Frontline Plc (FRO) 2018 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to today's Q4 2018 Frontline Ltd. Earnings Conference Call. (Operator Instructions) I must advise you that this conference is being recorded today, 28th of February 2019.

And I'd now like to turn the conference over to your speaker today, Robert Macleod. Please go ahead.

Thank you very much. And apologies, everyone, for the delayed start. But good morning, and good afternoon. Thank you for dialing in to Frontline's fourth quarter earnings call.

I will start by briefly going through the highlights of the quarter. Following that, Inger will run us through the financials. We'll then look at the Q4 and Q1 spot earnings and go through some pretty exciting market slides. We'll also look at the risks going forward. The call will be concluded by taking your questions.

Let's get started and look at the company highlights. Net income for the quarter was $25.4 million. Adjusted for noncash items, we made $26.4 million. The VLCC numbers were highly affected by ballast days towards the end of the quarter, deferring revenue recognition into the first quarter of 2019. The TCE effect per day per VLCC is around $8,300.

Q1 bookings are at a high level. 84% of the days are booked at $41,300, which includes deferred revenue recognition from the fourth quarter of 2018. I'll get back to earnings of Suezmaxs and Aframaxs later.

Our largest shareholder continues their support. The Hemen facility is extended to November 2020. We have also increased our ownership in Feen Marine Scrubbers to 28.9%, and our planning for 2020 is on track. VLCC Newbuilding Front Defender delivered in January. This brings Frontline's current order book down to 1 VLCC only, Front Discovery, which will be delivered in April.

With that, I will hand the call to Inger to take us through the financials in more detail.

Thank you, 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 $122 million and EBITDA, adjusted for certain noncash items, of $78 million in the fourth quarter. Frontline reported net income of $25.4 million, which is equivalent to $0.15 per share and a net income, adjusted for certain noncash items, of $26.3 million, also equivalent to $0.15 per share.

The noncash items this quarter consisted of $8.9 million gain on the termination of the leases on Front Ariake and Front Falcon. We had a $0.2 million share results of an associated company, a $5.4 million unrealized loss on marketable securities and also a $4.7 million loss on derivatives.

The fourth quarter shows an improvement of $31 million against adjusted EBITDA of $47 million and an improvement of $34.8 million against adjusted net loss of $8.4 million in the third quarter of 2018. The improvement in net income in the quarter of $34.8 million is mainly explained by an increase in result on time charter basis of $33.1 million. This is due to the increase in reported TCE rates in the fourth quarter compared to the third quarter. However, our net income in the fourth quarter was impacted significantly by a higher number of ballast days towards the end of the quarter, especially for the VLCCs, which deferred revenue recognition into the first quarter of 2019. The company is required to account for voyage revenues and voyage costs under the load-to-discharge method according to ASC 606 under U.S. GAAP.

The total impact of this is that $15.8 million in net worth revenues have been deferred into the first quarter, where $13.5 million relates to the VLCCs and $2.9 million relates to the Suezmax tankers. For the LR2 tankers, $0.6 million net voyage costs have been deferred into the first quarter.

I refer to Note 2 in our Unaudited Condensed Consolidated Financial Statements for more details.

The spot TCE estimates for the first quarter are $41,300 contracted for 84% of vessel days for VLCC, $33,300 contracted for 77% of vessel days for the Suezmax tankers and $26,100 contracted for 73% of vessel days for the LR2 or the Aframax tankers. This includes the deferred revenue recognition from the fourth quarter of 2018, which I just went through.

These spot estimates are provided using the load-to-discharge method of accounting as described in more detail in Note 2 to our Unaudited Condensed, Consolidated Financial Statements. The rates quoted are for days currently contracted. The actual rates to be earned in the first quarter 2019 will therefore depend on the number of additional days that we can contract and, of course, more importantly, the number of additional days that each vessel is laden. Therefore, a high number of ballast days at the end of the quarter will limit the amount of additional revenues to be booked based on accounting under ASC 606.

The load-to-discharge method of accounting results in revenues being recognized over fewer days, but at a higher rate for those days. Over the life of a voyage, there is no difference in the total revenues and costs to be recognized.

And when expressing the TCE per day, the company uses the total available days for the quarter and not just the number of days the vessel is laden.

Let's then take a look at the balance sheet on Slide 6. The changes to the balance sheet as of December 31 from September 30 mainly relate to a decrease in vessels of $25 million due to depreciation in the quarter; a decrease in vessels under capital leases by $46.8 million due to termination of the leases on Ariake and Falcon; an increase in other long-term assets of $7.5 million, mainly due to advances made on scrubber investments; a net decrease in debt with $25 million; and also a decrease in obligations under capital leases with $59.96 million due to the termination of the leases on Front Ariake and Front Falcon. We also had an increase in equity of $26 million, representing the net income in the fourth quarter.

As of December 31, Frontline has $158 million in cash and cash equivalents, including the undrawn amounts under our unsecured loan facility, marketable securities and minimum cash requirements. Our remaining newbuilding CapEx requirements amounted to $114 million related to the 2 last VLCC newbuildings. And we had approximately $114.7 million in debt capacity under our newbuilding credit facilities. We have no near-term debt maturities. The first debt maturity is in November 2020 and our senior unsecured loan facility of up to $275 million matures.

We have drawn down $186 million under this facility as of end of December. And following repayment of $15 million in January, we currently have drawn $171 million under this facility.

Then let's take a closer look at cash breakeven rates and OpEx on Slide 7. We estimate average cash cost breakeven rates for 2019 of approximately $24,400 per day for the VLCC, $19,900 per day for the Suezmax tankers and $16,700 per day for the LR2 tankers. These rates are all-in daily rates that our vessels must earn to cover budgeted operating costs and dry-dock, estimated interest expenses, TC and bareboat hire, installment on loans and G&A expenses. The reason for that is breakeven rates are higher than in 2018 is that we have included dry-dock costs for 6 VLCCs, 4 Suezmax tankers and one LR2 tanker in 2019.

In the upper right-hand graph, we showed some time VLCC cash breakeven rates, along with average VLCC spot earnings in the period, 2009 to 2019.

We can see from the graph that sometimes low cash breakeven rates offers a strong downside protection against the low-rate environment and, at the same time, creates a great upside potential in the strengthening tanker market. Every $1,000 per day in achieved rates in excess of our cash breakeven rates translates to approximately $19 million in incremental net income per year or $0.11 per share, which shows the high importance of maintaining those low cash breakeven rates.

The operating expenses per day in the fourth quarter of 2018 were $7,600 for the VLCCs, $7,000 for the Suezmax tankers and $7,100 for the LR2 tankers. We did not dry-dock any vessel in the fourth quarter, and one vessel is scheduled to dry-dock in the first quarter of 2019.

With this, I leave the word to Robert again.

Thank you, Inger. Pretty exciting with the upside on the earnings. $1,000 is over the breakeven is $90 million over the year. So hopefully, we'll keep some of that going forward.

Let's turn to Slide 8, please, and have a quick look at the Q4 performance and Q1 guidance. The spot earnings of these, we've already covered. We've made $26,100 in Q1 on the Suezmaxs. The Q1 bookings are strong, 77% at $33,300. Aframaxs made $18,700 in Q4, and they also are off to a good start with 73% done at $26,100.

Let's move to the next one, a very exciting slide, the spot market's recent behavior. The market pulled back as we entered Q1 due to uppercuts, accelerated fleet growth and seasonal factors. In recent weeks, the market has reversed course, with U.S. exports volumes and VLCC rates both doubling since January and showing a contra-seasonal trend. Reports show an undersupplied oil markets. Inventories are falling, and with rising refinery margins, more oil has

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the markets, increasing demand for shipping. This has created a strong pull on long-haul U.S. crude. Exports in March looked to be almost double those in January.

The result is that ships are drawn directly to Atlantic from Asia, which in turn has left the Middle East ship availability tight, and the market has, therefore, firmed significantly at an unusual time of year. The recent spike is very exciting, and we read it as a sign that the current tanker fleet is well balanced. A lot of ship capacity will be taken out in Q2 and Q3 due to dockings with scrubber and ballast water delays. 2019 could well be a contra-seasonal in multiple quarters and particularly strong in the second half. Our spot exposure is at 97%, so we are well positioned to benefit.

Slide 10, please. OPEC cuts change trading patterns. Forecasts imply that demand growth will increasingly be

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dislocated from incremental supply. U.S. production is expected to be the main incremental supply in the market, which should cause ton mile demand to continue to increase as surplus barrels are transported to Asia. New investments in U.S. export capacity are underway and will contribute to this dynamic going forward. In the meantime, supply disruptions, which have been seen recently in Venezuela and Iran, will create further dislocation and volatility in the markets.

Next one, please, the VLCC order book. We are currently in one of the highest delivery years for VLCCs seen in recent times, and year-to-date, 11 VLCCs have entered the markets. There will be slippage towards the end of the year, likely so in 2018, but we still expect around 60 of these to deliver in 2019. To balance that, we have what we refer to as a survey pool of net 120 vessels, either which many are expected to be recycled or converted over the same period. There will, of course, also be further orders placed for 2021 delivery onwards.

An interesting fact. The average age of a current VLCC fleet is at 16-year high at 9.5 years, up from 7.5 years in 2012.

Let's go to the last slide as a summary. Oil demand is strong, and new supply continues to come from the U.S. and it's a major factor in setting the spot markets whilst driving ton miles. As we have said, we think the vessel supply side is manageable. Frontline has taken steps to position the company ahead of the implementation of the new IMO emission regulations. We believe our 2020 preparation will lead to increased cash flow generation and allow us to return incremental value to our shareholders. But on the flip side, there will be a high pace of vessel deliveries this year, and scrubbing will slow down if the market continues to be strong, although IMO 2020 will make older vessels even less economical to operate.

Global growth could slow, and trade wars could continue to disrupt. Lost supply from Iran and Venezuela could also be a negative, pushing the oil price up and demand for vessels down. Newbuilding orders have slowed, but this could, of course, change.

To conclude. We expect the market to remain volatile but continue to trend higher as the [sea] prepares for new regulations and oil volumes return. Crude oil tanker demand will also receive a significant boost as refineries increase crude import runs to meet incremental demand for compliant fuels prior to the implementation of IMO 2020. Although there are always risks related to slowing global demand, multiple positive market drivers should result in a strong year-over-year growth in earnings.

With that, I'd like to turn over to questions, please.

(Operator Instructions)

We have had some questions come through. Your first question comes from the line of Jon Chappell from Evercore.

I wanted to say I really appreciate the transparency on the revenue recognition. I think that went a long way in explaining kind of the 4Q and the 1Q volatility. So thank you for providing that. The one big question I had was on the dividend. The Frontline of yesteryear with the fourth quarter profit and a big 1Q outlook would have paid a pretty sizable dividend. And it was kind of noteworthy that there was not only no dividend paid for the fourth quarter, but really no mention of strategy for 2019 other than saying kind of managing the balance sheet. So do you think that's prudent managing the balance sheet, given where you've come from? But how do you kind of think about the dividend, especially given your optimistic outlook for 2019?

Yes. I think, as you say, we definitely had a positive result in the fourth quarter, but we have to remember that we have just the less volatile quarters where we have had losses. And at the same time, when we experienced losses in these different quarters, we also had to draw on this facility that we have with our main shareholder. So we think it's prudent now to start to download the debt a bit, especially this more expensive debt that we have with our main shareholder and then we have with the -- the debt related to our vessels. But going forward, I think this is something we have to review next quarter. And with the outlook, which seems quite positive for 2019, I think we will review what to do, also how we should proportion this out going forward. But we definitely would like to have a healthy balance sheet going forward, and I think it's also in the interest of our shareholders that we actually are downloading a bit on our debt situation.

Yes, I agree with that, Inger. But just to be clear, is there any restrictions from the Hemen facility that keep you from paying a dividend or limit the amount you can pay? Or should we think about you want to get Hemen fully repaid before you kind of go back to the previous policies? Or it's just kind of going to be a quarter-to-quarter review?

I think it's fair to say here that the board will, obviously, look at this quarter-by-quarter. But I think it's -- the board will look at reintroducing the dividend sooner rather than later, and there's no restrictions on the facility.

Okay. My second question is just on the scrubber schedule for this year. You said there's only about $1 million left to pay in 2019, but that doesn't include installation cost. So if we think about the all-in cash outlay associated with scrubbers, how much cash will be going out in 2019 for those 20, I guess, the 18 not counting the newbuilds? And also, thanks for the schedule on dry-docks, [60Ls] for Suez what's the off-hire time associated with those?

Yes. I think you are referring to the note that we are stating that we have a CapEx related to the scrubbers of 15 point -- or $16.8 million was it? Is that what you're referring to?

Yes.

Yes. Okay, yes. And we also say that, that's not including the installation costs. And the installation costs we have included, I guess, in our -- with the total costs we have included in our cash forecast for 2019, I believe, is close to $47 million for everything in a way.

Okay, that's helpful. Any off-hire time to reach dry-docking?

Five to 10 days, I would say, or for the scrubber installations, I mean, in addition to ordinary dry-docking.

Your next question comes from the line of Randy Giveans from Jefferies.

Say, a few quick questions for me. So I see you continue to kind of grow your Feen Marine ownership. Is there kind of a -- do you own 100% of that? Is there any possibility? And how much has it cost you to get to that kind of current 29% kind of ownership?

I think we will stay where we are in terms of ownership. There is no desire from our side to go much out after that. So we have no decide to take over the company. We're going to focus on running ships. But strategically, given IMO 2020, we quite like the flexibility that the investment gives us.

Got it. And then the cost for that 29%?

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out, we're not going to comment on the cost in this call.

All right. And then just looking at the time charter market. I think with the surge in V's, you're starting to see those kind of pick up a little as well. I know you mentioned kind of your current spot exposure, but at the same time, with time charter rates pretty well above your cash breakeven levels, are there thoughts of kind of securing some tonnage on time charters here in the next couple of weeks or months?

Yes, that's a very good question.

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we -- obviously, we're looking at the time charter market all the time. It's finally come up to healthier levels, as you say, well above the cash breakeven. We did 2 Suezmaxs recently for a 1-year period, locking in some. At the same time, the spot is increasing, and we expect to put time charter to -- time charter rates to also keep improving here as we move towards 2020. So there's no immediate rush to secure more, but we are monitoring it closely. And as we did in the last strong market in 2015, we went from very low coverage up to 30%, and we will certainly look at taking some coverage this time around. But there's no sort of clear strategy as to what percentage to look for, but it is [true], I think, to do for a certain number of ships.

Okay, that's fair. I think it's last question on the scrubber side. All 20 of those to be installed this year, and any plans for kind of further in 2020?

The majority is this year. Some are going into next year. And just to add it, all of them are up of -- in conjunction with the planned dry-dock. So we've not done any such thing outside of dry-docks yet, it's something that we keep monitoring, and obviously, being a part owner of a production company will then give us flexibility to get these things on short notice.

Your next question comes from the line of Michael Webber from Wells Fargo.

I wanted to move back on scrubbers for a second and [FMSI]. I know they've got a facility that's only the primary driver for them being able to kind of expand their capabilities in Batom. It's scheduled to come online in February. Haven't been able to find any updates on it. Maybe I missed it. But has that happened? And if not, do you have a sense on how and when that will happen.

So the new facility, in Batom, just across from Singapore. I visited it myself here in January. So we are currently (technical difficulty) in large parts moving across the new facility, and we will be operational there during the month of March. So it's happening very soon.

Okay. So slide the month, but it sounds like it's pretty close.

Yes. The aim was end of Feb and it's slipping into March. So no big change. And for us, we put most of our dry-dockings to capital in Singapore. So we basically have our scrubber manufacturing just across from Singapore, so it's very easy access.

Yes, okay. That's helpful. And then just within in the context of positioning yourselves for 2020, we've seen some competitors and then maybe some potential suppliers start moving in advance to secure fuel or kind of get more dynamic in terms of kind of hedging their assets into maybe a bit of uncertainty around availability or at least a wide outcome set in terms of availability? How do you guys think about positioning Frontline for that over the next 9 to 12 months?

In terms of the spread, we've not hedged anything. So my personal opinion is that it's more likely to go wider than narrow. I think there's going to be lots of high sulfur around pushing prices down. So I'm not concerned about the availability. Our ships obviously trade to the large ports. We will be bunkering in the main ports as well where the availability is the easiest. If you have smaller ships going certain places in Africa or Asia, it's going to more difficult that we don't. So we're focusing basically on getting the scrubbers installed. We're focusing on more operational matters, getting the bunker tanks ready well in time so that we don't get any nasty surprises as we reach 1st of January. So hedging and -- which, in my opinion, is more speculative at this time, and in any case, we're living alone and we're being practical about it.

Okay. No, that's fair. I appreciate that. And then, finally, just on asset values, in general, just given rates, in general, eased off a little bit from -- through Q4 rather, but we've seen asset values kind of run in the other direction. When you look at the dynamics right now between day rates, your equities and asset values, decent disconnects. Do you think asset values have gotten ahead of themselves? Or do you think eventually cash flows rise before it levels to where they are now? And I say that within the context of, obviously, the knee jerk reaction will say, okay, well, equities and rates are going to rise before asset values where they are now. If they don't, we pull back a little bit into a catalyst you guys believe in, it could present an opportunity. So I'm just curious how you think about that dynamic right now?

I mean, the asset values, have not gotten ahead of themselves. I think they are -- that they've got more to go, I think, and I think the issue is more that the liquidity remains very low. So there's not much being done, but there are opportunities out there. And obviously, we keep looking at various things, and I think -- I don't see the risk of asset values dropping much as very high.

Your next question comes from the line of Fotis Giannakoulis from Morgan Stanley.

Robert, we have seen the rates for VLCCs to be much stronger than a lot of people expected despite the OPEC cuts. And as you mentioned, this is primarily attributed to U.S. crude exports. Can you give us a number of how much is the capacity of the port capacity for U.S. crude exports? There was a new high last week. I'm wondering if there are any bottlenecks from the shipping side such as the timing to load the vessel or the congestion that they can be a bottleneck to this ramp-up.

I think -- we look at how the exports developed here from January to March. I think March will be a good tester on eventual bottlenecks. I think the investments are obviously huge, and the things are improving very quickly. So it doesn't look to be the case, but I think March will be a test. And I think the U.S. will pass the test. And then, obviously, going into 2020, there's going to be more places to load these and things will -- capacity will increase further. So it could well be. I don't have a clear answer to you, but I think the risk of major delays is not there where you drop the export capabilities.

We have seen -- with exception of January that we had a few new orders. Generally, lull in newbuilding activity, especially since asset prices have increased compared to where they were about a year ago. Your discussion with the shipyards, given what is going on in the dry-bulk market, are there any concerns about potentially shipyards adjusting the newbuilding prices since they will have less demand for dry bulk orders?

That's a very good question, Fotis. And I think the answer is, my opinion, is that other segments in dry bulk are still placing orders. And you've got consolation going on in Korea, which will make them stronger. So if you look at the overall activity and interest for newbuildings, it remains very low, and to me, that's a very good sign. Looking at the market now, normally, in shipping, and then we're so used to bad times that if we can have a choice between, I mean, the ship delivering 2 months or in 2 years, we'd go for 2 years. But now with the outlook and so the general outlook in the market, then people sort of agree that we are going into stronger periods. So now you prefer to get a ship delivering earlier, and there are some ships to sell -- that will deliver within the next year. And interest even there is low. So -- I think there's a fair chance that newbuilding ordering will stay low, and the focus will be on resale. And obviously, that's something I'm also hoping.

Noted. One last question about IMO 2020. We've been focusing a lot about the movement of products. I'm trying to understand if you think that there is going to be any increase in the movements of fuel oil so far VLCCs, they do very rarely cargo, so fuel oil. With oversupply of fuel oil, the potential of Middle East absorbing more fuel oil, how much that would be the potential demand for the crude anchor sector? And especially if you have any discussions with the Middle Eastern clients, whether they are considering of switching some of the crude consumption for power generation into fuel oil, how quickly this can come? And how many ships or how -- what percentage of the demand can absorb for the VLCC market?

First of all, should take the first part where you mentioned products briefly. Then the others on the products, it's difficult to say. But IMO 2020 is probably going to lead to more trading, more movements and should be a positive trigger for sure. So we've had our -- we have our 18 owned LR2s. We've been through a very strong period on the Aframax market. But we did keep most of the ships clean in anticipation for a stronger, clean markets. And until 2 weeks ago, we were actually outperforming on the clean side. So that could be exciting here going forward. In terms of this fuel in the Middle East and how the switch will be, I think fuel will be -- I don't think -- there will be more fuel produced as we need a bigger crude output for the refinery, say, to meet these demands. So there's going to be a flush of fuel. So power generation using more fuel looks pretty certain. And how that's going to affect the various either, just coal or others, let's see, right? But that's likely to happen. Another thing on the fuel. There will be a lot of extra fuel. So I think the older ships that I mentioned earlier in the presentation, I think there is fair chance that some will go on to fuel storage in places like Singapore, as we've seen in the past, to find -- find places to store this.

The next question comes from the line of Magnus Fyhr from Seaport Global.

Just one question. You mentioned operationally positioning yourself for the IMO 2020. With the market being so volatile this year and refinery turnarounds coming up and more ships going into dry-docking, how do you commercially position the fleet near term to optimize your rates for the ships?

I think we're going to have to force ourselves to take -- even if the market's strong, we're going to have to force ourselves to take the ships out of service to get them prepared because we can't afford being late in this. So this will happen this year during the summer. We'll stick to that plan, how the stronger market is. And that investment, I think, will be repaid in 2020. And I don't -- we will certainly not be the only ones making this investment in Q2 and Q3 of this year, most likely ballast orders coming in September. So a lot of ships have to do it prior to that. So there's going to be a lot of ships going out in Q2 and Q3. And that's also why I think that Q2 and Q3, which is normally quite weak seasonally, could be upside down this year. And it's a year that's very, very exciting. It was up in the last 2 or 3 weeks, excites me. And I think we've got volatility, but we've got some spikes we don't normally see during the year coming up because of this.

Yes. And one wildcard we haven't talked about is the Iranian storage. Any color there on -- is it too early to tell with the sanctions coming into effect again?

I don't have the accurate data on that, Magnus. All I can say is that I'd be surprised if you don't see the same thing happening as was the case last time is that, gradually, they all go on storage because they don't have the land-based storage available.

Okay. And then just one last question, if I may. On the LR2s, I mean, it's been very strong seasonally. Any thoughts there of locking up ships? Or you're going to continue to play them spot?

That is a segment we are looking at doing a few charters on. And we did the same in 2015, and that was basically what saved us when the markets went down. So we've got low cash breakevens there between '15 and '16. So we've got a potential here to lock in some decent returns. So we will do that. Probably not that many units, but some will.

And where do you peg that market right now for 1- or 2-year charter?

It's in the range of 22.5 to 25 for 1-, 2-, 3-year charters.

And your final question comes from the line of Greg Lewis from BTIG.

Robert, just you kind of talked a little bit about your outlook for asset prices. Just as we think about that in Frontline, what's sort of your view right now on potential acquisitions of on-the-water tonnage? Is that something the company is looking at? Is there availability?

Yes, we are looking at it. There are a few for sale, but you'd be surprised how few it actually is. But there are some opportunities out there. And yes, as I keep saying on these calls, we keep looking, and you will see us do stuff.

Okay, great. And then just one more from me. Clearly, you guys have your scrubber investment. I imagine you're following this -- the overall tanker fleet that is taking scrubbers closely. Have you done any work around how much utilization impact we could see in the market from scrubber -- from vessels being out of the market to have scrubbers installed in '19 and in '20?

It's a great question. And yes, we've done some studies on it, and we've seen our own, and we've seen external. We have our guesses, but we don't put a figure on it. What we do think is that Q2 and Q3 of 2019 will see a lot of supply being taken out, and you could have the market that's very, very seasonal abnormal. So exciting, but I don't have -- I haven't put a figure on it.

There are no further questions at this time. Please continue.

Okay, thank you very much. I would like to thank everyone at Frontline for their great efforts and thank everyone for calling in to this presentation. All the best.

That does conclude our conference for today. Thank you for participating, and you may all now disconnect.