Frontline Plc (FRO) 2022 Q4 法說會逐字稿

Good day, and thank you for standing by. Welcome to the Fourth Quarter 2022 Frontline Plc Earnings Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Mr. Lars Barstad. Please go ahead.

Thank you there all. Thank you for tuning into Frontline's fourth quarter earnings call. I know it's been a busy day for at least those of you who are analysts. It's quite a few companies reporting today. I have a feeling, some of the questions in the upcoming Q&A will be focused on the termination of the combination agreement with Euronav, but let's for now focus on Frontline and the [smoking] markets we've had in the fourth quarter.

Although the implications of Russia's innovation of Ukraine caught most of the headlines, we believe, from a tanker market perspective, China was a catalyst to Frontline posting the best quarterly results in over 14 years, as we finally fired on all cylinders throughout the quarter and our lean and mean business model (inaudible).

Let's quickly look at our TCE numbers on Slide 3 in the deck. In the third quarter, Frontline achieved $63,200 per day on our VLCC fleet, $57,900 per day on our Suezmax fleet and $58,800 per day on our LR2/Aframax fleet. And finally, the inverted earnings relationship between our segments were at least temporarily reversed. So far, in the first quarter of 2022, we booked 87% of our VLCC days at $58,300 per day, 77% of our Suezmax days at a cool $72,400 per day and 68% of our LR2/Aframax days at a solid $63,900 per day. Again, all these numbers in the table are on a low to discharge basis, and they will be affected by the amount of ballast days we end up having at the end of Q1.

Before I give the word to Inger, let's just quickly jump to Slide 4 in the deck. I'll repeat a few key points on the Frontline fleet composition. Frontline continues to hold one of the most efficient fleets in the industry, and our diversification has proven profitable for all our shareholders during 2022.

Scrubber spreads continue to incentivize investments hovering north of $200 per metric ton, and we are installing scrubbers on 2 additional wheels -- [seeing] we have only 2 [these] left without the scrubber. The average age of our fleet is a comfortable 5 years and Frontline is well positioned in CII terms and also for the upcoming EU ETS considerations.

I will now let Inger take you through the financial highlights.

Thank you, Lars, and good morning, and good afternoon, ladies and gentlemen.

Then, let's turn to Slide 5. In the fourth quarter, we achieved a total operating revenues of $353 million, and we had an adjusted EBITDA of $297 million. We came in at a net income of $214 million which is the highest quarter net income we have had in -- since 2008. Then we had an adjusted net income of $215.5 million. The adjusted net income in the fourth quarter increased by $133 million compared with the previous quarter, and that was mainly driven by an increase in our time charter equivalent earnings due to the higher TCE rates that Lars went through earlier in the presentation. This was partly offset by a general increase in expenses.

We declared a cash dividend for the third quarter of $0.30 and for the fourth quarter of $0.77, and the fourth quarter dividend gives us a direct return of 17% on the share. As of December 31, 2022, we have revised the estimated useful life for our vessels from 25 years to 20 years, which is expected to increase depreciation expense by approximately $59 million for 2023.

Then let's take a look at Slide 6, the balance sheet. Total balance sheet numbers have increased with $227 million in this quarter, and the main drivers are delivery of Front [Orkla], revaluating gain on the Euronav shares, increase in working capital and also the net income that we earned in the fourth quarter.

As of December 31, 2022, Frontline had $556 million in cash and cash equivalents, including undrawn amounts under our senior unsecured loan facility, marketable securities and minimum cash requirements.

Then let's move to Slide 7, and let's take a look at cash flow potential. We estimated average cash cost breakeven rate for 2023 of approximately $27,000 for VLCC, $21,500 for Suezmaxs and $17,600 per day for LR2 tankers, with a fleet average estimate of about $22,300 per day. This average estimate includes drydock 2 VLCCs and 1 LR2 tanker in 2023, all in the first quarter.

With respect to operating expenses, we recorded $8,800 per day for VLCCs, $17,600 -- $7,600 for Suezmaxs and $8,700 for LR2 tankers, and with drydocked 2 vessels in the fourth quarter, that was 1 VLCC and 1 LR2 Tanker.

Looking at the right-hand side of the slide, we show free cash flow in millions and per share after debt service basis currently and alternative TCE rates. If we look at assumed VLCC rates of $75,000 per day, with 5-year historic spreads [ability] see for Suezmax and LR2 tankers, the annual free cash potential will be more than $1.4 billion or $6.46 per share.

And with that, I think I'll leave the word to you again, Lars.

Thank you, Inger. Yes, we are in kind of a market where the potential is substantial. If you move to Slide 8, and just recap what happened in Q4 in the bank market. I have the title here sneak-peak of what's to come. I think it's probably not a secret that we are tremendously bullish for the next couple of years. And during the quarter, all segments from Front operate -- performed. It was finally the turn for the VLCCs to shine. The average weighted market earnings for tankers are actually [flirting] with 2004 highs. So you see in this in the chart below on the left-hand side with the yellow column. And I think kind of, in general, the market hasn't recognized how substantial Q4 ended up being. And this is the average weighted earnings for all tankers, and obviously, what's happening on MRs, on LR1s, LR2s, Afras and [2s] -- and VLCCs together has made this possible. It's -- we are in market conditions where it's not only the VLCC outperforming, is basically all segments are performing.

Chinese imports are back above pre-COVID levels hovering around 10 million barrels per day, and the VLCC shipments to China are actually at all-time high. And I would like to say, the big ships are back.

During Q4, we saw the G7 crude oil price cap come into effect in -- on December 5th. We have seen already a lot of crude oil and fuel oils being redirected to around Europe to Asia and Middle East predominantly. So the effect of the 5th of December cap was somewhat muted. We also need to keep in the back of our head that during -- [to a] mild winter in the Northern Hemisphere, oil prices were also hovering below or around $80 per day, making Russian crude comfortably priced below the price cap.

Let's move to Slide 9 and look at what we believe is the 3 major themes as we embark on again what we upcycle. First is oil demand. As long as we have oil prices in the area where we are now, hovering $80 to $90 per barrel, we believe oil demand will continue to be fairly strong. If you look at the chart at the bottom left, this is from EIA. It's kind of a confused -- it's not a confusing chart. It goes in 1 direction, but it shows a lot of volatility going forward. But by the end of 2024, EIA expects global oil consumption to be more than 4 million barrels per day higher than where we are now. Asia, and in particular, China, is expected to be the key driver as China is returning from COVID lockdowns.

The second big part of this equation is obviously fleet supply. And total tanker fleet growth is set to turn negative during 2024. This has not been seen since 2002, and if you look at the middle chart below, you'll see the columns for the various years of growth. And as we kind of go through 2023, we expect to have about 3% growth in the total fleet of tankers globally. That will be reduced to 1% in 2024, and it will actually turn negative during the year. And in 2025, the overall fleet is expected to be reduced by 1%.

A change in trade dynamics may actually accelerate this. Right now, 12% of the tanker fleet is above 20 years. We've had very limited scrapping, and the ships are, in fact, trading kind of beyond their expected lifespan. So obviously, any regulatory changes or any initiatives in this respect could accelerate the fleet reduction.

World seaborne trade, and this is the bottom right-hand graph -- is expected to grow by 6% to 7% annually over the next 2 years. This is a function of the key demand centers being in Asia and key production growth coming out of U.S. and Latin America predominantly. The overall order book stands at 5% or actually slightly below, and now we're looking at delivery windows in 2026.

Let's move to Slide 10 and look at a bit further on the order books. During last year, we have the lowest contracting activity in decades. If you look at the graph on the top left-hand side, you will not find one column since 1996 -- and this is the history I actually have available -- that is lower than the -- around 7 million deadweight tonnes that was contracted in 2022. And as we go into 2023, this activity continues to be muted.

If you look at the VLCC fleet isolated, there are now -- during 2023, we'll have 112 VLCCs passing 20 years. That will be 13.2% of the entire fleet. The order book stands at 28 units, and that represents 3.3% of the existing fleet.

If you look at the Suezmax, this is even more pronounced. By the end of 2023, 85 vessels will be above 20 years. That represents 14.5% of the fleet. The order book is at a modest 10 vessels, and that represents 1.7% of the fleet.

The LR2 market, it's a bit more balanced. There's a few more ships on order, but they have the same age profile. So of the -- about 400 LR2s in the world, 25 will turn 20 during 2023. That represents about 6% of the fleet. The order book is currently at 51, and that represents 12.8% of the fleet. A point that I made before on the LR2s is that effective kind of age of an LR2 starts to -- or the effectiveness of trading on LR2 starts to be reduced after its turn 15 years due to quite a few charters limiting their chartering activity for vessels that go beyond the 15-year threshold.

If we then move to Slide 11 and we're going to look at some of the key exporting regions and what the states -- what kind of the state of the market is. I mentioned earlier that the 3 major teams are with the oil demand, fleet supply and distances. But in order for demand to be kind of sufficient supply, we need production as well.

World crude oil exports are now back to pre-COVID levels finally. We're hovering about 42 million barrels per day of oceangoing volumes. That's just north of 40% of global oil production. West Africa continues to struggle, but saw a modest improvement in the fourth quarter. Latin America is becoming an increasingly important export region, and in particular, Brazil and recently Guiana are the keys for growth.

Russian exports are surprisingly resilient and exports are back to [pre-envision] levels. I think some of the statistics there may be colored by kind of increased exports ahead of the 5th of December price cap, but still, Russia still seems to find a home for its crude. U.S. exports continue to be firm, and we're particularly surprised, after the SPR releases stopped during November in -- or more or less stopped during November last year. U.S. continues to be the region where we will see production increases and over the next couple of years, U.S. alone will actually represent close to 80% of new oil coming online globally.

Then if we move to Slide 12 and go through the summary. So Frontline reports the highest quarterly net income since 2008, a cool $240 million. Our cash dividend, which is obviously the combination of Q3 and Q4 is $1.07. We took delivery of the 3 remaining VLCC newbuildings from Hyundai and sold 1 VLCC and 1 Suezmax, both 2009 bills. As far as we see it, China took center stage in the fourth quarter and imports in China -- to China are back to pre-COVID levels.

Oil demand continues to recover. There is – a limited fleet supply and an increasing common demand are the key drivers for the years to come. We continue to believe that from plants' efficient and transparent business model, we'll generate shareholder returns.

And with that, I would like to open up for questions.

(Operator Instructions) Now we're going to take our first question, and it comes from the line of Omar Nokta from Jefferies.

Clearly, a lot of positive themes developing here. You touched here on the last slide, Lars, about the newbuilding program now being officially complete with the delivery of these final 3 VLCCs. You did sell a couple of older tankers, the Suez and the Afra. What are you thinking about Frontline's fleet here strategically as we move forward, absent large-scale M&A? How do you think about the fleet from here, so the first time in many years? I would say that you don't have an order book. Do you look to sell more ships in this market? Do you replace the ones you sold? How are you thinking about that?

It's a very good and timely question. What we've kind of observing is that asset prices are moving a bit ahead of the market to defend investing in, say, a new build -- if you look at the VLCCs, you need closer to $50,000 per day of earnings consistently for the next 20 years to make 15% to 20% return on the investment. So we feel that as the prices have moved maybe ahead of time of time charter rate and spot rate, so we don't really have -- we're not comfortable.

And also, secondly, due to the lead time to receive a newbuilding, you probably wouldn't get it until 2026. We have 2.5 years there of substantial kind of asset price risk should something happen to this market. On the retail side, the prices are continuing -- the prices continue to be elevated. And again, the spot and the TCE market doesn't give us kind of the returns we're looking for. So it's -- and then again, we have some assets in our portfolio that probably we should consider selling due to the high kind of asset prices.

The thing is that the earnings potential remains so high on these kind of more mature assets to call it out. That's -- we are a bit split-minds. Are we just going to continue and harvest and keep these units on as long as they make a lot of money? Or are we going to take kind of a huge opportunity here at elevated asset prices and take a profit on these assets? All our assets are actually fairly okay from a [CII] perspective. So we're not too nervous about that. But I think kind of the question you're raising here is probably the question most ship owners are asking themselves.

Yes, lots of different ways to look at this expensive -- as you mentioned, the return profile needed. So on newbuildings at least. So then maybe as, you know, kind of hinted out early on in the call about the discussion of the combination with Euronav, to the extent you can say anything about this? But clearly, a lot has changed here over the past several months. When it comes to Euronav, for instance, can you envision revisiting that combination or that merger, if for somehow CMB were no longer either involved or no longer an obstacle? Just simply wanting to know, as you think about the termination of the agreement with Euronav, is that just simply specifically because of the CMB situation? Or is there something else?

Well, to the last part first, which basically or probably answers the first question -- first part of the question. So it was not only the CMB blocking position that triggered the termination. There were also certain legal requirements that weren't in place. So I think kind of the blocking position was one of the major reasons our Board decided to terminate, but there were other factors -- legal factors in play as well. As it is right now a combination with Euronav is off the table. But obviously, there could be a scenario in the future where that discussion comes up again. But as it is right now, there has been absolutely no discussions with Euronav since the termination in this respect, and it is firmly off the table.

Now we're going to take our next question. And the question comes from the line of John Chappell from Evercore ISI.

Apologies for the minutia of this question, but it's pretty important. So your dividend policy, we're back to paying dividends. And I think with the ruling on February 7th, kind of all handcuffs are off, you can do it -- whatever you want to do with your cash. If we look at the third quarter and the fourth quarter distribution based on adjusted earnings, it looks like about an 80% payout ratio. So the first thing I wanted to do was confirm if there is an actual payout policy that we can model to 70%, 80% of adjusted earnings? And then the second part of it is this depreciation reset that you're doing where you're adding $59 million in annual depreciation, that's not cash, but it is earnings. So does that mean that the payout would potentially be pegged to cash as opposed to EPS going forward because of this DNA reset?

Let's take the first, first. And there is actually an offset payout policy installing, if that's what you mean. But I guess you can use the 80% that we have been paying now for the last quarter, that's a good guesstimate. But obviously, it will be the Board that will decide us going forward. With respect to the depreciation policy, I wasn't sure I got your question, but could you please repeat?

Yes, sure. So if your payout policy is based off of net income, adding $59 million of depreciation, it's pretty meaningful. It's over [$50 million].

It means that probably $0.05, $0.06, $0.25 in a way. It's not more than that.

Now we're going to take our next question. And the next question comes from the line of Amit Mehrotra from Deutsche Bank.

This is Chris Robertson on for Amit.

Yes. You spent quite a bit of time here in the presentation talking about the older end of the fleet and I think it's an important question moving forward. So in your mind, the owners with vessels over 20 years of age, do you think that they're simply going to ride out this current cycle and then exit the market? Or do you think these owners will engage in fleet replacement ordering at some point in the future? So I guess in other words, how much of the older end of the fleet is likely to get replaced at some point versus simply just going away forever?

Yes. That's again, a very good question. I think if we start with the older portion of the fleet, we have brackets of fleet. We have the absolute dark fleet, the one who have gone completely rogue and trade Benecel and an Iranian crude. That basically is a fairly large portion of the 20-year-plus fleet, and they are probably not going to reinvest in model tonnage at any point in time. They're probably just going to write these assets as long as they float. Then we have the more kind of mature ships, if you probably hovering around 17.5 years, which we now tend to call the gray fleet. A large portion of this fleet is currently being engaged in trading of Russian crude and products.

Again, I think the same goes for this fleet as well. I -- in the future, we're hopeful there's piece in Ukraine and the trading patterns normalize. I would envision some of these owners just exiting the market altogether and probably not doing much of a replacement.

So I think kind of where you're going to see the replacement activity is with normal compliant ship owners as ourselves as assets come to age. And we are in the industry for the long run, meaning that we're actually going to be here for the next 20 years as well. And so it's going to be actives like ourselves that are probably going to make us the order book at some point.

But again, back to Omar's question in the beginning here, we need the economics to work to make that financial decision, and you could say that we've had inflation on asset prices. We had inflation on wages. Actually certain countries struggle to even get workers into the yards. So -- but what we really need now is inflation on rates because the rates are simply not high enough to defend that investment at this point.

That leads into an important follow-up question, I think. You mentioned the yards here and the labor shortages. So my understanding, and correct me if I'm wrong, is that the limitations on shipbuilding capacity at the moment is more to do with the lack of specialized labor than it has to do with a lack of infrastructure? So in your mind, what's -- I guess, what is the likelihood that certain governments either engage in stimulus or try to revitalize their shipbuilding industries or try to incentivize training of laborers that could help kind of offset that in the future?

I think that's very likely, and particularly in China, who is net short hydrocarbons in general. They have a huge incentive kind of from a government side to try and revitalize the shipbuilding industry. And we're actually already seeing that a couple of yards in China that are kind of getting back online again to -- obviously, to a modest degree at this stage. But if you look at orders that can be placed in 2025, these are predominantly Chinese yards.

For Japan, it's a structural issue. I just learned that the average age of a Japanese shipyard worker is 57 years. I'm only 62 myself, but I want to know how much steel you want to cut when you reach 60. So in Korea, extremely efficient, high technology. They actually have a higher margin, building LNG carriers or VLCCs or even container ships. So it's a difficult -- I can't really give you a straight answer, just -- the color I just gave.

Now we're going to take our next question. The next question comes from the line of Greg Lewis from BTIG.

Lars, I was hoping you could talk a little bit about the market. And really, I guess some of the questions that we've been having, and we've been hearing from investors is the market is -- the VLCC market is strong. And really some of that strength in the market more recently has come in the face of really lower crude exports out of the Middle East i.e., Saudi Arabia, and we can appreciate that China is absolutely importing more crude oil. But I guess we're kind of wondering, is there a little bit of a zero-sum game in there where, if China is importing more, it just means another Asian producer or Asian consumer is consuming less? And really, just kind of any color you have around the strength in the market despite OpEx slowly ratcheting down production?

Of course, Greg. Basically, what we witnessed during 2022 was obviously -- it was a smaller segment that started to perform in the LR segment first, then LR1 and LR2s. LR2s were -- that were trading there to be cleaned up to trade products. That pushed kind of Aframax demand up. And then Suezmaxs started to have a field day on Aframax [temps] and the VLCC started trading Suezmax temps .

So you are right in a way that a lot of the demand for VLCCs currently is actually what you typically would call a Suezmax-trade, U.S. Gulf to U.K.. For instance, we've seen a large activity and high amount of fixtures where VLCCs are actually stepping in. We also saw it briefly in Q1 as soon as the West African market for VLCC started to become a bit shaky.

The VLCC is quickly to cap the Suezmax earnings. So to try and make sense of it, I think the situation around oil being redirected from Russia to -- from going to Europe being redirected to Middle East and Asia. You're basically seeing both Aframaxs and Suezmaxs, getting drawn into that trade, limiting the amount of macro ships in those markets -- in the compliant markets. That has given the VLCCs opportunities to enter that market and basically have good returns in that market too. So it is a bit of the various asset classes eating into (inaudible) business segments. And you're right in saying that for pure kind of traditional VLCC trade, there probably isn't enough oil to engage the fleet fully at this point. But it's -- this is going to move back and forth in cycle, I believe, as we proceed. And I think it was quite encouraging to see where everything bottomed out in the first quarter where we're still very solidly north of at least our cash break evens when the markets turn.

And then another question that I think people are wondering around -- and I know there's not an easy answer here, is around the dark fleet. I mean clearly, everywhere you read, I guess, sanctioned cargoes are still moving. I guess I'll ask it this way. Do we have any sense for how many vessels -- obviously, excluding the Russian flag fleet or the Russian owned fleet could potentially be in that market. And really, as vessels are in that market, is there any way to kind of gauge what the utilization of those vessels would be? And say, if I'm trading in, I guess, a dark type fleet, I'm assuming that's less efficient, but kind of any color you have around there, I think, would be helpful.

Yes. Regretfully, it's going to be a bit of guesswork and –-

Your guesses are better than mine.

But first, I'd like to say that just with the gray fleet and the fleet trading on Russia, that is still a good quality fleet trading in accordance with the IMO rules, well maintained ships and so forth, although they may be a bit challenged by age. So I would kind of leave that at the side.

On the dark fleet, I've seen estimations of 5% to 6% of the VLCC and Suezmax fleet being engaged in that trade. If you look at the efficiency, if you call a compliant modern, we also see 100%. I would say these ships are probably -- and we've previously modeled the overall VLCC fleet in that manner, where we would say that over a 20-year vessel that has an owner you've never ever heard of, you would attach the 30% efficiency to that ship compared to, say, a dark -- gray fleet, Russian trader who will probably only get 50% to 60% efficiency out of the ship, basically due to the limitations in the compliance market -- a ship with Russian history has.

And thirdly, the modern compliant normal VLCCs as we own will then be 100%. And if you do that exercise, you would even see how the fleet growth is -- or rather the fleet is not growing anymore. And it's actually the capacity to freight oil globally, is being reduced as we go forward.

On the dark fleet, the ones trading illicit barrels, I don't think that fleet is growing as much as it did for the last couple of years. That is obviously good. But that is also a scary as it is growing older. And remind you, these are ships that are not being properly maintained. So we're probably getting closer to an environmental disaster at some point here.

Dear Mr. John Chappell from Evercore, (Operator Instructions) And the questions come from the line of John Chappell from Evercore.

Just to revisit that topic again -- and I'm sorry, I know it's only $0.07 a share, but I just wanted to know, like, with the depreciation going up so much, it's going to have an impact on earnings. So Frontline's historically been a dividend payer based off of net income. I was just wondering if that may shift to -- from free cash flow, given the fact that the depreciation is changing by so much?

So going back to why we have done this then, I mean, what we have done in a way is to just reassess the useful life of our vessels. And we believe in a way that 20 years is a more realistic estimate of useful life than 25 years is. So that is why we have done this change. And if you look at many of our repairs, they already have 20 years. So this is not only us in a way, it's a kind of common thing. And what I said with respect to numbering, if you just divide it by 4 quarters, you obviously get to that -- the number using a payout policy of 80% would be about $0.05 per share. So that's what we're talking about.

And then you paid down $60 million of the Hemen facility. I think there's some use of proceeds from those vessel sales. With the cash that you're generating illustratively based off of this year, do you foresee a more aggressive pay down of debt and especially the Hemen facility. I think there's some user proceeds from those vessel sales. With the case that you're generating illustratively based off of this year, do you see a more progressive paydown of debt, and especially the Hemen facility just with cash from operations? Or do you think you need to sell more older tonnage to kind of accelerate that deleveraging?

So we have not made any specific plans of further repayment of the Hemen facility or the Sterna facility, which actually is called. It matures in May 2024, and that's it in a way. So, no.

Now we're going to take our next question. And the next question comes from the line of Amit Mehrotra from Deutsche Bank.

This is Chris Robertson again. I'm just going to try to sneak in one last question here as it relates to Chinese demand. So there's been an impressive demand recovery so far. I guess how much further do you think this can go just based on post-COVID recovery? And then in the coming years with the new refinery additions that are being added, where do you think that overall Chinese import demand can shake out over the coming 12 months.

I'm not that sharp as an oil analyst, I must admit. But we have seen China act quite aggressively in periods where they feel that the oil price is discounted, and they're preparing kind of for increased demand -- domestic demand. It's -- and I believe the highest we've seen from China is around 13 million barrels per day of imports in a sustained period of time. It's difficult to say. What I'm sharing a little bit is that I did allude to some of the oil production growth for oil export growth that we've seen, and we're back to pre-COVID levels. China is not back to recover levels in terms of domestic demand. They actually have a very big and high consuming airline markets internally in China.

And as we kind of go towards the summer, where Europe is going to recover -- We're going to go on holiday too, so are the Americans and so are then the Chinese. I think that's going to be quite exciting, considering the fact that the oil production levels are not really higher than what we have. And we're missing a couple of years of normal demand growth, which historically at least has been between 1% and 2% per year. So I do subscribe to those that are quite bullish oil prices in the second half of the year. And I'm a bit worried about how the supply and demand picture is going to look on once is fully up and running again. Obviously, OpEx has bare capacity. So they can still supply China with more barrels. But I'm -- yes, I'm looking forward to see how that story evolves. We also need to keep in mind here that although China has imported a lot of volume, they're also exporting a significant amount of products. That will obviously stop when domestic demand catches up. So, yes, it's going to be interesting one.

(Operator Instructions) There are no further questions at this time. And I would like now to hand the conference over to our speaker, Mr. Lars Barstad for closing remarks.

Yes. Thank you very much for -- again, for dialing in and listening to our Q4 presentation. Frontline management is always available should you have further questions over the coming weeks. And I would like to obviously thank the Frontline organization for a fantastic result and a fantastic quarter. Thank you.

Okay. That concludes our conference for today. Thank you for participating. You may now all disconnect. Have a nice day.