Frontline Ltd. (NYSE:FRO) Q2 2022 Earnings Conference Call August 25, 2022 9:00 AM ET
Company Participants
Lars Barstad – Chief Executive Officer
Inger Klemp – Chief Financial Officer
Conference Call Participants
Jonathan Chappell – Evercore ISI
Chris Tsung – Webber Research
Lars Barstad
Good morning and good afternoon to everyone. Welcome to Frontline’s Second Quarter Earnings Call. As mentioned in our release, this is the quarter where the LR2s took center stage. The market tends to forget that close to a third of our vessel days come from this asset class. We started to see the displacement of Russian crude and products also affecting the Suezmaxes during the second quarter. And finally, the VLCC got a pulse as the second quarter came to an end.
Before we get to the Q2 financials and what lies ahead, let’s have a look at the highlights on Slide 3 in the deck. So in the second quarter, Frontline achieved $16,400 per day on our VLCC [Technical Difficulty] $6,500 per day on our Suezmax fleet and very impressive $38,600 per day on our LR2/Aframax fleet. So far, in the first quarter of 2022, we have booked 73% of our VLCC days at $28,100 per day, 73% of our Suezmax days at a solid $45,000 per day and 62% of our LR2/Aframax days at even more impressive $46,200 per day. All numbers in this table are on a load to discharge basis and maybe affected by the amount of ballast days we end up having at the end of Q3. This is more relevant to the VLCCs that normally tend to go on the longer voyages. It occasionally affects Suezmaxes and to a lesser degree, LR2s.
With that, I will now let Inger take you through the financial highlights.
Inger Klemp
Thanks, Lars and good morning and good afternoon, ladies and gentlemen. Let’s turn to Slide 5 and look at the income statement. This quarter, Frontline achieved total operating revenues of $159 million and adjusted EBITDA of $98 million. We reported net income of $47.1 million or $0.23 per share and adjusted net income of $42.5 million or $0.21 per share in this quarter.
On the right hand side of the slide, we show the adjustments made this quarter, which consists of a $8.9 million gain on derivatives, a $6.1 million share results of associated companies, a $1.3 million amortization of acquired time charters, a $0.8 million gain on insurance claim, $12 million loss on marketable securities and $0.4 million loss on termination of leases. The adjusted net income in the second quarter increased $44.1 million compared with the first quarter. And the increase in interested net income was driven by an increase in our time charter equivalent earnings due to the higher TCE rates in the quarter, but it was partly offset by an increase in ship operating expenses of $7.5 million, mainly as a result of higher drydocking costs and other movements in income and expenses.
Then let’s take a look at the balance sheet on Slide 6. Total balance sheet numbers have increased with $304 million in the second quarter compared to the first quarter. The balance sheet movements in the quarter are primarily related to taking delivery of the 2 new buildings VLCCs, Front Alta and Front Tweed together with the acquisition of the Euronav shares in exchange for Frontline shares in addition to ordinary debt repayments and depreciation. As of June 30, Frontline had $351 million in cash and cash equivalents, including undrawn amount under our senior unsecured loan facility, marketable securities and minimum cash requirements.
Let’s then take a closer look at Slide 7. Keeping costs down has always been in Frontline’s DNA and core values of the Frontline platform is keeping it simple and focused and maintain lean and efficient management teams. This slide shows that Frontline [Technical Difficulty] on OpEx, G&A and interest expense. And this, together with outperformance of peers on revenues for at least two out of three segments this quarter explains the superior operational performance of Frontline in the second quarter of 2022.
Then I think we should look at Slide 8. That is the cash breakeven and cash generation potential. We estimate average cash cost breakeven rates for the remainder of 2022 of approximately $24,900 per day for the VLCCs, $20,000 per day for the Suezmax tankers and $17,200 per day for the LR2 tankers. This gives a fleet average estimate of about $20,700 per day. The fleet average estimate includes drydock of 6 vessels in the remainder of 2022, with an impact of about $530 per day. The distribution of these 6 vessels is 2 VLCCs, 1 Suezmax tanker and 3 LR2 tankers. In the second quarter, we recorded OpEx expenses, including drydock of $8,100 per day for the VLCCs, $10,400 per day for the Suezmax tankers, and $8,400 per day for the LR2 tankers. And in the second quarter, we have drydocked 6 vessels, 4 Suezmax tankers and 2 LR2 tankers. The graph on the right hand side of this slide, this shows the free cash flow per share after debt service and free cash flow yield basis current fleet and share price, August 24 alternative TCE rates.
Based on historic Clarkson TCE rates for non-eco vessels in the period 2021, adjusted for premiums on scrubber and eco vessels, Frontline has a free cash flow per share of $2.34 and a free cash flow yield of 20%. Free cash flow yield potential increases with higher assumed TCE rates and on a fully delivered basis.
With this, I’ll leave the word to Lars again.
Lars Barstad
Thank you, Inger. So let’s move on and have a look at Slide 9 and recap the second quarter. I have basically made a title here called a “pivotal point for tankers.” Q2 is normally a softish quarter also referred to as a shoulder quarter. But as we see on the graph at the bottom left, something happened as we went into Q2 this year. So global oil demand came in 700,000 barrels per day lower in Q2 compared to Q1, averaging up 98.4 million barrels. Supply came in at 99.1 million barrels per day, up a modest 0.2 million barrels per day in the quarter. It’s basically the volatility we’ve seen in the market in Q2 and the first and foremost, on the LR2s is a ton-mile story. And we’re currently reaping the benefits of that story that started during the second quarter.
We are seeing highly inefficient trading patterns developing and this to the benefit of oil in transit and utilization, as you can see on the graph at the bottom right. Towards the end of the second quarter, we saw all Frontline asset classes, including the VLCC start to move up. Asian and in particular, Chinese demand was still subdued, but current level of activity paints an interesting picture for future starts to come.
Let’s move then to Slide 10. So global exports, and what we’re looking at here are two charts where basically it’s the tracked output of oil and products, split from basically every producing country in the world and every producing or products producing region in the world. We have seen a dramatic change in demand and trading patterns for refined products developing during Q2 this year. I think people tend to forget and it’s a bit overshadowed by the situation in Ukraine that most of the Western world has actually fully come out of COVID – of the COVID-19 pandemic with the effects that have had on demand. And at the same time, refining capacity, particularly in Europe and to some extent, in U.S. was reduced quite dramatically during the pandemic, where these regions experienced horrific refining margins. And in addition to that, we’ve had the situation with sanctions on Russia, making Russian oil and products more difficult to move.
So basically, what we see is that global clean product exports are actually approaching the highest we’ve seen. And this takes us back to 2017. If you go further back, AIS tracking is not as efficient as it has been in this period. But we are reaching all-time high on clean products exports globally. Global crude oil exports is improving. It’s lagging though, on the product side. This is – but kind of the appreciation in the global crude oil exports is primarily caused by U.S. SPR releases and U.S. production and their export capabilities are growing. U.S. production has increased by 1.4 million barrels year-to-date according to EIA. And as most of you would know, the U.S. are releasing what’s equivalent to almost 1 million barrels per day of their SPR or from the SPR. In – I would say, writing, but in speaking, we currently see very high demand for tonnage, both in the Middle East and in the U.S. Gulf, indicate that this positive development for freight looks to continue.
Let’s move then to Slide 11. And the order book continues to dwindle in particular on the crude side. There has been no orders for VLCCs or Suezmaxes in the last 12 months. I have to correct myself there a little bit, because I saw reports this morning that there were VLCCs ordered or rumored to be ordered in Japan, but we will get back to that. In order to get a significant change to this picture, we need far more.
On the VLCC side, we have seen 27 vessels delivered year-to-date, and there’s still 21 to come. Some of those will obviously move into ‘23. But the total order book is at 41 vessels. We have a fleet of 861 vessels, of which 81 during this year will be over 20 years old. Once this order book is finished delivered, 114 VLCCs will be above 20 years old.
On the Suezmaxes, it’s even more pronounced. We’ve seen 25 Suezmaxes delivered this year. There are eight more to come, six next year and two in 2024. That’s the 16 total in the order book, and we have 65 Suezmaxes that will pass this 20-year threshold this year. And looking at time the order book delivers, it’s a total of 111 Suezmaxes that would effectively be disqualified from the commercial trading oil market.
On the LR2s, we have, in fact, seen some orders placed this year. The broker of course varies, but we’ve landed on identifying 13 orders placed. And – but still, I would argue that, that’s not an alarming development. There are 20 LR2s or at least vessels that are registered as LR2s that are going to be over 20 years this year. But if you kind of heightened the threshold a little bit and put it at 15 years, which for anyone that trades clean products, no is a more relevant yardstick. You have more than 70 LR2s built prior to 2008. So basically by this order book has – when this order book has delivered, this will come to age. So we’re not really that alarmed about the development on LR2s either.
I think if we look at the chart at the top left side here, and this has been become quite repetitive over the quarterly presentations that we have. And the blue line is the absolute deadweight size of the tanker order book, and the yellow one is as a percentage of the fleet. And as we can see in absolute deadweight, we’re back to 2000-2001 period, and we all know that the oil market is much larger now than it was in 2000. In the percentage of the fleet, it’s even more pronounced where we need to go back to 1996 and even before. I actually don’t have history prior to 1996 on this. So it’s difficult for me to gauge whether if we are early-90s, mid-90s or in the ‘80s. But this is an alarming development, I would say. And we’re starting to see the early signs of that tankers could become a bottleneck in the energy logistical chain.
And I’d like to add, though, for those of you not that familiar with freight and tankers is that not every country in the world is blessed with oil. And there is also an asymmetrical relationship between population growth and oil resources. So this transportation need is actually real. So let’s see how this develops.
Let’s then move over to Slide 12. And I find this quite exciting. The time charter market has almost erupted over the last month. The time charter of the period market is an old school bellwether for large oil transporters expectations. These are, as we referred to as the big guys, the Shells, the Equinors, the BPs, the Chevrons, the big boys in the game that have equity crude have substantial transportation needs are in the market, all of them for up to 3-year commitments on time charters. And to them – even for them, a 3-year commitment is significant. We have seen earlier kind of in the reporting season, even 5-year charters being concluded. And this is extremely interesting and extremely encouraging. This is obviously in line with the spot, but it’s not that often that you – after a relatively short period of firm spot markets, it is a kind of activity in the long-term time charter market. So this basically means that our analysis might be in line with some of these guys analysis.
Frontline will remain a spot focused owner with the objective to offer our investors stock-market returns. However, a certain degree of secured revenue and margin plays a part of our long-term vision. And as we have reported, we are actively looking at the time charter market for some of our asset classes.
So let’s move over to Slide 13. We are – although it’s been fairly quiet from Frontline in this respect for the last couple of months or actually not months last month, I would say. Frontline and Euronav combination is on rails. We are moving forward, basically, the part of the process we are in now is led by legal and it’s more a regulatory job towards the regulators, and we’re working towards a Frontline relocation filing to – for the relocation of – from platform Bermuda to Cyprus. That will be followed by a tender offer. We expect that to happen in Q4 this year.
There is always also been discussions around the various outcomes of this tender offer. I’ve left the achieving less than 50% acceptance out of this. But obviously, if that should happen, we don’t believe it will. We think this is an industrial solution the market wants, but I just left that out. If we get above 75% acceptance amongst the Euronav shareholders, we will go directly to a merger with Euronav. Should we, in the case end up between 50.1% and 75%, the outcome is more or less the same. Frontline gains control of Euronav and a combination of the two complementary platforms will be created will perform basically as one company, although Euronav will be veridically a subsidiary of Frontline.
So let’s – with that move to Slide 14 and a summary. So Q2 ‘22 was a shoulder quarter in the terms of oil demand. And in fact, Q3 should have been the same. That’s if you follow normal seasonal patterns. This is currently a turmoil story with sanctions on Russia being a catalyst, but we may face a structural catalyst when it comes to products. I mentioned earlier in the presentation the dislocation between refining capacity and demand. Global crude oil exports are approaching pre-COVID levels and oil in transit is already there.
Order books continue to dwindle, and there are currently no incentive present to invest in new capacity interest yet. Also, there is a question of when this capacity can be ready to the market should the ordering start now. The other question then is, are we starting to feel the structural bottlenecks of oil transportation that may come. Frontline has a modern, efficient spot exposed fleet, and the stars are looking to align and I might add, winter is coming.
I’d like to draw your attention to the chart at the bottom, which is different from the last three quarters, and it’s basically a seasonal chart of the average weighted earnings of all tankers. It’s not Frontline tanks, it’s all the tankers, basically all the tanker indices. And as you might notice, it’s a very unseasonal pattern evolving.
And with that, I’ll open up for questions.
Question-and-Answer Session
Operator
[Operator Instructions] The first question from Jonathan Chappell from Evercore ISI. Please go ahead.
Jonathan Chappell
Thank you. Good afternoon. Lars, two quick questions on capital allocation. First of all, it’s good to see the dividend renewed for the first time. If we do the math, it looks like maybe a 70% payout ratio has just been so long. Just want to get confirmation on a rough range? And then the second part to that question is, as we’re going through the final steps of consummating the Euronav transaction, are there any restrictions on the amount of dividends or any other corporate actions you can take until that process?
Lars Barstad
First of all, Inger just handed me a note here. I believe it’s up 79%…
Inger Klemp
Yes, because we need to calculate the dividend basis to 222.6 million shares [indiscernible] outstanding at the end of the quarter – second quarter, I mean. So then you will come to that is 79%.
Lars Barstad
Yes. And back to your other question, there is the combination agreement was made public in July and the exchange ratio is set and it’s within that exchange ratio that the dividend has been – is being paid. But for future dividends, it needs to be basically adjusted either via the exchange ratio, which is very unlikely. And then via the amount of shareholders that Frontline will have post merger.
Jonathan Chappell
My second question for you Lars is, you mentioned in the presentation that you haven’t really seen China come back to the market yet. It feels like Russia is still pretty reliant on – I am sorry, Europe is still pretty reliant on Russian crude and the sanctions clearly haven’t gone into effect yet. Is it – is there any way to quantify or even qualify what’s driven this VLCC spike before you are really seeing the impact of these two potential big catalysts into the market?
Lars Barstad
Well, first, I would like to say that the European and U.S. sanctions on Russian crude has not affected the Russian flows per se, but it’s altered the trading pattern. So, basically, what we see right now is that Russian crude oil and Russian products is sailing past Europe and to Asia. And at the same time, Europe has had to change their purchase patterns and are importing to a much larger degree feedstock and products from Middle East, West Africa and the U.S. So – and this is what created this highly inefficient trading pattern. So, it has – kind of the sanctions has stopped Russian crude to enter Europe just as far as we see it. With regards to the VLCC, that’s a very kind of recent development. And I think it’s more related to the U.S. production and the U.S. SPR release and their export capacities. So – and as you know, and as I have described this before, on previous calls that the oil market is a bit like a toothpaste tube. If you press it, the toothpaste will pop out somewhere. And basically, U.S. crude oil has then priced itself to go far east, basically by the share price itself to go far east, basically by the share volume being offered. So that, I think is the game changer here. I also think not to be too technical, the flattening of the oil curves in a very, very steep backwardated market, it’s quite expensive to hold large volumes of crude oil over a long voyage is basically unhedgeable. But obviously, with the flat structure in the crude oil market. It’s easy to hedge your exposure over the 60 days you need in order to transport crude from say U.S. Gulf to China.
Jonathan Chappell
Okay. That’s all very helpful. Thank you Lars and thanks Inger.
Operator
Thank you for your question. We are now taking our next question. The next question is from Chris Tsung from Webber Research.
Chris Tsung
Hi. Good afternoon. How are you?
Lars Barstad
Thank you. Very good.
Chris Tsung
Thanks. Yes. Just to follow-up on that last question. So, are you saying that you will continue to see VLCCs/Suezmaxes for the near-term, is that right?
Lars Barstad
So basically, what we are seeing is that at least VLCC – when these large trade lanes open up as we have seen U.S. Gulf to Asia or to North Asia. You utilize the vessels for over a very, very long period of time. So, it takes away capacity for a long time. So – and we also see the activity continue. When we fix VLCCs now, we fix them for late-September. So basically, the oil will be lifted in September and delivered to China sometime in late-October early November. And this, we see continue as October dates are already being addressed. This does, however, create a bit of a hole in the Suezmax program, because they are fixed closer to the loading dates. But at the same time, the Suezmax has a lot of support from the flow of crude from both Middle East, but primarily West Africa into Europe. So, we basically see – this seems to be maintaining or maybe even firming.
Chris Tsung
Okay. Great. Yes. Thanks for that color. That’s really helpful. Just on to your fleet mix, I know in the presentation, you guys are not looking at new capacity to ship, but with these delivering into early next year and the potential merger with Euronav fleet, which is heavily be-weighted. I just wanted to understand, is there a desire to rebalance your fleet mix, or how should we think about that?
Lars Barstad
You are absolutely correct. It is to rebalance our fleet mix. And historically, Frontline has been a predominantly VLCC company, secondary having Suezmaxes. And the LR2 additions to our fleet is actually kind of in the long-term, fairly new. We do see them obviously as very efficient trading vehicles. And I think this quarter has a story of that. But no, it’s a simple analysis, which we have repeated a few times, but I am happy to repeat it again. If you look at the average cash breakeven Frontline has per vessel class, and you also then think of the economies of scale in oil transportation. You will find that the lid on – or the kind of where the VLCC peaks is so much higher than, for instance, for the VLCC, and Suezmax or compared to an LR2. So, it means that you get to put a bit in variable on the more bang for the buck owning VLCCs in a good market. And this has basically been from clients philosophy all along. We are also quite good at running VLCCs, have a good client base in that segment. And so, this has basically been kind of where the bread and butter over the years has been gained from Frontline. So, the Euronav transaction is a part of that kind of continuing that story.
Chris Tsung
Got it. Great. Thank you. And just if I can squeeze one last modeling question just noticing your admin costs have inched up a bit this quarter. Is this a one-time thing associated with the time merger with Euronav versus something else?
Inger Klemp
Yes. And you are right. We do have some more professional fee of – expenses related to professional fees and legal costs in this quarter than we usually have related to this merger.
Chris Tsung
Okay. So, it wouldn’t be like the run rate going forward is just slightly elevated this quarter and maybe into next?
Inger Klemp
Sorry, I didn’t catch your question?
Chris Tsung
I was just saying that this shouldn’t be looked as a new run rate for admin expenses, and it’s just this quarter and next, is it just going to be slightly elevated?
Inger Klemp
Well, I mean as long as we are in the process of let’s say, combining the companies, I guess you could assume that we will also have higher professional fees and legal expenses in the next quarters to come.
Chris Tsung
Alright. It makes sense. Thank you, Inger. Thank you, Lars.
Lars Barstad
Thank you.
Operator
Thank you for your question. We are now taking our next question. Please stand by. The next question is from Omar Nokta, Platou [ph].
Unidentified Analyst
Hi there. Hey guys. I have a couple of questions for you just on the Euronav transaction. Obviously, in the second quarter, you did a few share deals that took your stake up to around 20% in Euronav. Is there anything that prohibits you from doing more, assuming the opportunity exists to take your position higher ahead of the tender offer?
Lars Barstad
It is in fact – and this leads to kind of transactions, you can call them, were bilateral, and they were kind of driven by incoming to put it that way. There is a regulatory kind of mechanism called the creeping tender offer. If you continue to do this, at least the U.S. legislators will kind of arrest you not like physically, but you will – they don’t deem it the correct way of going about this. So, that’s why we kind of stopped there. Also, there are limitations to – when you become a related party and so forth. That’s not necessarily a big issue for us as we are very much related through the combination agreement already. But there is no kind of big incentive for us to continue that path or it is in a part continue those – or to do more of those transactions.
Unidentified Analyst
Yes. Got it. That makes sense. Appreciate that. And I guess this is maybe a sensitive I understand, if you are not able to respond, but are you having any discussions with the Euronav shareholder that has been vocal in his opposition to the deal, maybe reaching amicable solution, or does it just simply come down to how the tender offer comes about later in the year?
Lars Barstad
In the end it comes down to how the tender offer – what happens when we count the shares at the end of the tender offer.
Unidentified Analyst
Understood. Okay. Alright. Thanks Lars.
Lars Barstad
Thank you.
Operator
Thank you for your question. [Operator Instructions] There are no further questions at the moment, I will hand back the conference for closing remarks.
Lars Barstad
Okay. Thank you very much for calling in. Again, these are exciting times. We are quite excited both by the market developments and our ambitions with regards to the combination of Euronav. So, with that, thank you and have a good day.
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