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Frontline's Choppy Seas

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By Hohum77
May 29, 2009

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Frontline (FRO) is one of three tanker companies (the other two are OSG and TK) I like to refer as Tanker "biggies". I call them "biggies" because each one has a large tanker fleet.  They are also "biggies" because many smaller tanker companies charter some, or all, of their vessels with one of the three "biggies" to gain tanker "benefits".  Buying and selling of vessels is also in the business plan of all three "biggies".

Let me start by giving FRO a plug. FRO usually has a presentation that accompanies their quarterly/annual results.  That presentation is a really well done document, and has a format that I wish more  companies would imitate. Essentially, I like to think of it as: - This is us (results and items specific to FRO),  - This is our sector (items specific to the tanker sector),  - This is how things fit in the bigger picture (oil industry and what is going in the world economy).  There is also a richness of detail that is really informative (more on this shortly).

FRO reported Q1 results early yesterday (5/28). In my opinion, probably the most noteworthy item was the cancellation of six vessel orders  (in shipping lingo, newbuild or NB) - 2 VLCCs (Very Large Crude Carriers) and 4 Suezmaxes  (a tanker vessel class that can navigate through the Suez Canal). These vessels were part of multiple orders totaling 18 vessels (10 VLCCs, 8 Suezmaxes)  scheduled to be delivered to FRO between 2009 and 2012.  Total NB cost: $1.8B

Richness of detail - Slide 19 - how many VLCC vessels delivered and deleted from the fleet - Slide 20 - how many Suezmax vessels delivered and deleted from the fleet - Slide 23 - # of Contango vessels from Oct 2008 - May 2009

�Let me back up for a second and provide some background data. 1. An International Maritime Order (IMO) calls for the phase out of  Single-Hull (SH) tankers in 2010,  and a definite ban by 2016. Some countries (Singapore, Philippines, most EU countries)  already enforce the SH ban today.  2. FRO's fleet includes 8 Single-Hull (SH) vessels- 7 VLCCs & 1 Double-Sided (DS) Suezmax.  These vessels would obviously need replacing in the next year or two, else their delivery areas would be severely limited. 3. I never thought FRO would take delivery of all 18 newbuilds. In at least one previous earnings call, FRO's mgmt team did suggest that for the right price,  the company would be willing to part with one or more newbuild vessels. 4. The vessel orders were placed at different times, and from different yards. The orders were a. Waigaoqiao (shipyard) was a 2 + 2 VLCC order i.e. an initial order of 2 vessels with an option to order 2 more vessels b. Rongsheng I think was a 4 + 2 + 2 Suezmax order i.e. an initial order of 4, an option for 2 more, and another option for 2 more vessels c. Jinhaiwan was a 4 + 2 VLCC order

�So now we go back to the subject- Paying for excesses. Things were rocking in the tanker world the first half of 2008. Shipping rates were really good.  FRO had a great Q4 2007, a better Q1 2008, and an even better Q2 2008.  Each earnings period, FRO kept dishing out a higher dividend. That last order, the vessels from Jinhaiwan shipyard, went out in April 2008.

FRO had a financing plan in place for the first 2 VLCC vessels from Waigaoqiao + the 4 Suezmax  vessels from Rongsheng. (See Slide 14, bullet 1). The financing of the other 2 VLCCs from Waigaoxiao (Slide 14 bullet 2)  is a more recent development. I think FRO did originally have a partial financing plan for the Jinhaiwan vessels.  Complicated story, let's just say FRO made another purchase, a few more vessels, in the Summer of 2008.  What did pay for the Jinhaiwan vessels downpayment?  Well, the usually high dividends got slashed in Q3 and Q4 2008. (Shareholders paying for the excesses here)

When FRO reported Q4/Annual 2008 results, there was about a combined $300M financing shortfall in 2009 and 2010. If one looks at Slide 15, the Cap Ex and Financing columns match up a lot better. What do I think became a major factor to necessitate the cancellations? Skip over to slide 21 and look at the two charts on the left. Thru roughly the end of 2008, newbuild costs for both VLCCs and Suezmax vessels had been going up, so if the vessels had been delivered,  FRO could have sold any of its newbuild vessels for a profit. Not longer true in the current time-frame. FRO paid $135M for each Jinhaiwan VLCC,  and the current cost has slipped below $130M. For the Suezmax vessels, they perhaps break-even.  (Company paying for the excesses here- market glut)

I still own some FRO shares, so I look for positive items. I think there are a few. 1. FRO completed the financing of 2 more VLCCs. 2. FRO slashed its debt burden by over $550M. 3. The company was able to apply the deposit on canceled vessels to other newbuild vessels (By Q4 2008, FRO had paid at least 20% down on all 18 NB vessels).