Frontline (FRO) Q2 2020 Earnings Call Transcript

Frontline (FRO 0.69%)
Q2 2020 Earnings Call
Aug 27, 2020, 9:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Robert Macleod

Good morning and good afternoon, everyone. Thank you very much for dialing into our second-quarter earnings call. First, I would like to express the gratitude toward our shore staff and crew members for their extraordinary efforts and dedication, which clearly are defining factors to our strong results. Our markets are very volatile.

But the volatility seen in the last 12 months have been extreme and serves as a reminder of how little it takes for the tanker mark -- market to rally. Frontline performance in the first half of 2020 was the strongest since 2008 and we've also made solid bookings for the third quarter. Despite the recent fall in rates, 2020 will be a very good year for Frontline. Let's start with Slide 3 and have a quick look at the highlights from the second quarter.

Net income of $200 million or $1 per share, certainly a solid quarter. Adjusted for non-cash items, the net income was $206 million. We declared a $0.50 dividend, the last dividend was $0.70 for Q1 2020. We opted to repay $60 million on our Hemen facility in the quarter, which is the main reason for the reduced dividend.

Inger has done some great work in financing, she will take us through that later on the call. Two build, new buildings were delivered in the quarter, one Suezmax and one VLCC, leaving us with only four ice class LR2s on order and they deliver next year. VLCCs made $75,800 in Q2 and we have booked 76% of Q3 at around $61,000. Suezmax has made $51,100 in Q2 and we've booked 77% of Q3 at $29.5.

LR2s made the just shy of $37,000 and we have booked two-thirds of Q3 at $14.5 million. These Q3 rates do not include the long-term time charters. And then before moving on to the market, I will hand the call over to Inger to take us through the financials.

Inger Klemp -- Chief Financial Officer

Thanks, Robert, and good morning, and your good afternoon, ladies and gentlemen. Let's turn to Slide 4 and look at the income statement of the highlights. Frontline achieved total operating revenues, net of voyage expenses of $301 million and adjusted EBITDA of $259 million in the second quarter of 2020. And we reported net income of $200 million approximately and $1.01 per share, and adjusted net income is $206 million or $1.04 per share in the quarter.

The adjustment this quarter was in total $6.4 million net and they consisted of a $5.9 million loss on derivatives, a $0.9 million unrealized gain on marketable securities, a $2.7 million share of losses on associated companies, and a $1.3 million amortization of acquired time charters. The adjusted net income increased by $27 million this quarter and it was mainly driven by an increase in our time charter equivalent earnings due to the higher reported TCE rates for our VLCC and LR2 tankers in the second quarter, along with a gain of $12.4 million, as a result of the sale of one VLCC previously recorded an investment in finance lease. Let us then take a look at the balance sheet highlights. The main happenings in the second quarter, which affects the balance sheet where that we took delivery of the Suezmax tanker from Cruiser and also, we took delivery of Front Dynamic and we drew down debts on these vessels.

We -- as Robert mentioned, we repaid our senior unsecured facility with $60 million. We entered into two new loan facilities to be financed to loan facilities with total balloon payments of $349 million, which were due in December 2020 and in March 2021, on terms in line with Frontline's other loan facilities. We then also paid $138 million in dividends and we earned adjusted net income of one -- oh, sorry, net income around $199.7 million. At the end of the quarter, Frontline has $462 million in cash and cash equivalents, including undrawn amounts under our senior unsecured loan facility, multiple securities, and minimum cash requirements.

The current portion of long-term debt includes $240 million debt maturity of the $466.5 million facility due in April 2021 and $80.3 million debt maturity of the $109.2 million facility in June 2021, which we both expect to refinance. Our remaining newbuilding capex requirements at the end of the quarter was $161.1 million related to the four LR2 tankers, where two of them are expected to be delivered in January 2021 and in February 2021, and two are expected to be delivered in August 2021. In this connection, Frontline has obtained a financing commitment for a loan facility in an amount of up to $133.7 million from CEXIM and Sinosure to partially finance these four LR2 tankers. This facility will have a tenor 12 years, it will carry an interest rate of LIBOR plus the margin in line with Frontline's other loan facilities and it will have an amortization profile of 17 years, and the facility is subject to final documentation.

Let's then take a closer look at the next slide on cash breakeven base and opex, Slide 6. We estimate average cash cost breakeven base for the remainder of 2020 of $22,600 per day for VLCC, $18,900 per day for the Suezmax tankers, and $15,700 per day for the LR2 tankers, and the fleet average estimate is about $19,100 per day. These are the rates. They are all-in daily rates that our vessels must earn to cover the budgeted operating cost on dry docks, estimated interest expense, TCEs, and bareboat hire, installments on loans and G&A expenses.

In the graph on the right-hand side of the slide, we have shown, as usual, the incremental cash flow after debt service per year and per share assuming $10,000, $20,000, $30,000, or $40,000 per day achieved in excess of our cash breakeven rate, respectively. And the numbers, they included vessels on time charter-out and we are looking at the period of 365 days from July 1st, 2020. As an example, with a fleet average cash cost breakeven rate of $19,100 per day and assuming that we have $30,000 on top of the average fleet TCE rate would be then $49,100 and Frontline will then generate the cash flow per share after debt service of $3.49. With this, I'll leave the word to Robert again.

Robert Macleod

Thank you very much, Inger. Let's have a look at the Q2 tanker market on Slide 7. So the first six months of 2020 brought a dramatic crude oil demand correction, the likes of which we've never seen. The demand shot brought on by COVID-19 was so large and sudden that global commercial inventories quickly surged to record levels, effectively utilizing all available land-based capacity.

At the same time, the crude oil market went into contango, encouraging traders to store oil on tankers and driving demand for short-term charters of our ships. This in turn resulted in exceptionally strong tanker rates, which are reflected in our results for the second quarter of 2020. The freight market has since declined to lower levels. And although the signs of recovery are evident as economies continue to reopen, the recovery in demand is unlikely to be linear and the extent and duration of the impact of COVID-19 is difficult to predict.

COVID-19 related challenges have been extensive through the industry. These include logistics around crew changes, delayed discharge, and diminished capacity at shipyards for dry docks and surveys. These are all factors that positively impact effective fleet supply. There is significant month-to-month volatility in the demand forecast, as shown on the chart at the bottom of the slide.

Let's move to Slide 8, please, and have a look at the global fleet capacity growth, which is slowing. The vessel supply side of the equation continues to improve, which is very positive. The order book as a percent of the total fleet is at the lowest level since 1997. At the same time, the average age of the VLCC fleet as of the end of the second quarter of 2020, is at the highest level since September 2002.

By the end of next year, there will be 65 vessels older than 20 years and an additional 85 older than 17.5. The effect of strong fleet supply growth will be pushed out to 2021 or 2022, but it should be material and lead to a sustained period of higher rates. We do like the current situation where new vessels enter the market at a controlled pace, the order book continues to shrink, and retirement of vessels is inevitable. Present markets and a bit of outlook.

The demand shock is likely behind us, but volatility can be expected. The present freight market remains under pressure, crude production is down almost 10% since January, and the lost volume reduces the volume that is normally shipped. Meaning that the cargo counts are down by as much as 20% to 25%. On the positive side, inventories are being drawn, a short-term pain, but possibly long-term gain.

Forecasts suggest that a significant portion of the OPEC cut could return in the coming months and combined with the Northern Hemisphere moving toward winter, this gives grounds to believe in a stronger freight market. So in conclusion, the large moves in tanker rates during the last 12 months illustrates the tight balance in the market and the fact that it does not take much for the tanker market to rally. Looking ahead to 2021 and beyond, recovering demand for crude oil transportation will coincide with rapidly declining fleet growth, which supports our long-term highly constructive market outlook. So as a Frontline, we enjoy the younger street and lowest breakeven levels in the history of our company.

Frontline's earnings potentially substantial, $23 million annualized for every $1,000 above $18.7 million. So we are very well-positioned. With that, let's turn over to questions, please.

Questions & Answers:

Operator

[Operator instructions] And now for your first question, it's come from -- it's coming from the line of Randy Giveans from Jefferies. Please go ahead. Your line is now open.

Randy Giveans -- Jefferies -- Analyst

Hi, Robert and Inger, how are you?

Inger Klemp -- Chief Financial Officer

I'm fine, thanks.

Randy Giveans -- Jefferies -- Analyst

Great. Well, yeah, I guess, first question is around the dividend, right? So in the fourth quarter of '19, the first quarter of '20, you paid dividends above, I guess, 70% of net income. Now for the second quarter, you reduced this to 50%. I think you mentioned part of it is because of the $60 million paid down back in April on that Hemen facility.

So, I guess, is that the entire reason for it? Or are you kind of bridging to a weaker dividend next quarter? And then, should we expect at least 50% of net income going forward?

Inger Klemp -- Chief Financial Officer

No, this is the entire reason for it. So if you add that on top, I guess, you will get to $0.80 dividend, which I guess, is probably what you assumed.

Randy Giveans -- Jefferies -- Analyst

If you include the Hemen $60 million, that was you're referring to?

Inger Klemp -- Chief Financial Officer

Yeah. So that's the entire reason for that, the dividend is 50%.

Randy Giveans -- Jefferies -- Analyst

OK. And then going forward, is a 50% net income a fair assumption?

Inger Klemp -- Chief Financial Officer

Going forward, it's standard normal that we have in a way. It's not changed at all in a way. We just -- this quarter opted to repay the facility with $30 million, which is $60 million, [Inaudible], which is $0.30 per share. That's for [Inaudible] this quarter.

Randy Giveans -- Jefferies -- Analyst

OK. And about the Hemen facility, I believe that was done back in April, right?

Inger Klemp -- Chief Financial Officer

Yeah.

Randy Giveans -- Jefferies -- Analyst

Do you expect to repay the remainder of that here in the third quarter?

Inger Klemp -- Chief Financial Officer

No, we don't know yet. We haven't really decided what to do with the remaining part of it in a way. It might be --

Randy Giveans -- Jefferies -- Analyst

Oh, I --

Inger Klemp -- Chief Financial Officer

It might be that we can extend the facility, it might be that we'll repay it, we'll have to see.

Randy Giveans -- Jefferies -- Analyst

OK. And then I guess, last question around your scrubbers. You know, what's the status of those scrubber installations? I know you postponed a few, I think it was four. Any expectations on when those will be installed or kind of your plans going forward on remaining scrubbers?

Robert Macleod

So -- so, Randy, we've done that. We've got a couple of being installed as we speak, but the four that we postponed, we've not done anything further with. So what we'll do is that when these ships that was supposed to have the scrubbers installed, when they dry dock over the next coming quarters, then, we will prepare these ships. So all the underwater work will be done, which is a small cost.

And then, the actual scrubbers can be fitted or retrofitted, and they are now stored at our production facilities in Indonesia. So, we'll see here. The spread is improving a little bit, but we have the optionality. And for the time being, they will remain in storage.

Randy Giveans -- Jefferies -- Analyst

Got it. Bye, everyone. I'll turn it over. Thanks, again.

Robert Macleod

Thank you.

Operator

Thank you. Your next question comes from the line of Jon Chappell from Evercore. Please go ahead. Your line is now open.

Jon Chappell -- Evercore ISI -- Analyst

Thank you. Good afternoon, Inger and Robert. A couple of quick clarification questions first. You know, I think we're always here where the quarter-to-date bookings look very elevated, basically because of the load to discharge accounting.

I know you guys really try to flush out the differences here. So maybe a way to ask it is, as you look at the rest of the quarter, the other 24%, let's say, for the VLCCs, is there any extreme or out of -- out of the ordinary uncontracted or contracted vessels where, let's call that stub part for the rest of the quarter would be higher or lower than the market averages?

Robert Macleod

So, it all depends, obviously, whether we fix the loading dates at the end of September or early October, that's what's going to determine. So it's -- but there's nothing -- to answer the second part of your question, there's nothing specific, there's nothing special. But what I would say about the earnings, it's important here to look at earnings over several quarters. So if I was to just say, if you ask me, how is Frontline down on VLCCs so far this year, then, might take is that we had a very good Q1.

We outperformed our peers. We -- we're giving some of that back in Q2, as you see from the numbers. And my guess is that we're on the -- we're on a pretty good rate level and on a good percentage here for Q3. So I would say, outperform well in Q1, we know, slightly below in Q2.

And then, I think we're looking quite good for Q3.

Jon Chappell -- Evercore ISI -- Analyst

OK. And then just another clarification, Robert. I think you said that the long-term contracts are not included in the quarter-to-date rates. In the press release, it says the short-term charters are included in the forecast.

So what is between the long-term and the short-term? I guess, you have two that are nine and a half months and one that's 12 months, and then, you have four that are just below six months. So just to be clear, that the ones -- the ones that are just below six months that is included in the quarter-to-date and then the longer ones or not?

Robert Macleod

Yeah, correct. So -- so basically, after the six-month charters, which are basically six months plus minus one, so it's a minimum period of five months. So those deals that we consider spot in the numbers and anything above, which then starts in the eight month deals and it's -- we have a couple of one year deals and we've got the five Suezmax on the three-year deals. So -- so anything above the six months, that is then considered longer -- longer-term and are not included.

Jon Chappell -- Evercore ISI -- Analyst

Got it. And then also, I noticed in the disclosures that you have seven ships chartered to affiliates of Hemen. I'm assuming those are the seven that you did in the second quarter. Just curious, is there any options associated with those? Or are those kind of strict on the uh -- on the timing?

Robert Macleod

There are no options at that.

Jon Chappell -- Evercore ISI -- Analyst

OK. Final question, Robert, is I think you've laid out a very balanced second half of the year outlook for the market. And clearly, given the start to third quarter, you will be cash flow positive and Inger has kind of laid out the dividend strategy. When you think about the cash going forward, do you think this period of, let's call it, choppiness or uncertainty provides you with an opportunity to add tonnage? Or do you think that you spend this next six months continuing to delever the balance sheet to position yourself for the favorable 2021, '22 outlook that you -- that you spoke of?

Robert Macleod

We're pretty happy with the -- with the size. We're very happy with the age. As I said in the intro, we -- the company's in a very good shape. But -- so I don't think we need to do anything.

It's -- if opportunity come up, for example, something like the Trafigura deal we did, which we quite liked, then, maybe. But base case is to enjoy what we have and then harvest from that through having, hopefully, what is the best operation.

Jon Chappell -- Evercore ISI -- Analyst

Great. Thanks so much, Robert.

Robert Macleod

Thanks.

Operator

Thank you. Your next question comes from the line of Chris Tsung from Webber Research. Please go ahead. Your line is now open.

Chris Tsung -- Webber Research -- Analyst

Hi, good afternoon, Robert and Inger. How are you?

Inger Klemp -- Chief Financial Officer

Good afternoon, we're fine. Thanks, how about you?

Chris Tsung -- Webber Research -- Analyst

Good, good. Thanks. I kind of wanted to just touch on the cash breakeven levels again. On Slide 6, I know Jon asked this earlier, too, but I guess, I'm asking it from a slightly different angle.

So on Slide 6, the cash breakeven levels of like $19,000 on a fleet average. In the press release it says that the charter coverage are not included in the breakeven level. So I was wondering, would that mean the breakeven levels excluding the time charters, would show a slightly higher breakeven for the fleet?

Inger Klemp -- Chief Financial Officer

No. I mean, the cash breakeven rates that we disclosed are the total cost that our fleet has divided by the different number of days for each segment and then shown on a gross basis. If you have contract coverage, above the breakeven rate, that would, obviously, take down the cash breakeven rate for the spot vessels. So it will not increase then.

Chris Tsung -- Webber Research -- Analyst

Right, right, right. So like if the charter -- if the contract coverage takes it down if we were to exclude it, would that bring it up and you're saying the answer is no?

Inger Klemp -- Chief Financial Officer

[Inaudible] with that makes it even, no, yeah. No, yeah.

Chris Tsung -- Webber Research -- Analyst

OK. All right. I just wanted to clarify. Thanks.

And I kind of wanted to just ask about your investment in Clean Marine. I guess when the investment was made back in October of '19, I guess, it seemed like it would be a smart hedge for IMO 2020 in scrubbers in general. And fast forward, you know, 10, 11 months now, COVID, OPEC, and market vol, what are your plans for this investment going forward?

Robert Macleod

We will see how they -- how this develops. We're now -- we own about 17% and the company uh -- the company has a production facility, which is owned in Indonesia, it's got its stocks and so forth. And we have -- we only -- our investment is now -- we only have a very small loan to the company. So we don't really have any risks there.

We don't see the need to put any money into the company and I think there will be some positive news, at some point, going uh -- going down the road. It's not turning out to be uh -- to be as aloof to this -- what we were hoping, of course, but the downside was -- so the risk in that was always controlled and limited.

Chris Tsung -- Webber Research -- Analyst

Right. I see, OK. Makes sense. And -- and last question.

Just given the news about the voluntary cuts from several key OPEC members, the congestion that's happening around Chinese ports, and Hurricane Laura in the U.S. Gulf. I'm just curious in terms of how you guys choosing to position your fleet in the near-term?

Robert Macleod

What we're doing now is that it's an extremely difficult market to predict and that is the easy obvious thing to say because it's -- I've been doing this for a few years and my sort of gut feel is that we are going toward a more normal market. We're well, well down on volumes, as we know. It looks from the last patch that we're seeing, then the world production is 3 million to 4 million barrels lower than the consumption, which is, obviously, hurting freight, but it could build -- it could build a better case as we move toward winter and Q4 is normally a strong quarter. So my -- well, [Inaudible] with no sort of high conviction, I got a feel that things will get better as we -- we move toward the end of the year and what we're doing with the fleet is that we are trying to reposition in the Suezmax in the Atlantic Basin.

And if we have the choice between the long voyage at current rates or a shorter one, we opt for the shorter one. There are some potential triggers out there so we're watching it all very closely, and we've got a feel that things uh -- things might get better. At the same time, the volumes remain low. So it all depends on the cargo account.

What we've seen in the Middle East over the summer, where basically one out of three cargos has disappeared. Has uh -- has, obviously, dented the earnings. But hopefully, something -- demand will steadily come back and there could be some better times ahead. But I'm very cautious.

I'm not going to put on the bullish hat just yet.

Chris Tsung -- Webber Research -- Analyst

Huh, all right. Makes sense. Thanks, guys. That's it for me.

Operator

Thank you. Your next question comes from the line of Greg Lewis from BTIG. Please go ahead. Your line is now open.

Robert Macleod

Hi, there, Greg.

Operator

Excuse me, Mr. Greg Lewis, your line is now open. Please chack your line if you're on mute. Thank you.

OK, let's just take the next question. It's coming from the line of J Mintzmyer from Value Investor's. Please go ahead. Your line is now open.

J Mintzmyer -- Value Investor's Edge

Thanks for taking my questions.

Robert Macleod

Hi, J. How are you doing?

J Mintzmyer -- Value Investor's Edge

Hi, doing excellent. Thanks. So first of all, congrats on a good quarter. As we're looking toward the shifting interest rate environment, I know you've done a few swaps and hedges in the past on some of your debt profiles.

I know you also have a new debt profile coming up with the new builds. Is there any plans to expand or extend those interest rate swaps? Is any of that in the works? Or are you going to maintain some floating exposure?

Inger Klemp -- Chief Financial Officer

Uh, so we do have entered into quite a lot of the interest rate hedges now recently. So I guess, at the moment, we have no further plans for entering into even further interest rate interest. But also we had on -- we have $550 million of hedges now at the moment. And also as short as an additional portion of about $100 million, which is very soon going to mature.

But at the moment, I think we're happy with that.

J Mintzmyer -- Value Investor's Edge

OK. Makes sense. Yeah. I was tracking, you had about one-third or so hedged.

I was wondering if that -- those plans have changed. You know, Jon asked earlier about kind of your cash plans and if you looked at maybe expanding or new builds or second hands or anything like that. Sort of a related question, Frontline carries a nice premium to some of your tanker peers, I think Frontline is probably the only -- one of the only tanker companies that carries what you could say is like a respectable valuation in today's market. Is there any opportunity out there for Frontline to become a equity consolidator? I know there's some peers in the Norwegian market, for example, we won't name names today, but they're trading at a significant discount NAVs.

Is there some opportunity for consolidation there? Or is that sort of off the table?

Robert Macleod

No, there are opportunities. And as you say, we have the pricing. We're well below where the premium we normally are at and that premium is there for the obvious reasons. We do -- do have a main shareholder who remains hugely supportive and that will remain so.

But in terms of consolidation, yes, we are a potential consolidator, but we are happy with what we have now. We will keep tracking opportunities though, so let's see what comes up and what makes sense. But with the size we already have, then our earning potential, it's already there and which you can clearly see from the Q2 numbers.

J Mintzmyer -- Value Investor's Edge

Excellent. Excellent. You'll have to forgive me for this one, Robert, the parting question here, but you know, we talked back in April and you had kind of a fun bet gamble about if rates would come back down, unsurprisingly, that you'd be walking across Norway. So I just wanted to check in on that and see when the trips are planned.

And maybe it's after COVID, we can get a group together.

Robert Macleod

I'd tell you what, you would probably enjoy the walk. Of course, It's a beautiful walk. As long as you start from the East side and then walk toward my home town and it's the right -- you're going the right way. But J, we have actually settled the bet, so it ends up being a -- being a dinner.

And -- but I must say, with the confidence I had a bet was high and it did came -- did come very, very close. But fortunate enough, I got away with it.

J Mintzmyer -- Value Investor's Edge

Excellent to hear. Thanks, again, Robert. Have a good one.

Operator

Thank you. Your next question comes from the line of Louis McGiven, a private investor. Please go ahead. Your line is now open.

Unknown speaker

Hello, Robert and Inger. The -- hey, I'm calling from Pittsburgh, which is the home of the steel industry that a good Scotsman named Andrew Carnegie had made famous. And I was curious, what effect does scrap steel rates have on the retirement of vessels?

Robert Macleod

Scrap -- sorry, did you say scrap steel price?

Unknown speaker

Well, the decision to retire vessels, I know it has to do with the five-year intervals and so forth in the market of you know -- but do high or lower scrap prices affect your decisions in the industry to retire ships? I just wondered if the rate of scrap steel would go up if that would result in more retirements, which would be beneficial for your industry?

Robert Macleod

Interesting question. And the fact is, yes, yes it does. And to give you an example, so our larger ships. So by the way, our older ship now is 2009, so we don't have really any candidates.

But uh, if you look at that market, as I mentioned in the introduction, there are a growing number of older ships, and looking at the last 18 months, then, the value -- the steel value has fluctuated between $11 million and $18 million. So it's -- now it's at the lower end of that scale. So it's is part of the decision-making here, whether to scrap or not is, obviously, then linked to this price. It is -- it is a good portion of the value of the contract.

Unknown speaker

Well, maybe you could talk some shipbuilders into offering bonuses to the scrappers to tie in a sale of the new vessel to scrapping a ship.

Robert Macleod

Yeah. That could be a way of doing it or combining making a pool of all the old ships and get the balance back quicker that way.

Unknown speaker

OK. Well, thanks.

Operator

We have no further questions coming from the phone lines. [Operator instructions] Please continue.

Robert Macleod

OK. No, I think uh -- I think we'll round off. So I'd just like to thank everyone for calling in, and also to my colleagues and everyone at Frontline. Thank you very much for all your efforts.

Duration: 34 minutes

Call participants:

Robert Macleod

Inger Klemp -- Chief Financial Officer

Randy Giveans -- Jefferies -- Analyst

Jon Chappell -- Evercore ISI -- Analyst

Chris Tsung -- Webber Research -- Analyst

J Mintzmyer -- Value Investor's Edge

Unknown speaker

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