Frontline Ltd. (NYSE:FRO) Q1 2023 Earnings Call Transcript

Frontline Ltd. (NYSE:FRO) Q1 2023 Earnings Call Transcript May 31, 2023

Frontline Ltd. misses on earnings expectations. Reported EPS is $-0.01 EPS, expectations were $1.03.

Operator: Good day, and thank you for standing by. Welcome to the Q1 2023 Frontline PLC Earnings Conference Call. At this time, all participants are in a listen-only mode. I would now like to hand the conference over to the CEO, Mr. Lars Barstad. Please go ahead.

Lars Barstad: Thank you very much dear all, and thank you for tuning into Frontline’s first quarter earnings call. We’re a bit late, but we’re expression is. We’ve had a seasonally strong first quarter of the year. Russia still has an impact on the market or there are sanctions on Russia, but I think kind of the key part of the action in Q1 was related to China. The strong Q1 has given us ability to book quite strong numbers into Q2 as well as the Frontline team relentlessly growing to create shareholder value. Before I give the word to Inger, TCE numbers on Slide 3 in the deck. In the third quarter, sorry, in the first quarter Frontline achieved $52,500 per day on our VLCC fleet, $64,000 per day on our Suezmax fleet, and $56,300 per day on our LR2/Aframax fleet.

And we are, in fact, back to a somewhat reverted earnings relationship between our segments with the Suezmax is outperforming the VLCCs and the same for LR2s. We have secured quite firm numbers as we progressed into Q2, with 78% of our VLCC booked $75,000 per day, 71% of our Suezmax days booked at $65,000 dollars per day, and 63% of our LR2/Aframax days at a very respectable $65,700 per day. Again, all these numbers in the table are on a load-to-discharge basis, and they will be affected by the amount of ballast days we end up having at the end of Q2. And mind you, this is Q2, which is supposed to be the weak point in the market. With that, I’ll give Inger the word. She will take you through the financial highlights.

Inger Klemp: Thanks, Lars. Good morning and good afternoon ladies and gentlemen. Then let’s then turn to Slide 4. The profit statement and look at some highlights. As Lars already has stated, Q1 2023 is the highest first quarter profit since 2008. Q1 2023 is also the first interim financial information presented by the company on IFRS. And following in that transition to IFRS, one important thing is that drydocking costs will be capitalized and subsequently depreciated over the period to the next scheduled drydocking, which is from 2.5 years to 5 years. Q1 2023 drydocking costs was 3.6 million that has been capitalized and 3 vessels were drydocked in the quarter. I will also mention that the company has revised the estimated use for life of its vessels from 25 years to 20 years.

And that was effective from January 01, 2023, which resulted in an increase in depreciation expense of 12.7 million in Q3, compared to Q4 2022. Then let’s turn to Slide 5 and look at some balance sheet highlights. The company has no remaining newbuilding commitments and Q1 2023, as the completed delivery of the two last business unit buildings, Front Orkla and Front Tyne in January 2023. The company has strong liquidity of 584 million in cash and cash equivalents, including the undrawn amount of unsecured facility, marketable securities, and minimum cash requirements. Then the company lastly has a healthy leverage ratio of 52.9%. Then I would like you to turn to next slide. And lastly, let’s look at the cash flow potential of the company. We estimate industry leading cash break even rates fleet average and that includes drydocking cost for 8 Suezmax tankers in 2023.

4 of them is to be expected to be drydocked in the third quarter, and 4 is expected to be drydocked in the fourth quarter. The Q1 2023 average OpEx, excluding drydock was $7,300 per day. The free cash flow indicates strong potential return for the company as you can see from the table on the right hand side. Just the scenario where we assume these received rates of $75,000 per day, with 5-year historic spread to be received for Suezmax and LR2 tankers. The annual free cash flow potential is about $1.4 billion or $6.29 per share, representing a free cash flow yield of 42%. And with this, I’ll leave the word to you again, Lars.

Lars Barstad: Thank you very much, Inger. Let’s have a quick, kind of look back at the Q1 2023 tanker market. So, I already mentioned that it was typically seasonally strong. Normally, in the Q1, we’ll kind of get sober after the Q4 hype. And markets will fairly quickly start to deteriorate into February. What happened this time around was that we have the second peak in the market in March and the whole segment from were performing very, very strong. If you look at the chart at the bottom left here, you would find how elevated the average weighted market earnings are. The reason for this is obviously that it’s not only VLCC and Suezmax, but it’s also Aframax and LR2 being very, very strong. If you compare it to the period that we like to look back on with the period from 2003 until 2009 in the most recent times, we are actually quite high up on the earnings side, then the markets are performing very, very well.

Chinese imports moved to all-time high, if we look at the chart at the bottom right. We also saw the highest number of VLCC shipments to China. As I already said, Russian sanctions continue to yield inefficient trading patterns, but it is more about China as that situation seems to have found some, sort of . We did, however, have a very mild winter in the Northern Hemisphere, both in Q4 and Q1 and this muted oil demand to some extent. If we then move on to Slide 8 or Page 8, and we did receive an OPEC cut or a voluntary cut. The volumes are indeed down for May, but what about ton miles? So, Russia continue to export. With the current oil price scenario we’re in, the G7-Cap is not an obstacle to Russian oil exports. And we see Russia pump relentlessly.

This is quite interesting now ahead of OPEC meeting on June 4. Both OPEC+ and non-OPEC volumes were down in May, but this is – and we need to remember, this is the seasonal slow point of the year with high refinery turnarounds. Global oil demand is expected to rise by around 2 million barrels per day in second half of 2023. And if we look at the whole picture, the global exports overall are indeed back to pre-COVID levels, albeit a little bit slow in May. It’s going to be very interesting to see what the U.S., Brazil, and West Africa are able to do post summer and those are the three candidates to have the ability to export more volume as we proceed into winter. Let’s then move to Slide 9. So, vessel utilization is still high, but it’s volatile.

We see that on the bottom left hand side, and this data is from Signal Ocean where they basically record every fixture done on the various asset classes and measure the amount of days that vessels are laden. And if you look at the chart at the bottom left, if you look at the VLCC, we are quite elevated, compared to historical patterns. It has corrected down yet, it might be a bit muted right now, but the VLCC is probably still affected by the rally in Q1 and the mini rally, we just served a couple of weeks ago. If you look at the Suezmaxes, they issued are high relative to the previous years, but again, I’m corrected over the last couple of months. LR2s are back to trend, I’d say, although high in the trend, but I think the key takeaway from these 3 charts is to look at the overall direction of the utilization and of the ton mile demand throughout the year.

It’s clearly that we are firstly at the low point in the cycle. And secondly, that’s the direction towards the end of the year. Well judging on history could be very interesting. Let’s then move to Slide 10, and have a quick discussion on the order book. I’m not going to go through all these charts in detail. I think they tell their own tale. It’s quite incredible that by the end of this year, we’ll have 111 VLCCs still operating in the market above 20 years of age. That amounts to 12.6% of the current trading fleet. The order book stands at 16 vessels yet to deliver and that’s 1.8% of the fleet. If you look at the Suezmaxes, about 14% of the fleet will be above 20 years as this year ends. And the order book stands at after having grown actually quite a bit in Q1 and Q2.

That amounts to 3% of the existing fleet. LR2/Aframax, the global fleet is only 415 vessels. 25 of those are over 20 years, here is actually more relevant to look at 15 years, but just to be conservative, let’s just look at the 20 years. That amounts to 6% of the existing fleet. The order book there is growing and it’s sizable. So, it currently stands at 12.8% of the existing fleet. If you look at overall for the segments that Frontline are exposed to or the asset classes that we are engaged in, about or close to 12% of those fleets are above 20 years of age and the order book stands at 4.6%. It’s very, very difficult to see a scenario on the supply side that will rock, kind of the tanker story at least until well into 2026. And then finally to sum up.

So, Frontline delivered the highest Q1 profit since 2008. 193 million and a cash dividend of $0.72 per share. We continue to capture value on time charter analysis at an in the cycle. There are new orders being seen for Suezmax and LR2 with 2025 is now firmly sold out and you can build in 2026 in China. In Korea, you probably need to look to 2027. And we also see only two orders year to date although more are being discussed and 12% of the tanker fleet that we are exposed to is going to be about 20 years by the end of this year. The OPEC transactions have had a limited impact so far in May, and it looks like it’s counted by . And again, China will be the x factor as we grind through the summer low. Lastly, I’d like to explain a little bit on the chart below.

I just had a presentation for a group of students from Denmark and basically explaining the long-term picture in oil and tankers. And what you see is the blue line is oil demand, which tends to grow with population growth. And on the right hand side, or the yellow graph is annual fleet growth as we get into 2025. And although this is a bit of apples and pears, it just doesn’t add up. And with that, I would like to open up for questions.

Q&A Session

Operator: And the first question is from Jon Chappell from Evercore ISI. Please go ahead. Your line is open.

Jon Chappell: Thank you. Good morning, Lars or good afternoon. First question is on strategy, some interesting development since in the end of the quarter with the sale of the vessel and the two time charters on the LR2s. Are you at the point on the cycle now where you’re looking at harvesting some of the older tonnage, which may not be core? I think there’s 10 ships that are over 8 years old. And then also are you at the point where you’re looking to do more time charters maybe on the LR2s and keep the bigger crude ships available for spot?

Lars Barstad: Yes. Kind of first of all, when we look at the fleet and which vessels that could be potential sales candidates, we look at efficiency primarily. And we are preparing for a tighter regulatory framework for CII and ETF and whatnot. So, it’s basically with that in mind, we look at it. And obviously the values that are achievable. As it’s been so far, it’s on the time charter side. We’ve seen elevated values on the Aframax/LR2. And we’ve seen a lot of, kind of price action on the second hand Suezmax side. So, I think it’s just natural. But yes, we will, kind of tap into the markets when we see values that are basically what we call it internally is, when you can achieve unicorn numbers on certain asset classes for a sustained period of time.

We basically just have to take it. The average cost – the average cash breakeven on our Aframaxes/LR2s with kind of to keep that in mind when you can achieve $46,500 per day, against the cash breakeven of 16,800, it’s basically something you can’t pass. On the asset side, we’re not publicly offering all our vessels that’s really a good strategy, but yes, for the less efficient vessels, we will be prone to take advantage if the opportunity is there.

Jon Chappell: If I could just follow-up on both of those topics, which is, kind of a more recent update, there seems to be a lot more skittishness, the OPEC cut global recession, oil price is weak etcetera. Although you’ve laid out a framework where the next two years should remain quite robust. Have you seen any slowdown in transaction activity in the older vessels, which seem to be pretty parabolic over the last 12 months? And then the same token, have you seen any slowdown in the willingness for charters to lock in for that 2 year to 3 year period?

Lars Barstad: I would lie if I didn’t say, yes. And as you know, you’ve been in this industry for a long time, we tend to be more focused on big deals when the spot market is strong rather than the opposite. And right now we’ve had volatility. We also have some weakness in the segments and that’s, you know basically it changes sentiment somewhat. So – but I wouldn’t say, I see this as, kind of ebb and flow short-term kind of event. I don’t foresee unless we end up in a situation where global oil demand falls . I don’t see that being sustainable. So, it’s a very typical for Q2 to be quite honest.

Jon Chappell: Yes, that makes complete sense. Thank you, Lars.

Lars Barstad: Thank you.

Operator: Thank you for your question. We are now taking the next question. Please stand by. And the next question is from Amit Mehrotra from Deutsche Bank. Please go ahead. Your line is open.

Chris Robertson: Hey, good morning and good afternoon. This is Chris Robertson on for Amit. Thank you for taking our questions. Well, I just wanted to touch on the LR2 fleet for a moment. How many of those are currently trading dirty at the Frontline level, but also do you have a general sense maybe across the fleet of how many LR2s are engaged in a dirty trade at the moment?

Lars Barstad: Thank you, Chris. That’s a very good question because the switch between has become increasingly effective over the last half year. So, it’s actually very difficult to follow. Not obviously, not around on our own fleet and quite comfortable, but with what happens, kind of out there in the world, just to explain to you, you can turn around a dirty vessel into clean in the fairly quickly by doing a couple of short trips with the . And at least up till now, the market has been willing to price hefty premium for that ability. So, basically the owners to do exactly that, but at least on our own of the vessels that we still control that are not on time charter route, that would be 14. Therefore

Chris Robertson: Okay. Got it. Switching gears here, just looking at shipyard capacity, you mentioned that limitations, the Chinese charts maybe for 2025 delivery, Korea in 2026, but I guess do you have a sense of how much mothball capacity could come back online over the next few years? And is the limitation out there right now more of a labor issue or is it more of the yard can solve the real estate aspect of it?

Lars Barstad: I think we have seen not new kids on the block, but we’ve seen, I wouldn’t call them mothballs, but yards in China with very, very much reduced capacity that are, kind of getting revitalized. And willing to take orders. This is obviously a risky exercise, but if you’re an owner, to utilize these yards, but there are a few. I think it’s difficult to quantify it. But if you look at some of these new kids, you can’t get a ship before 2025 or you can’t even get it before 2026, and that’s basically because it takes time to get these yards up and running. I think on the labor side, I don’t – it doesn’t seem like China has much of a problem. In Japan and Korea, that’s definitively a fact also in Korea, what we see is that although a tanker is a fairly complicated ship, they tend to focus on out of more labor intensive or more technical technology .

So, they’re actually not really – well they’re offering, but they’re pricing themselves out of their question to . But with regards to kind of the overall potential volume there, it’s very difficult to gauge and there is not a potential volume until, well, it’s starting in 2026.

Chris Robertson: Okay. Yes, that’s great color. Last question for me, this just relates to, I guess, your expectations around the OPEC meeting coming up here in a few days. Now, that Brent prices are trending well below $80 a barrel, which we, kind of see as a threshold price, some market commentary out there around the speculators in oil pricing. Is your fear that there could be additional cuts on the table going into this meeting or how are you thinking about that?

Lars Barstad: I can’t really do much more than reading. I think what you guys read in the press, I must say however that when you do a cut with effect in May to then suddenly start an additional cut in June, is kind of – it looks a bit strange because you need this and it’s also at a low point in the demand cycle. So, I guess you need to have a little bit of patience when you do such a big move coming – being an OPEC strategist. I think what’s disturbing the situation is that Russia although claiming to adhere to the voluntary cuts strategy, physically, they are obviously not doing that. So, it’s – yes, it’s going to be an exciting one. And it’s almost impossible to give a qualified kind of guess. What I have to do – what I will say though, that any kind of demand increase since this is a voluntary cut, it’s going to be reversed very quickly once demand, kind of shows its time.

Chris Robertson: Yes, I think that’s fair. It seems more like a compliance enforcement issue in the short-term and then they can ramp back on over time as you said, okay, yes, thank you very much for taking the questions.

Lars Barstad: Thank you, Chris.

Operator: Thank you for your question. We are now taking the next question. And the next question from Omar Nokta for Jefferies. Please go ahead.

Omar Nokta: Thank you. Hi, Lars. Hi, Inger. Good afternoon. Just wanted to just check back on the new building discussion. Clearly, I think that the Slide 11, the very simple chart probably just says it all in terms of oil consumption growth and the fleet growth. I remember Lars on the last call you had mentioned, I think it was the last one you had mentioned, new buildings weren’t that interest thing to Frontline. Just wanted to see, kind of if you have an update there, obviously, you just highlighted in your comments about how we’re looking at firmly into 2026, perhaps 2027 to take delivery, but just in terms of how you’re seeing the opportunity to get into the new building market? I guess one, is that something you’re perhaps revisiting? And then two, how would you maybe compare the opportunities when it comes to maybe placing VLCC orders versus Suezmaxes and LR2s?

Lars Barstad: Yes. No, it’s a good question, but regrettably or not regretfully, I think the answer is the same. There are three things that we need to consider when we look at the newbuilding market. Number 1 is obviously what technology we’re going to go for, but say you were looking for a conventional, then it’s the delivery time until you can actually get the cash flow from that investment. And then lastly, if the price of the asset itself. And basically what we’re seeing is, I hear arguments that inflation has kind of yet to hit asset prices because if you look at asset prices adjusted for inflation of long dated a 2008, 2009 VLCC equivalent would be $70 million today. So – but in order for that to be true, you need inflation also to hit the rates and so forth.

And then we need like the long-term time charter market to be to be far higher than what we’ve seen, kind of glimpses of in the last couple of quarters. So, I think kind of with that in mind, it just doesn’t look very interesting to Frontline. I also note that some of the orders we’re seeing, it’s either against long-term charter commitments, which is not something from plan with the gauge to our proposition to our shareholders is give spot exposure. Secondly, the ones that are not connected to a long-term charter, seem at least to me as somewhat opportunistic. So, basically you pay a 20% or 25% down payment on a call option for a market that could be quite interesting in say 2026. So – and we are not in that business either. So, this is why we obviously we look at it, we observe it, but we’re not there to press the button.

Omar Nokta: Makes sense, Lars. Thanks for that. I guess as we think about that, clearly, you do need inflation in terms of the impact on charter rates to really induce some ordering, how do you then think about – I mean obviously Frontline you guys have been very acquisitive over the years, but in general, when you think about deploying capital, obviously have a capital allocation policy of paying out meaningful dividends. But in terms of where maybe there’s an opportunity or the value set or whatnot, is it new buildings clearly off the table? How do you then think about whether you’re doing stuff in the sale and purchase market? Is there opportunities in the younger tonnage are there opportunities maybe in the older tonnage where people have maybe ignored because of the transition here towards the greener future? Any kind of thoughts about where there could be an opportunity to pluck some assets on the cheap, whether it’s age range or perhaps type?

Lars Barstad: Yes. No, I think kind of the best-in-class side, we would be, kind of studying closely any LR2/Afra, Suezmax or VLCC that is below 5 years, but or after 5 or below, but if you look at the visibility and the offering in that kind of portion of the market, it is virtually zero. So, it’s – a lot of the modern VLCCs, you can say that that have been delivered over the last few years are actually on time charters and even relet again to operators or traders or oil measures. So, these guys are not really sales candidates. And so, there is basically a vacuum for vessels in that, kind of age group that would be interesting to us. So, I think that’s basically the answer. And with that in mind, we’d rather sit tight and churn out the best return we can from that as we hold until we make, kind of an investment decision.

Omar Nokta: Sure. Yeah, it makes sense. You already have that critical mass. Maybe just one, if I could, obviously very sensitive, but just wanted to check-in and see since you’re in the – since you’re having this call, any public comments that you’re willing to make in terms of the situation at Euronav with the shift in management and the board? And then, also I know it’s probably more sensitive and not necessarily directly related to Frontline, but any comments to make about the back and forth with International Seaways yesterday?

Lars Barstad: Yes. No, I understand the question, but it’s not really for me to comment to be quite honest. I’m an observer just like you are on both of your announced situation, while we are shareholders, but that’s basically as far as it go. And International Seaways is the same. It’s – I read what you read and I have limited visibility.

Omar Nokta: That’s good enough. Thanks, Lars. I figured I’d ask. I’ll turn it over.

Lars Barstad: Thank you.

Operator: Thank you for your question. We are now taking the next question. And the next question from Chris Tsung from Webber Research. Please go ahead. Your line is open.

Chris Tsung: Hey, good afternoon, Lars. How are you?

Lars Barstad: I’m good. Thank you. And yourself?

Chris Tsung: Good. Good. Thanks. I wanted to just ask, like, in your deck, you highlighted the Russian sanctions and you’d like to be, you know, inefficient trading patterns which that’s obviously been a tailwind for a lot of tanker owners. Do you believe these inefficiencies could be worked out or are they more structural in nature until the war is over and until sanctions are removed?

Lars Barstad: Well, what I’ll say is, and I was contemplating adding that to this deck, but I wanted to further checking, but with basically all whatever that’s called, basically, what I’m observing, what we are observing is that if you look at the Suezmax and Aframax fleet, and you look at how many are calling on Russia, if you do that study for the last 3 months, you’ll find that approximately 30% of the Afra and 30% of the Suezmax fleet is still at calling on Russia. So, this suggests that, kind of the interconnection between the gray fleet, if you call it that, and the white fleet if we use that word is actually very, very high. So, it means that there are obviously inefficiencies, but maybe not as pronounced as one would expect because it’s not so that we’ve lost 30% of the ships in the well, non-Russian trading market.

So, I think it is a bit more balanced picture. What is true though is that a vessel of less quality and kind of outside of the age restrictions and so forth or maybe operated by a company that has a red flag attached to it. They will obviously not be able to access the compliant market, but it seems like the interconnectivity is actually quite efficient as you would expect in the tanker markets. But this has actually some positives to it because it actually means that the risk on – well, it’s wrong to call it risk. But whenever this situation reverses, maybe the negative impact on the ton miles won’t be that, kind of as well.

Chris Tsung: I see. Thank you. And maybe just one follow-up on the arbitration. I just wanted to ask if are there any notable milestones that we should be on the lookout for from now through June 2024?

Lars Barstad: No, not at the moment.

Chris Tsung: Okay. Fair enough. I’ll turn it over. Thank you guys.

Lars Barstad: Thank you.

Operator: Thank you for your question. We are now taking the next question. And the next question is from . Please go ahead. Your line is open.

Unidentified Analyst: Good afternoon. Thanks for taking my question. At first, I want to do a quick follow-up on an earlier question about the clean and dirty LR2s? How long does it take to switch in LR2 back to the clean trade? And what are the costs associated with doing so?

Lars Barstad: It obviously depends a bit on how you do it. But if you do three very short compensated calls across you can be partially cleaned up within 21 days. And then you’ll just do a manual clean to get the remaining whatever is left. So, add a few more days. So, yes, so somewhere between – so say 25 days.

Unidentified Analyst: That’s helpful. Thanks. And then given the limited fleet growth you highlighted on Slide 10, if demand holds up, could ships over 20 years see retrofits to extend their life or maybe slip into the Russian trade or are there other factors that are going to push them to the scrap yard?

Lars Barstad: No, I think you’re hitting the nail there. Obviously, in the more opaque tanker markets there is life that’s more or less past 20 years of age. But I have to say though that what we’ve seen over the last month or so is that certain, you know, kind of in China, you have the Shandong Province, which is home to a lot of the independent refiners in China. And so, it’s a huge discharge port for all . And the fact that they have started to clamp down on some of the older kind of less maintained vessels is actually a positive sign that people are starting to have a proper look at this. Also, if you probably read about this, I think it was called an Aframax sitting outside Malaysia or Singapore that blew up. I think this is, kind of raising the attention from regulators on the risks in this market.

So – but for well approved tanker and there are probably many and well-maintained there is no reason why it shouldn’t be extended. But this again would kind of common scrutiny with divesting of the various, kind of in the charter – on the charter side. What we basically are consuming in our kind of fleet modeling is that a shape that passes 17.5 years will lose about 25% of its efficiency. And if you go beyond 20 years, you lose 50% of your efficiency. So, utilization wise or the ability to, kind of service the oil markets falls by 25% and 50%.

Unidentified Analyst: That’s really interesting. Thank you. I’ll turn it over.

Operator: Thank you for your question. There are no further questions at the moment. There are no further questions. I will hand back the conference over to management for closing remarks, please.

Lars Barstad: Well thank you very much for dialing in. It’s been a pleasure to report another good quarter. Hopefully, we’ll continue to do that and look forward to what’s to come. Thank you.

Operator: And that conclude the conference for today. Thank you for participating. You can all disconnect.