Robert Macleod - CEO Inger Klemp - CFO

Jon Chappell - Evercore Fotis Giannakoulis - Morgan Stanley Magnus Fyhr - Seaport Global Jim Nelson - Credit Suisse

Good day, and welcome to the Q1 2017 Frontline Ltd. Earnings Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. Robert Macleod. Please go ahead, sir.

Thank you very much. Good morning and good afternoon, everyone. Thank you for dialling in to Frontline's earnings call for the first quarter of 2017. I will start this call by briefly going through the highlights of the quarter and the subsequent events. Following that, Inger will run us through the financials. We'll then look at Q1 earnings segment-by-segment, and I will guide you on our Q2 earnings and update you on our time charter cover. We will then move on to the current market conditions, the crude tanker order book, and how the fleet is dissected. The call will be concluded by taking your questions. Let's get started and look at the company highlights. Our earnings in the first quarter was satisfactory, but down from Q4 of '16. We achieved net income of $27.9 million or $0.16 per share, adjusted for non-cash items. Our results underscore both the benefits of our low cash breakeven levels as well as Frontline's earnings potential. We acquired 2 VLCC newbuildings from Daewoo at $77.5 million per vessel, delivering in September and October of this year. We signed a financing facility with China Exim Bank to partially finance 8 of our newbuildings. We also approached DHT Holdings twice with all-share offers -- proposals to acquire the company. This was, as I'm sure all listeners are aware, declined by their board. Subsequently, we have also ordered 2 VLCCs from Hyundai Heavy Industries at $79.8 million each, and we obtained options for 2 additional sister vessels, financing has been secured in these contracts. Inger will get back with more detail, and Frontline's newbuilding program remains fully financed. We took delivery of 3 vessels during the quarter, and our order book is now at 12. That is for 6 VLCCs, 4 LR2s and 2 Suezmaxes. Over to the DHT process. On the 17th of May, there was a hearing in the Marshall Islands, and we expect to know more soon. The DHT process has been very public lately, and we will not make any further comments on this call. Inger, please, can you take us through the financials in more detail.

Thanks, Robert. And good morning and good afternoon, ladies and gentlemen. Then let's move to slide second, financial highlights. Frontline achieved total operating revenues net of voyage expenses of $122 million in the first quarter. EBITDA came in at $76 million and net income at $27 million, equivalent to earnings per share of $0.16. In the first quarter, we reported certain non-cash items. These non-cash items consisted of a gain on the termination of the long-term charter of Front Century with Ship Finance of $20.6 million; a vessel impairment loss of $21.2 million relating to 4 vessels in the structured finance and a loss on derivatives of $200,000. After adjusting for these non-cash items, we show adjusted EBITDA of $77 million and adjusted net income from operations of $28 million in the first quarter, equivalent to $0.16 per share. On this basis, Frontline declared a dividend of $0.15 per share in the first quarter. Then I would like you to move to Slide 3, income statement. Frontline achieved net income adjusted for certain non-cash items in the first quarter of $28 million against $34.5 million in the fourth quarter. The decrease in result from operation in the first quarter of $6.6 million is mainly explained by a decrease in result on time charter basis of $4.8 million due to less trading days in the first quarter compared to the fourth quarter. We had a decrease in admin income of $1.6 million. We had a decrease in contingent rental income by $3.4 million. The fourth quarter included a contingent rental income of $7.2 million and the first quarter, a rental income of $3.8 million. And the contingent rental income in the first quarter is due to the fact that the actual profit share of $5.6 million was $3.8 million less than the amount accrued in the lease obligations payable when the leases were recorded at fair value at the time of the merger between Frontline and Frontline 2012. Then we had an increase in running expenses of $3.9 million, primarily due to dry docking of one vessel. There were no vessels dry docked in the fourth quarter; and delivery of 5 new vessels in the first quarter. We also had a decrease in charter hire expenses of $6.7 million due to the effect of redelivery of 2 vessels on TC in the fourth quarter of 2016 and 5 vessels on TC in the first quarter 2017. And then finally, we had a decrease in other expenses by $400,000. Then I would like you to move to Slide 4, balance sheet. The changes to the balance sheet ended March 31, 2017, from the end of December in '16 are a total increase in balance sheet value of approximately $124 million. The changes in assets are mainly related to a decrease in cash of $74 million due to that cash provided by operating activities and financing activities that's less than cash used for investing activities in newbuildings and shares. We had an increase in marketable securities of $45 million due to the purchase of DHT shares in the first quarter. We had a decrease in newbuildings with $29 million, an increase in vessels by $291 million due to delivery of prior vessels in the quarter offset by $15.8 million of depreciation. We also had a decrease in vessels on a capital lease of $41 million due to impairment charges and depreciation and a decrease in other long-term assets by $3 million. Total liabilities are up with $175 million, which mainly related to other current liabilities that increased by $42 million, mainly due to accrual for 2 newbuilding assortments. We had a drawdown of loans of $189.5 million. We had ordinary loan repayments of $16.8 million, and we had a reduction in capital leases with $24.6 million due to the termination of Front Century and a reduction of -- in capital leases with $13.6 billion in ordinary reduction. Equity has increased with $8 million. Then I would like you to move to Slide 5, cash breakeven rates and OpEx. We estimate the average cash cost breakeven rates for the remainder of 2017 of approximately $22,300 per day for VLCCs, $17,300 per day for the Suezmax tankers, and $15,500 per day for the LR2 tankers. These rates are the all-in daily rates that our owned and leased vessels must earn to cover the budgeted operating costs and dry docks, the estimated interest expenses, the bareboat hires, instalments on loans, and the G&A expenses. While we have competitive running expenses and admin expenses, the low cash breakeven rates are, to a large extent, explained by the long-term debt amortization profile and the low interest costs on new and existing debt. We have obtained commitment with - for 2 senior secured term loan facilities to partially finance 4 newly acquired VLCC resale and newbuilding contracts on terms supporting our low cash breakeven rates. Every $1,000 per day lower cash breakeven means approximately $20 million extra net income per year or $0.12 per share, which shows the high importance of maintaining these low cash breakeven rates. The OpEx per day in the first quarter was $9,700 for VLCCs, $7,700 for Suezmax tankers and $7,400 for LR2 tankers. One VLCC was dry docked in the first quarter. In second quarter, one VLCC is scheduled for dry dock, and we plan to dry dock 5 VLCCs and 1 Suezmax tanker in total in 2017. With this, I leave the words to Robert again.

Let's move to the current market, please. Sorry, let's look at Slide 6 first and look at the Q1 performance. Quick on the papers. The quarter generated satisfactory returns given the market conditions. The older ships did put pressure on the rates in the quarter. They are increasingly difficult to trade, and we are very pleased to have terminated the charters of 4 older VLCCs and 2 Suezmaxes recently. The spot earnings for the quarter were just under $35,000 on VLCCs, just over $22,000 on Suezmaxes and $19,000 on our LR2s. In Q2, we have locked in 64% of our VLCC days at $25,000. On the Suezmaxes, we have fixed 61% of our trading days at $16,000, and the LR2 number is about $14,000 and 67%. Important to note, these numbers do not include the ships we have time chartered out. We estimate a locked-in profit just north of $10 million in Q2. Now let's move to the current market, please. The market started the year on a strong note, perhaps in slip, partly due to the high pace of newbuildings being delivered at the beginning of the year. We are now back at the levels we saw in Q3 of '16. We expect the near-term pressure on crude tank rates to continue, but believe that the market will ultimately return to balance probably in 2018. A seasonal improvement in the second half of '17 can also be expected. Demand for crude oil remains robust, and import volumes into Asia, especially India and China, continues to grow. Q1 imports to China were at the highest level ever. The average forecast of demand growth is about - is around 1.3 million barrels per day for '17. The recent market weakness and other factors have contributed to a historically low asset price environment and has presented us with opportunities to acquire modern tonnage at attractive prices. The OPEC cuts have been extended, affecting the Middle East volumes, but the Atlantic volume to Asia has, on the flip side, increased. Please move to Slide 8, and we'll have a look at the order book. Newbuilding deliveries accelerated in 2016. 47 VLCCs and 26 Suezmaxes delivered. However, the market was pretty resilient despite the historically high delivery pace and the other factors discussed earlier. This has, as expected, put pressure on the tanker market. We expect vessel scrapping to pick up as we progress through 2017, particularly in light of the implementation of the ballast water treatment convention later this year. Along with all demand, this is definitely a main factor, and it will determine the development of the tanker market. A lot of focus has been put on orders placed recently for ships delivering in 2018 and 2019, but it is scrapping that will determine the longer-term outlook for tankers. We believe scrapping will outnumber new deliveries. We, therefore, believe that the market will begin to tighten in 2018 as vessels are retired from the global fleet and old demand has continued to grow. The annual demand growth equates to around 500 million barrels of crude oil. One VLCC transports around 10 million barrels a year. Let's move to Slide 9, and we'll have a look at the current fleet and how it is dissected. The age composition of the fleet against the backdrop of expected growth and demand looks quite interesting. I've earlier touched upon the challenges of trading older vessels in the spot market, mostly due to the strict vetting environment amongst oil majors and national oil companies. The fleet composition suggests that a growing portion of the VLCC and Suezmax fleet will be exposed to these challenges in the coming few years. Close to 23% of the VLCC and Suezmax fleets are past the 15 year mark in 2017. We strongly believe that ballast water and other regulations will contribute to increased scrapping or conversions of older tonnage going forward. Let's move to the summary slide, please. As our actions indicate, we have been able to take advantage of numerous opportunities the market has presented us to acquire modern, high-quality vessels at attractive prices. The results of our efforts, which are ongoing, is that we have significantly grown and modernized our fleet. With our strong brand, access to capital and significant scale, we often see these opportunities before others. Our goal remains to further increase our commercial scale and earnings potential. We expect tanker markets to return to more profitable levels when the trend of increasing fleet growth slows next year. Over the long-term, we expect our strategy to result in significant cash flow, which we intend to return to our shareholders, as Frontline has done throughout its history. With that, I would like to hand over to the questions, please.

Thank you. [Operator Instructions] We can now take our first question. It comes from Jon Chappell of Evercore. Your line is open there. Please go ahead.

Thank you. Good afternoon, guys. Robert, the first question I wanted ask you is you've spent a lot of time, both in the press release and on the call, talking about pursuing opportunities. And you did place the order for the 2 new ships and the 2 new options. How does that kind of line up with your views on the market in '18, '19? I mean, you're talking about delivery schedule that's declining. But then for the market leader to be out there placing new orders, do you feel like you're doing your part and is this just a kind of one-off thing, would you assume most would be the second hand purchase market?

Yes. The - our focus remains, as it's been, for the earlier in the year and also throughout last year when our focus is ships on the water and companies. And I think we've shown clearly in a certain part of this year that we're doing what we can to achieve this. So here, it could be seen - or should be seen as an isolated - there's not - we're not going to be placing many orders, I think, in terms of slots available now prior to 2020, there’s only a handful. We will show in the deal that - what we found attractive, and that would be taken out. So we took the opportunity and at the same time, we exposed 4 old VLCCs. So we thought it was worth taking. But our focus is certainly not to increase the order book further. It's on vessels on the water.

Right, okay. And then you talked about, I guess, your confidence in scrapping, which is a little bit surprising just because the scrapping pace over the last few years has been incredibly weak. And I know that we have these regulations coming up on this year around 2020. You have some older ships yourselves. Can you just speak about the economics associated with both ballast water and the sulfur emissions and how you think about putting this ship through a third special survey or a fourth special survey as opposed to sending it to the scrap yard and removing it from the fleet?

Yes. To take various costs. So these are, obviously -- but these costs are very dependent on the ship and the volatility and so forth. But let's first take a step back and look at 2016. During the winter of 2016, the per ton you were looking at, about $250 scrap value, which equates to about $10 million plus/minus on the VLCC. That has - went then up 2 months ago to about $400, so $16 million. And now it's back to $14 million, around $350 a ton. So scrap - the value of scrap has come up significantly. And at the same time, the value of the ship itself has come down. So the gap has narrowed tremendously in the last year. And then you look at the cost of ballast water. It could be for $2 million to $4 million, depending on the ship or - and the size and so forth. The cost of these, the fifth special survey, or the sixth, could be anywhere between $2 million and $7 million, a significant cost. So if you have the combination that we have now and we expect to have through the summer over weak spot market, then I think it's - a lot of people will turn around and say, okay, this doesn't make sense. It's better to take the scrap and not invest further because our customers, at the same time, are more and more reluctant. And I'm talking about this every quarter now for a long time, that our customers are - they - in terms of the older ships, they are more and more reluctant.

Okay. And then just a super quick follow-up on that. You said the $2 million to $7 million for the special survey, was that including adjustments made for ballast water treatment or for scrubbers or how much more could those potentially add to that economic potential?

They are extra items. And when I say $7 million, then you're coming up to a lot of steel work. So - but I'm saying - I'm giving you a wide range because that's how it actually is. It really depends on the ship.

Okay. Last one for Inger. You guys did a great job obtaining a lot of financing, both last quarter and this quarter. I think it adds up to something like $550 million. But then I was surprised to see the $50 million drawdown in May from the Hemen facility, which is obviously a lot more expensive than the LIBOR plus 190. What was the reasoning for that drawdown? And will that be paid back pretty quickly with some of the new facilities?

You cannot compare that sort of drawdown on that facility with bank loan facilities, of course, because the loans that we put in place for financing our delivery on newbuildings is that they are saying LIBOR plus 190 basis points. But that's limited to 65% of the market value of the vessel. So what - we're going to use the Hemen facility. That's a different purpose, anyway. But yes, we don't intend to, let's say, have that drawdown on that facility for long term.

Okay. What was the purpose? Was there a special expenditure that required it?

This is a normal way of using this facility. That has been the intention the whole time, anyway.

Okay. Thanks, Inger. Thanks, Robert.

Thank you. We can now move along to our next question. It comes from Fotis Giannakoulis of Morgan Stanley. Your line is open. Please go ahead.

Yes. Hello and thank you for the opportunity Robert, I want to ask you about the market. You mentioned about the weakness towards the end of the quarter. I want to ask also about your guidance for the second quarter. It seems that it is lower than your other peers. You guided $25,000 versus $30,000 and $32,000 of 2 other companies that reported earlier this quarter. I want to ask, this weakness toward the end of the quarter, where is it attributed? Is it because of the increase in deliveries which they haven't shown yet in the order book or because of any sharp decline in Middle Eastern volume? And how do you view the next couple of quarters that we usually go through the seasonal weakness?

Now to say for the Q1 here, I think that the number of ships in - earlier in the year - through '16, the ships were absorbed. But at some point, we had to have some faith in it. We've gone from 650 ships to - VLCCs to 712, so i.e. a 10% increase over 16 months. So we saw here - a patch of it in Q3 last year, and then we expected to - as we go into '17, we - it us in Q1, and I think you say in the Middle East volume, yes, it's - that's found. But that's - a lot of that's been absorbed by more volume at the Atlantic. So that's - so that almost - the voyage to Asia, which is still the main sort of pull of volume, that almost covers it. So what I think is skewed when you look at the OPEC and we have a period here where the oil market is more balanced than over the last - over the next 2 years, there's about 3 million barrels more demand coming. And so at some point, the supply will come back. So I think this balancing in the medium to long-term will be good for the tanker market. In terms of the guidance for Q2, yes, we are below. And it's - some of it's down to the older ships, for sure, last voyages and positioning for termination of CPs and so forth and also, another factor is that we in...

I guess the timing of your guidance is a little bit later. Is that correct?

Yes. Because not - we've covered 2/3 of the older vessel tanks. So we're further out in the quarter, and that's also an important factor. But overall, if you look at us and our performance in 2016 on the VLCCs, where we were one of the older fleets, which we're now, in terms of average age, we've come down a lot. We were at the top of the game there. And yes, we have a weak quarter, as I said earlier, and a quarter is a short period to guide on. But yes, it goes up and down, and I'm sure that we will keep performing going forward.

I want to ask also about your growth strategy. Obviously, we had - I don't want you to comment on the DHT situation, but I was wondering if there are other targets, other potential companies that they might be more open to a stock transaction. And also related to your expansion, if you feel a little bit less confident in expanding at this point given the increase in the order book and the intention of OPEC to extend the cuts for another 9 months and bring the market into backwardation.

I think I answered this question in the other call here, and our folks remain the same. We think it's a good time and cycle to grow, and we're looking at opportunities. And that's - our preference are ships in the water through single acquisitions or company.

Okay. Do you think that there are other companies, either public or private, willing to consider stock transactions? Is this something that you have been actively looking at this point?

I think the situation has not changed much over the last 9 to 12 months.

Okay. Thank you very much Robert.

Thank you.

Thank you. So we can now move along to our next question. It comes from Magnus Fyhr of Seaport Global. Your line is open. Please go ahead.

Yes. Hi, Robert and Inger. Just a quick question kind of follow-up on the market. I mean, looking at the weekly numbers here the last 2 weeks, it looks like the rates have come up quite a bit. Can you comment at all where you have seen your last fixtures? I know the summer market is taking on here and we're going to see weaker numbers, but it'd be nice to get some more color?

The numbers now, they're anywhere between 10 and 22, depending on the ships, depending on the voyage. So it's widespread. I would say, average, we're - the markets, especially in the high teens, somewhere. But if you can [indiscernible] on the modern eco-ship and you get the right combinations, you are in 20s.

Okay. And you've been doing a good job in trading your LR2s. I know it's not a big portion of your fleet, but can you comment what you see there as far as developments there going forward? There's - the reverse final [ph] I guess, is still down and expected to come up maybe towards the end of the year. But any color there will be nice.

Yes. On the LR2s, it's been - it is in the spot rates. I think we've - fortunately, we've locked in a number of ships, and that's been the right thing. And actually on - in the short term, I don't think there's going to be any big changes. But it's a segment I like. There's a lot of ships that have gone dirty. And you get spikes in the Aframax market and they go dirty. And longer term, I think the products market, I think the LR2s will be the winners, and it's a segment we definitely like.

So I mean, we could see further investment in that segment away from your crude segment or...

The good thing - our focus will remain crude, but the LR2s give us the option. And we have ships that have been back in and out of crude and switching between crude and products. And yes, it's good. But then again, we have 20 ships. So we have a call fleet. So we'll - we always look for opportunities. And our core segments remain Aframaxes, Suezmaxes and VLCCs.

Okay. And just one last question on newbuilding activity. You did place 2 ships. Can you comment at all on the pricing of those? I think you got very attractive pricing, but also on the options that came with those.

Yes, just below $80 million is the confirmed price.

And then do you see any change? I mean, it looks like the shipyard's filled up a lot of those slots. I mean, can you comment anything where you see current offers to -- for 2019 deliveries?

In terms of price, we're definitely in the 80s. In terms of capacity, as I'm sure you know, it's no shipping here in Oslo, so we have a lot of visitors and talking to the various yards. I think for the - this is now - I'm talking about the tanker market and specifically the VLCCs. It's - for '19, there are slots available, but it's not - there's not a great amount. So in terms of visibility in the fleet in terms of deliveries for - until out to 2020, we know quite a bit with what's been placed so far this year. So the fact that I'm - that we are - we have a firm view on scrapping, that, that will increase. And that's what we will monitor very closely, and I think that will give us a very good guide on how the tanker market will develop.

Okay. Great. That’s it from me. Thank you.

Thanks.

Thank you. [Operator Instructions] We can then move along to our next question. It comes from Gregory Lewis of Credit Suisse. Your line is open. Please go ahead.

Good morning and good afternoon. This is Jim Nelson on for Greg today. Thank you for taking my question. Just maybe one, Robert, on the market. You kind of called out earlier maybe some of these new trading patterns developing. And what are you seeing, particularly coming out of the Atlantic? We've heard some noise about the U.S. Gulf kind of rising in its prominence. Do you view this as being sustainable? And I know you're seeing the infrastructure in place there to - for this to continue going forward.

What we're seeing is - now I looked at the latest numbers. These change all the time, so I use just the latest I've seen. And in terms of - back to Asia. Asia is where demand growth is, and Asia now has to source more from the Atlantic because some of the Middle East volume's gone. So what we're seeing is about 600,000 barrels a day now moving from the States to East. And this is, from a tanker perspective, obviously very good news. I think there's many on the call here who know the interruptions far better than me, but what we're seeing is that the volume is increasing. We also think that the U.S. will need volume from the Middle East due to the heavier grades. So it's a good development, and this development is happening whilst the oil market is getting more balanced due to OPEC cuts. So again, I think for the medium to long term, there are some interesting things happening.

Great. And then as we think about the kind of opportunity set in the second hand asset market. I mean, it sounds like you had a preference for ships on the water. I mean, if you had to place it, I mean, just how many modern VLCCs are really out there that are realistically up for sale right now?

There's very few. There are very few. And there is - yes. If you call out someone and say, okay, I want 10 VLCCs max 5 years that at [indiscernible] you will not be able to get it. So this shows that the asset prices - or the values are getting support, and they're taking up here and there. So there is not much around. But you see the spot market weak over the summer here, that could obviously change. So it's something we monitor very closely.

Great. Appreciate the time for today. Thank you very much.

Thank you.

We have no further questions at this time. [Operator Instructions] We have no further question at this point. So at this stage, I turn the call back to the speakers for any additional or concluding remarks. Thank you.

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

That will conclude today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.