst

Good afternoon. How are you, Lars and Inger?

Lars Barstad, CEO

Good afternoon.

Chris Tsung, Analyst

So, I guess I just want to start it up, kind of following up on what Jon was talking about regarding your strong balance sheet and you guys pushing out and said that. And instead of asking about acquisitions in the span of the fleet, what about – is there any appetite to kind of increase your operational leverage even possibly turning in charters? What could be the strength of this market and what sort of durations can we expect?

Lars Barstad, CEO

I am so sorry. We can't hear you too well. I'm sorry for that.

Chris Tsung, Analyst

Is this better?

Lars Barstad, CEO

Yes, this is better.

Chris Tsung, Analyst

Sorry. So, I guess I was just following up on what Jon was saying and commenting that I noticed that you guys have an incredibly strong balance sheet. Inger has done a great job in pushing out the debt maturities out to 2023. And instead of just focusing on a fleet expansion perspective, what about your appetite to increase your operational leverage?

Lars Barstad, CEO

Yes. So, if I got you correctly, basically to increase our appetite to increase our operational leverage. The thing is that – let me answer the question in a different manner. Right now, we're really happy with the situation we're in because we have a fleet that's spot exposed to a very large degree apart from the five Suezmax we have on long-term time charter out. We are nearly 100% spot exposed. So basically, we are in a position where we want to reach the benefits whether if we want to increase kind of our ability to make more money. I think that's potentially a few months out. And back to the previous comments, we are looking but I can't really confirm anything.

Chris Tsung, Analyst

Yes. No, that's fair. And I guess if you're looking – are you able to sort of color if you're looking at these specific propulsion technologies or maybe in the more traditional routes?

Lars Barstad, CEO

Sorry, I am really struggling to hear you, but did you mention propulsion?

Chris Tsung, Analyst

Yes, yes. Sorry, is this better?

Lars Barstad, CEO

Yes, you're breaking off, I can't hear you properly.

Inger Klemp, CFO

You’re breaking off here.

Lars Barstad, CEO

But whether if we are looking at various propulsion types? Yes, we are. But we're not ready to invest in that yet. We think the jury is still out. As I mentioned in our Q3 presentation, with our modern fleets, we're actually in pretty good shape, at least when it comes to emissions toward 2030. Obviously, for us to make an investment in propulsion, and with that I mean retrofitting or ordering of ships with a different propulsion than the traditional one, we actually need to see – it’s a little bit like the scrubber discussion. We didn't start to invest in scrubbers when it was obvious the economical case for it. On propulsion, it’s not yet clear. We don't know – well, we're pretty sure there will be a carbon tax. We don't know how much it's going to be or how it's going to be applied. But, long story short, the propulsion discussion is still something we debate. I could easily say that both LPG and LNG and then eventually ammonia look probably one of the ways to go. I'm pretty sure there are various propulsion types depending on what kind of trade you're doing. But I think it's very important to keep in mind that ship owners, we can't be paying for this kind of upgrading. So basically, the market needs to tell us what it's willing to pay.

Chris Tsung, Analyst

Okay, great. Yes. Part of it, but – I mean, I'm going to just try to reconnect and jump back in the queue. So sorry about my connection. Thanks, guys.

Lars Barstad, CEO

Okay.

Operator, Operator

Thank you. Our next question comes from Randy Giveans from Jefferies. Please go ahead, your line is open.

Randy Giveans, Analyst

Hi. Lars and Inger, how are you?

Lars Barstad, CEO

How are you? Very good.

Inger Klemp, CFO

Fine.

Randy Giveans, Analyst

Good, good. All right. So just asking about the dividend. Obviously, you bought that back last year, haven't paid a dividend now for the last two quarters. So, if earnings return as expected, I guess here in the coming quarters, is there a formula for the dividend to return? Or is it kind of fully discretionary? And if so, what will cause you to reintroduce the dividend?

Inger Klemp, CFO

Randy, I think it's like we stated in the earnings release. We are dedicated to returning dividends to our shareholders with the board, but we would have to look at the positive results first, we have to have a positive result. And then, obviously, also we have to look at the market in the presentation. So that’s the same burden in a way as we have in our press release.

Randy Giveans, Analyst

Got it, okay. And then as you operate in both the crude and products tanker market, which of those or maybe which asset class VLCCs, Suezmax, LR2, are you most bullish on here in the coming months?

Lars Barstad, CEO

Well, I've been asked that a couple of times today actually. We are a company that operates like a four-cylinder engine, where we have the VLCCs and Suezmax. We have the LR2 that are trading clean and dirty. Recently, we've seen at least some spark in the Suezmax cylinder, not to any excitement at all, but at least recovering from negative returns. Right now, we have the Aframax space where there's some excitement due to weather and disruptions in the U.S. Gulf. I am unsure which segment will be hit first to be quite honest, when the recovery story starts to come true. Potentially the VLCC markets might benefit first because eventually you need refinery runs to increase for products to flow, but the start of any return on volume will probably come from the Middle East, which would firstly benefit the VLCCs, I would say.

Randy Giveans, Analyst

Got it. All right, that's fair. And then quickly here on asset values, how have those been impacted kind of in this current market weakness? However, there's also an optimistic outlook right for the back half of this year. So, it seems like the share price rally has maybe outpaced the increases in asset values? Is that accurate? Or what are you seeing on that front?

Lars Barstad, CEO

I agree with your analysis. I believe that the share market is pricing the recovery a little bit further out. So, obviously, jumping over the uncertainty in the front here. But we've seen a few transactions that kind of underpin the values, at least, if you look at the five-year-old market. We're also about to get some price transparency, I believe, on resales and new builds. But I wouldn't say it's an upward movement, but I would say we're at least firmly at what might be the floor.

Randy Giveans, Analyst

Sure. Good deal. Well, that's it for me. Thanks again.

Lars Barstad, CEO

Thank you.

Inger Klemp, CFO

Thank you.

Operator, Operator

Thank you. Ladies and gentlemen, we have no further questions at this time. Please go ahead. We have no further questions at this time. Please continue.

Lars Barstad, CEO

Okay. I'd like to thank you all for listening. We are excited for the time to come in tankers and wish you all a great weekend. Thank you.