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Frontline Ltd  (NYSE:FRO)
Q2 2019 Earnings Call
Aug. 30, 2019, 12:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by. Welcome to today's Second Quarter 2019 Frontline Limited Earnings Conference Call. [Operator Instructions] I must advise you that this conference is being recorded today on 27th of August 2019.

I would now like to hand the conference over to your speaker today, Robert MacLeod. Please go ahead, sir.

Robert Hvide Macleod -- Director and Chief Executive Officer of Frontline Management AS

Thank you very much, and good morning and good afternoon, everyone. Thank you very much for dialing in to what is Frontline's second quarter earnings call. There are very exciting market dynamics in play now, as the market looks to -- look set to improve further from the recent recovery. Last week, we announced the purchase of 10 Suezmaxes, and we hold options for a further four. We do this at a time we believe is ideal, more on that very shortly. This call will conclude by taking questions. Let's get started and look at the Company highlights for the quarter.

Net income was $1.1 million. Adjusted for non-cash items, we made $4.2 million in the quarter. For the VLCCs, the spot TCE was $25,600. Q3 bookings show 83% of the days booked at $28,000. This number will likely decrease, as stated in the [Phonetic] press release due to accounting treatments of voyage charters.

Suezmaxes came in at $16,200 and 70% of Q3 is done at $18,300 [Phonetic]. On the Aframaxes or LR2s, low $18,000 in Q2 and similar guiding for 68% of Q3. We recently obtained financing commitment at very attractive terms on our 2020 Suezmax delivery in May. And we have been continuously able to secure attractive financing.

Let's look at the right side of the slide and the Trafigura-Suezmax deal. As I will discuss later, we have a very constructive view on the market. And we believe we are right at the start of a market upturn that could be the start of a strong tanker cycle. This view gave us the conviction to acquire 10 too fast and '19 built Suezmaxes, all of which are fitted with scrubbers from Trafigura. Five vessels will be chartered back to Trafigura for three years at $28,400 with a profit-sharing scheme, where we will receive 50% of all profits.

We find this to be a very attractive value deal and it also protects our downside. Importantly, we don't have to wait for the acquisition to close to get access to the vessel earnings. We will take the ships on time charter within the next few weeks or month, and five vessels will immediately be time chartered back to Trafigura. We are very pleased with Trafigura becoming a strategic shell of Frontline. And we see potential synergies going forward, given their significant presence in the global oil trading markets.

We've also, which is independently from this deal, formed a joint venture with Trafigura to establish a global supplier of marine fuels. We believe we are exceptionally well positioned ahead of IMO 2020, through this joint venture and other steps already taken by the Company, including our investments in scrubber manufacturer, FMSI.

IMO 2020 looks to us to be the biggest event in the shipping market and the tanker trade for decades, and we believe it will play out very positively for our shareholders.

With that, I'll hand the call over to Inger to take us through the financials in detail please.

Inger M. Klemp -- Chief Financial Officer of Frontline Management AS

Thanks, Robert, and good morning and good afternoon, ladies and gentlemen. Let's turn to Slide 4 and 5, and look at the financial highlights and the income statement.

Frontline achieved total operating revenues, net of voyage expenses, of $103 million and EBITDA adjusted for certain non-cash items of $56 million in the second quarter. Frontline reported net income of $1.1 million, equivalent to $0.01 per share, and a net income adjusted for certain non-cash items of $4.2 million, equivalent to $0.02 per share in the second quarter. The non-cash items this quarter consisted of $1.7 million unrealized gain on marketable securities, a $0.8 million in share of results of associated company and $5.6 million loss on derivatives.

The second quarter shows a decrease of $40.7 million against adjusted EBITDA of $96 million, and a decrease of $41.1 million against adjusted net income of $45.5 million in the first quarter of 2019. The decrease in net income in the second quarter is mainly explained by a decrease in result on a time charter basis, due to the lower reported TCE rates in the second quarter compared to the first quarter.

Let's then take a look at the balance sheet on Slide 6. The changes to the balance sheet as of June 30 compared to March 31st, 2019, mainly relates to a decrease in cash and cash equivalents of $5 million, which is the net effect of capex payments to the payment of debt, draw down on debt, cash from operations and the proceeds from issuance of shares under the ATM program in the quarter. An increase in vessels of $70 million is due to the delivery of Front Discovery in April and depreciation in the quarter. A decrease in vessels under finance leases by $3 million due to depreciation, net increase in debt with $31 million in the quarter, following $59 million in repayments and $89.5 million in draw downs.

A decrease in obligations on the finance leases with $3.3 million, due to amortization of profit share expense and lease repayments. And finally, an increase in equity of $10.5 million, representing the net income in the second quarter and $9.3 million of share issuance proceeds in relation to the ATM program.

As of June 30, Frontline had $257 million in cash and cash equivalents, including the undrawn amount under our unsecured loan facility, marketable securities and minimum cash requirements. Our remaining newbuilding CapEx requirements amounted to $225 million related to one Suezmax tanker and one VLCC which are both expected to be delivered in May 2020, and two LR2 tankers which are expected to be delivered in January and March 2021.

We estimate approximately $164 million in debt capacity for these new buildings. We have no near-term debt maturities. The first debt maturity is in November 2020, when our senior unsecured loan facility to $275 million matures. We had drawn down $120 million under this facility, and $155 million remains available and undrawn as June 30, 2019.

Then, let's take a closer look at cash breakeven rate and cash generation potential on Slide 7. We estimate average cash cost breakeven rate for the remainder of 2019 of approximately $24,500 per day for the VLCCs, $21,300 per day for Suezmax tankers and $16,200 per day for the LR2 tankers. These rates are the all-in daily rates that our vessels must earn to cover budgeted operating costs and dry dock, estimated interest expenses, TC and bareboat hires, installments on loans and G&A expenses.

We had included dry dock costs for four VLCCs, four Suezmax tankers and one LR2 tanker in the second half of 2019. Frontline's low cash breakeven rates offers a strong downside protection against low rate and at the same time, it creates a great upside potential in the strengthening tanker market.

Every $1,000 per day in achieved rates in excess of our cash breakeven, translates to approximately $22 million in incremental net income per year or $0.12 per share, which shows the net -- the high importance of remaining -- maintaining our low cash breakeven rates.

In the graph on the right-hand side of the slide, we have shown incremental net income per year and per share, assuming $10,000, $20,000 and $30,000 per day in achieved rates in excess of our cash breakeven, respectively. The operating expenses per day in the first quarter of 2019 were $10,500 for VLCC, $7,500 for the Suezmax tankers and $7,100 for the LR2 tankers. We did dry docked 2 VLCCs in the second quarter, and four VLCCs and one Suezmax tanker are scheduled for dry dock in the third quarter of 2019.

And with this, I leave the word to Robert again.

Robert Hvide Macleod -- Director and Chief Executive Officer of Frontline Management AS

Thank you so much. So let's look at the key market developments. We are once again seeing the market behave in a counter-seasonal manner this year, as we also saw in the first quarter when U.S. exports began to surge. In Q2, we witnessed the largest decline in global refinery throughputs seen this decade, due to extended maintenance ahead of IMO 2020. Looking back, I would actually say that rates kept up pretty well, given what was going on with the refineries.

Recently VLCC rates have again moved up sharply, refineries are now restoring capacity and throughput looks to be rebounding quickly. Crude oil demand growth is forecasted to be stronger for the balance of the year, after softening through the first half.

For the balance of 2019, we expect the tanker market to remain volatile, due to crude oil supply concerns and geopolitical tensions, that continue to trend higher. Importantly, U.S. crude oil production is growing year-over-year, while OPEC production is declining following production cuts. This is leading to increased exports from the Atlantic, which we expect to continue. This expectation is supported by both increasing U.S. production and export capacity, which has been coming online steadily. A large portion of incremental production is flowing to Asia, supporting strong growth in tonne-mile demand.

Next slide, please. We'll have a look at how deliveries decline after 2019 and older vessels will face costs. The growth of the crude oil tanker fleet is a key factor for our markets. So far in 2019, 41 VLCCs have been added to the global fleet, compared to three vessel demolitions. An additional 33 VLCCs are scheduled to be delivered in 2019, with 43 more to follow in 2020, before the order book declines sharply.

Despite continued deliveries of newbuilding vessels in the short term, effective crude tanker capacity growth is expected to slow as vessels are taken out of service, regular dockings, scrubber or ballast water installation and other preparations for the IMO 2020 regulations. While the pace of recycling has slowed significantly compared to last year, there are still 170 VLCCs that are greater than 15 years of age, and we believe a large number of all the vessels will be taken out of the market and either be recycled or go on floating storage as part of a regulation-driven phasing out of all the vessels.

Let's move to the summary slide, please. There are obviously various factors to support our positive market outlook, and we constantly monitor developments. In the short-term, we have already seen the market rebound, following extended refinery maintenance ahead of IMO 2020. Although, global demand growth is forecasted to slow down, the pace of growth remains a positive. The fact that incremental production is coming from the U.S. and a good deal of it is heading east is a clear positive for tonne-mile demand growth. Replacing barrels from the Middle East with barrels from the Atlantic is widely viewed as positive for tanker markets, given the increase in distance travels.

Finally, the vessel's supply picture looks very positive, after new vessel deliveries have put pressure on our market for the last two years. As we just looked at, there is still a fair amount of vessels to be delivered over the next 18 months, but this number has eclipsed by the number of vessels created in 15 years. And we should also see some effective reduction in capacity as vessels are temporarily taken out of the trading markets. On the other hand, the risk of a global slowdown in GDP growth is dominating the news headlines and a real risk that has added volatility to the equity markets.

Finally, there's always the chance that IMO 2020 implementation will not proceed as expected. And although we believe in fuel spreads to widen as we approach 2020, it could, of course, narrow and diminish scrubber economics.

To conclude, we expect the market to remain volatile, but continue to trade higher. Crude oil tanker demand will continue to receive a significant boost as crude demand increases in the second half of this year. Although there are always risks related to slowing global demand, multiple possible market drivers should result in a strong tanker earnings for the balance of the year, and we expect this strength to kick off 2020 positively for us. We believe Frontline is well positioned going forward, now with even greater earnings potential.

With that, I would like to turn over to questions, please.

Questions and Answers:

Operator

Ladies and gentlemen, we'll now begin the question-and-answer session. [Operator Instructions] The first question comes from the line of Randy Giveans from Jefferies. Please ask your question.

Randy Giveans -- Jefferies -- Analyst

How's it going? How are you all doing this morning?

Robert Hvide Macleod -- Director and Chief Executive Officer of Frontline Management AS

Good. Thanks, Randy.

Randy Giveans -- Jefferies -- Analyst

Excellent. All right, so looking at your fleet, in recent months, you ordered two newbuildings, acquired some resales, most recently bought those 10 Suezmaxes from Trafigura. So how are we thinking about kind of further fleet growth from here? Are you pretty satisfied with the fleet following this most recent large acquisition?

Robert Hvide Macleod -- Director and Chief Executive Officer of Frontline Management AS

I think looking at the fleets overall, let's say, over the last three, four years, we've transformed from our returns of average age, we've really brought it down. We've had a lot of ships delivered. We sold off a lot of the old ships. So I think, the process here, has been very positive for the Company. We've been looking actively at growth for periods here, and we have to say, we've done resales. And last week, we did a Trafigura deal. We -- overall, as you look at our fleets, we've had product exposure through the LR2s for some time, which in terms of size, we're pretty happy with.

We'd like the other preference, we'd like the crude segment in terms of growth. We found that growth on Suezmaxes. But I think it's fair to say the way our fleet is structured now than in terms of future growth, then VLCCs will have our special attention.

Randy Giveans -- Jefferies -- Analyst

Sure. That makes sense. And then looking at your investment in the joint venture with Trafigura, was there a monetary cost to this to acquire your present ownership? And also, will there be financial risk from either profitable or unprofitable bunkering trading? Or is it solely kind of an operational play for your fuel requirements?

Robert Hvide Macleod -- Director and Chief Executive Officer of Frontline Management AS

[Indecipherable] with this, we will put a small amount of working capital into it, and that's it. So there's no investments as such. And in terms of the risk profile, we will be very conservative, so we capitalize.

Randy Giveans -- Jefferies -- Analyst

All right. And then, I guess, last quick question. Do you have an updated kind of cadence for offhire days and kind of capex spend on the scrubber installations? Like how many scrubbers do you expect to have by January 2020 in the next three or four months here?

Robert Hvide Macleod -- Director and Chief Executive Officer of Frontline Management AS

So we've been -- so the simple numbers have been that about one-third of our fleet will have them installed by Q1. Given the Trafigura deal, we're fast forwarding the amount with that deal. So by Q1 next year, we'll be just below half the fleet.

Randy Giveans -- Jefferies -- Analyst

Q1 half fleet. Excellent. Hey, thank you so much for the color and congrats on all the deals.

Operator

Thank you. Our next question comes from the line of Jon Chappell from Evercore. Please ask your question.

Jon Chappell -- Evercore -- Analyst

Thank you. Good afternoon, guys. Robert, to follow up on the other question in the fleet. So you've obviously made a pretty big transaction. You talked about maybe focusing on the VLCCs going forward. At what point do you feel that you're in kind of harvest mode? And you're done spending, you already have a fleet that's under four years of age, and you kind of transition to the Frontline [Indecipherable], where capital return takes priority over continuing to build the size of the fleet.

Robert Hvide Macleod -- Director and Chief Executive Officer of Frontline Management AS

Now we -- in terms of earnings power now, or seeing a [Indecipherable] through the slide, where we have -- we are substantial. So I think the focus now will be to possibly do something on the VLCCs, we certainly don't have to. If this market takes off as we expect, then we have great earnings potential as it is. But as for our strategy coming into this, then we keep -- we paid now spot for quite some time, because we've had a belief that we will see a strengthening market coming into 2020. So hopefully this plays out and then we will take opportunities there, like we did when doing the Trafigura deal to lock in some charters and we will do some of that and have a conservative approach to the cycle.

Jon Chappell -- Evercore -- Analyst

And I know it's not kind of the legacy MO of Frontline to delever, but after this Trafigura deal, looks like about 80% leverage, if we take the high end of the cost range, just for this deal alone, which brings Frontline back above 60%. So how do you think about using cash flow from operations, if the cycle plays out, as you and I both expect to delever the balance sheet a little bit, as opposed to maybe jacking up the dividend?

Inger M. Klemp -- Chief Financial Officer of Frontline Management AS

I guess this is something that the Board will have to discuss going forward, how we are going to approach that. But according to our dividend strategy, that remains unchanged anyway. And that says, as you know, that the excess cash flow from the Company should be used in more or less for dividends going forward.

Jon Chappell -- Evercore -- Analyst

Okay. The last one, Robert, it's kind of fresh, so I don't know if you've had a chance to assess it yet. But the addition of crude oil to China's retaliatory tariff list, you mentioned, yourself the importance of the Atlantic in the long haul trade and we're at the belief that that's what's really been supporting the market in the phase of these OPEC cuts. Have you assessed either operationally, what it potentially means for your fleet, or financially from a supply demand perspective? If these tariffs were to be enacted and the U.S. became uneconomic -- U.S. crude became uneconomic in China, what that -- what might that do to your outlook on the tanker markets?

Robert Hvide Macleod -- Director and Chief Executive Officer of Frontline Management AS

No. I think it's an excellent question, but on this call, and I'll refrain to conclude much.

Jon Chappell -- Evercore -- Analyst

Okay, thanks, Robert. Thanks, Inger.

Robert Hvide Macleod -- Director and Chief Executive Officer of Frontline Management AS

Thanks.

Operator

Thank you. The next question comes from line of Gregory Lewis from BTIG. Please ask your question.

Gregory Lewis -- BTIG -- Analyst

Yes. Thank you, and good afternoon. Robert, I guess, thanks for providing the kind of guidance for Q3, but I guess at this point, we are almost in September. Just kind of curious, we've seen a nice run up in VLCC rates over the last couple of weeks. Do we have any kind of visibility at this point into what Q4 bookings already look like? Have we started to get anything on the books for Q4?

Robert Hvide Macleod -- Director and Chief Executive Officer of Frontline Management AS

No. For the Q4, we've done a little bit, but very little. We're seeing in sales, we'll see in the last few weeks. There's a lot of momentum in the market. The Vs have moved, the Suezmaxes are on the move. So I think the -- to look at the quarters, I'd say that Q3, have to say, we've already booked a lot when the market started turning, I think we should look at Q3 as being not a great quarter, we have -- you see in the guidance, right? But the good thing is that we're starting to move market moves so that the Q4 bookings days started at low percentage, where we're seeing the high numbers. So hopefully we've teed off it to get a really good Q4, but the next month will show.

Gregory Lewis -- BTIG -- Analyst

Okay. And then with it Trafigura acquisition, I guess, congratulations on that. That Suezmax guidance that you gave on that slide, does that include that -- those vessels? Or was that more like the end of the Q2, so prior to the acquisition of those vessels?

Robert Hvide Macleod -- Director and Chief Executive Officer of Frontline Management AS

So that -- [Indecipherable] -- that's excluding those.

Gregory Lewis -- BTIG -- Analyst

Okay. So that's excluding those. Okay, great. And then just one more for me. I guess as we look at the decision to go into the Suezmaxes, it seems like over the last couple of years there's, you've even mentioned it yourself, the order book for the Suezmax has come down. Strategically, like how should we think about Suezmaxes in the crude market now? Jonathan mentioned, clearly, there's been a lot of oil moving from the U.S. to Asia. That's not [Indecipherable] Suez trade, just kind of, how you're thinking about the Suez market given that you just made a pretty substantial acquisition into the space?

Robert Hvide Macleod -- Director and Chief Executive Officer of Frontline Management AS

We like the Suezmax segment. We already had 18 ships in the segment, all modern. And the thing about the Suezmax, you can triangulate them. So if you look at our earnings, when these -- the VLCCs are down into low teens, for example, then normally the Suezmaxes trade just above and that's due to the triangulation. And they're doing a lot of West Africa. They're also doing lot of the Atlantic [Indecipherable]. So they're doing some long-haul trades, also short, so this is a very flexible and versatile ship unit, which also with the ratios we have in the market, it's a very good segment for us. So I think in terms of commercial performance, over the last four, five quarters, then Suezmax [Technical Issues] is probably our strongest.

Jon Chappell -- Evercore -- Analyst

Okay, perfect. Thank you for taking my questions. Have a great day.

Operator

Thank you. The next question comes from the line of Robert Silveira from IE Silveira [Phonetic]. Please ask your question.

Yes. Hello, Robert, thank you for doing a good job. How do you see the horizon as far as coming back to a dividend? First quarter of 2020, second quarter, could you give us some color on when that might occur?

Robert Hvide Macleod -- Director and Chief Executive Officer of Frontline Management AS

I think, the -- this as well as Inger said in other question, I think it would be down to the Board. But the way I see this is that we're coming into positive territory and in terms of facility payable to Mr. Fredriksen, we've drawn now $120 million and the overall Company is looking good. And I would always say, it's always fair to say, that we will return to paying out dividends sooner rather than later.

Operator

All right. Thank you. Could you give us some color on what's going on these days in the Strait of Hormuz where you had problems in the past? Do you see it coming down or is it still very tenuous?

Robert Hvide Macleod -- Director and Chief Executive Officer of Frontline Management AS

We are very much on the alert still.

Operator

Alert? Okay. Is it affecting your bookings from that area? Some companies have actually decided to stay away. You have not decided to do that, right?

Robert Hvide Macleod -- Director and Chief Executive Officer of Frontline Management AS

No, we've not decided to stay away with -- so we are doing business there, but we have chosen other trades due to the situation. So also the Frontline trade was a very, very crucial situation and we've gone down in terms of bookings. But we are still trading in the area, but with heightened security and we will be keeping a very close eye on everything that's going on.

Operator

Okay, good. Could you give me a little color on how you see Brazilian production and how that may balance, for instance, what's going on in the United States with tariffs with China, etc. etc.? Will it change things very much and how is Brazil coming as far as paying out...

Robert Hvide Macleod -- Director and Chief Executive Officer of Frontline Management AS

It's one of them [Phonetic] earlier question, it is a difficult one to be very precise and conclusive on, but if you look at the expiration and the plants in the country and the investors being brought in, also from our state in which a company that we know, then I think it's fair to say that it looks like it's going to be a growth area in terms of exports.

Operator

Okay. Well, that's it for me. Thank you very much for taking my questions.

Robert Hvide Macleod -- Director and Chief Executive Officer of Frontline Management AS

Thank you.

Operator

Thank you. The next question comes from the line of Lukas Daul from ABG. Please ask your question.

Lukas Daul -- ABG -- Analyst

Thank you. Good afternoon, Robert and Inger. Just a quick one on the 10 Suezmaxes you are adding. How should phase them in terms of those start-up dates etc.?

Robert Hvide Macleod -- Director and Chief Executive Officer of Frontline Management AS

So the first one was delivered, so back to the deal, we take exposure on these ships as soon as we can. So the first one actually delivered at the time of signing and then we're about to take delivery of the second one. And so they don't call at the same time, the delivery is connected to calling various ports, but certainly I think we should be -- we should have all the ships within September.

Lukas Daul -- ABG -- Analyst

Okay. Within September. Good. And then on -- you sort of mentioned in the press release, when you announced that looking at different options, how to finance it? Could you sort of share of bit of light on that? What would be the ideal financing structure?

Robert Hvide Macleod -- Director and Chief Executive Officer of Frontline Management AS

We're not going into be [Indecipherable] on what we will clearly focus. We have various options now. What we can say is that, assume this deal was ultimately [Technical Issues] pre-checking. The finance is definitely available to Frontline and it is at very, very attractive terms. We will aim to conclude finance as soon as we can. We will then lower the cost that we are currently paying. So it's a top priority for us to close the production and do the finance as in.

Lukas Daul -- ABG -- Analyst

Okay. Sounds good. Thanks.

Operator

Thank you. [Operator Instructions] Dear speakers, there are no further questions at this time. Please continue.

Robert Hvide Macleod -- Director and Chief Executive Officer of Frontline Management AS

Okay. Then, thank you very much. I would like to thank everyone at Frontline for all their hard work and great efforts. And thank you all for calling into this presentation. All the best.

Operator

[Operator Closing Remarks]

Duration: 31 minutes

Call participants:

Robert Hvide Macleod -- Director and Chief Executive Officer of Frontline Management AS

Inger M. Klemp -- Chief Financial Officer of Frontline Management AS

Randy Giveans -- Jefferies -- Analyst

Jon Chappell -- Evercore -- Analyst

Gregory Lewis -- BTIG -- Analyst

Lukas Daul -- ABG -- Analyst

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