Frontline plc (FRO) Earnings Call Transcript & Summary

Good day, and thank you for standing by. Welcome to the investor presentation 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 speaker today, CEO, Mr. Lars Barstad. Please go ahead.

Thank you very much. Good morning, and good afternoon to those of you in the U.S., we're sorry to disturb your Columbus Day. And thank you all for taking the time to join us on this a bit extraordinary call on this, what we believe is a very exciting day for Frontline. I first want to kind of start off with saying that this transaction has been made possible by 2 titans of shipping coming together, together with the Supervisory Board of Euronav, namely John Fredriksen and Marc Saverys. Together, they managed to create an integrated solution to what has been a strategic and structural deadlock in Euronav. This benefiting Euronav shareholders by offering them a choice Frontline for growing it -- to grow its fleet and to bring Euronav back to CMB. I think we'll focus on the Frontline part of this transaction. And let's start off by jumping to Slide 3. So this is a broad outline of the acquisition that we're very excited to announce today. Frontline will buy 24 VLCCs from Euronav. This is a modern and high-quality fleet, average age of 5.3 years, and all of them are ECO vessels. All these vessels are on the water, and I think this is important to note, as we on previous calls, have explained to the market how illiquid the modern resale tanker market is, but by this, we're able to access 24 of these units at what we believe is a good time in the cycle. Frontline will increase our total fleet size to 89 vessels and will become the largest tanker owner in the public domain measured by the deadweight tonnage. We reduced our average fleet age overall to 6.1 years and we increased our operational leverage toward the shipping segments that we believe has the highest upside as we move forward here. The acquisition is fully funded through an attractive debt package. It will be accretive to free cash flow and earnings per share. Frontline will -- Frontline already have a robust balance sheet, but will have so post transaction as well. What we're seeing right now and what we have communicated numerous times, is that we are in a position where we have the lowest VLCC order book since the 1980s. We see Asian imports and in particular, Chinese moving to all-time high as they come out of the pandemic. We continue to have the picture with extended trade lines -- lanes due to the Ukraine Russian conflict. And we believe there is a strong rate and supply outlook in particular so for the VLCCs. Let's move to the next slide. So this is a fully funded acquisition of 24 ECO VLCCs. This has been a key focus point for us. Basically, we focus on the segments that yet has a lot of room to perform. All these ships are -- or they're predominantly Korean built, high-quality ships, the oldest one is from 2015. All of them are ECO design and 9 of them have scrubbers. I think I would like to add that our main shareholder has been very involved in this transaction showing your support and also showing -- giving Frontline ample support on finance. And as you all know, this is a segment that's very close to his heart. With that, I'll move over to Inger to explain the details.

Thanks, Lars. Yes, the purchase price is $2.35 billion. And the acquisition is then fully financed, as Lars said, I will go through the details of the financing. We will use the sale of Frontline's 13.7 million shares in Euronav to CMB generating proceeds of $252 million. We will have some cash on hand, which is $37 million in received dividend on the Euronav shares. We will part drawdown under the existing $275 million senior unsecured revolving credit facility. And we will also have a new 5-year senior secured term loan facility in the amount of $1.41 billion provided by a selection of leading lending banks. This facility carries an interest rate of SOFR plus some margin in line with Frontline's other credit facilities and has an amortization profile of 20 years, commencing on the delivery date from the yard. In addition, Hemen Holding has offered Frontline a subordinated unsecured shareholder loan of up to $540 million on similar terms of the bank loan, to enable an swift execution with limited complexity and time then to optimize the capital structure post closing. The shareholder loan may not be fully drawn as Frontline is exploring other alternatives to free up capital including re-leveraging part of the existing Frontline fleet on attractive terms and/or at sale of older nonequal efficient vessels. Today, Frontline has a historically low loan-to-value and comfortable leverage capacity to refinance the shareholder loan through releveraging part of the existing fleet in Frontline. With this, I'll leave the word to Lars again.

Yes. I'll go through some of the kind of more practical details of this transaction. The sale of Euronav shares and the Fleet acquisition is interconditional. As some of you may have noticed today, CMB filed what is referred to as an Article 8 which puts them effectively in a mandatory bid position. When that mandatory bid becomes valid, the Frontline shares will be passed on to CMB and [ Pharmaton ], of course. And then CMB will pay for them in cash. And then the rest of the shareholders will have a cash bid in their hand. At that time -- at that exchange time, that's when the [indiscernible] vessel connected to all these ships become effective and Frontline start to take delivery of the vessels. The only conditionality or the only 2 conditionalities to this structure is an approval by the Special General Meeting in Euronav, which is going to be called fairly shortly and secondly, normal regulatory approvals. As a part of these agreements, the arbitration of the legal actions initiated by Euronav against Frontline will be terminated. Frontline will post transaction, I think Inger mentioned, have a very strong balance sheet. Frontline has no new building commitments and no meaningful debt commitments before 2027. With that, let's move into Slide 5. This is what Frontline will look like. [indiscernible] relationship to peers post transaction. So having scale allows us to better serve our clients, size also matters in respect of synergies. Synergies achieved on technical management, operations and so forth within Frontline. Frontline platform, in fact, is set up to accumulate this kind of transaction and to -- in a very good position to increase the fleet. Here, we're actually increasing the Frontline fleet by 57% or close to 60% in deadweight terms. I believe most of you know our history. We first started with entering into the LR2 or Aframax market, this has been hugely beneficial in the last period, in particular, having 3 legs to stand on. Then Frontline did some heavy lifting on Suezmaxes, basically renewing and growing that asset class for the company. And now we believe it's the VLCCs turn to shine and we achieve even greater economies of scale. With that, I'll go back to Inger and look at the post transaction cash generation.

Yes. Let's then look at Slide 6 and post transaction cash generation. We have updated our usual slide on cash generation with the acquisition of the 24 VLCCs and we estimate then post transaction, cash breakeven rates of $27,500 on a fleet average. That includes dry dock costs for 8 VLCCs and 3 Suezmax tankers in 2024. The post-transaction estimate for 2024 fleet average OpEx, including dry dock is $8,300 per day. The average cash breakeven rate post transaction increased with about $4,900 per day compared to pre-transaction but so does the potential cash generation and potential return. At this graph on the right-hand side at assumed VLCC TCE rates of $75,000 per day, with 5.5-year historic spread to VLCC for Suezmax and for LR2 tankers. The annual free cash flow potential post transaction is $1.8 billion or $8.19 per share, translating to a free cash flow yield at of 45%. This is an increase compared to pre transaction with 29%. So with that, I leave the word again back to you, Lars.

Thank you, Inger. So let's move to Slide 7, and I'll start to dig into the fundamental rationale we have in entering into this transaction. If you look -- sorry yes. If you look historically, the order book-to-fleet ratio is quite interesting to address between the various asset classes. And to explain this slide, if we go to the left-hand side, the LNG order book was at its lowest point at 11% of existing fleet in 2010. Since then, from 2011 to 2013, the LNG earnings outperformed the long-term average by 56% and so it goes on. Containers was the lowest point in 2020. For VLCCs, it was at its lowest point in 2011. In dry, the lowest point on the Panamax side was in 2002 and we saw the following 3-year average came in 42% above the long-term average. The product tankers, the order book or the MR product tankers in specific, the order book found its lowest point of 5% in 2022. And so far, the 2023 average is at $29,000 per day. If you look at the car carriers, we had the lowest point in 2020. And in the 3 years past that, they had 113% higher TC than the long-term average. On the VLCC side in specific, we assume, we are at the lowest point, and we are at least at the lowest point in the last 20 years. And we expect that for the next 3 to 4 years, will have a relatively high outperformance compared to the long-term average. Let's move to Slide 8, and we'll look at the unique combination that's going on right now. The unique combination of high utilization and rates and record low order books. Most of you are aware that we've actually been through 12 months of very solid VLCC markets. It started around this time last year. But despite this strength, the order book has not started to grow. Also in the time charter market, the forward TC rate offering is north of $50,000 per day. We are experiencing short-term headwinds, which we believe is more related to seasonality than anything else, but this unique position motivates us to be very ambitious and by that entering into this transaction. If we move to Slide 9, and this is kind of a new swing on something we have addressed numerous types. As mentioned, the VLCC order book is at record low levels, hovering 2% of existing tonnage. Also in deadweight tonnes -- in absolute deadweight tonnes, although the oil market is much greater now than in previous years. It's the lowest we've seen in -- since 1980 or the 1990s. The VLCC ordering remains muted. Only 11 vessels have been ordered in the last 12 months. This representing 1% of the existing fleet. We have an astonishing 14% of the fleet still floating around over -- of the age over than 20 years. We have 30% of the fleet older than 15 years. And we actually have 30% of the fleet being non-ECO and we're all aware of the regulatory tightening that we are expecting going forward for [indiscernible] principles and so forth. And 30% of the VLCC fleet will be challenged by EEXI and CII or energy efficiency as we move forward. We are in a situation also where we have reduced yard capacity. Shipyards are full of contracts for other shipping sectors, including LNG and containers. And the earliest new building slot available right now is 2026, and a material amount of orders you need to look to 2027. Currently, only 40% of the VLCC are ECO exactly the segment that we are now [taking about that.] And the VLCC order book, as I said, is virtually nonexisting for the next couple of years. Then let's move to Slide 10. This slide should be familiar to many of you. And the carrying capacity of deep sea tankers is -- or we argue is in question. If the oil demand projections are correct, we look to end up in a deficit on the shipping capacity going forward. In this argument, we're looking at VLCC equivalents, basically comprising of all the Suezmaxes and all the VLCCs in the market there in the world in addition to the crude carrying Aframaxes. In order to cater for the expected growth in oil demand going forward, we would need 92 VLCC equivalents coming into the market by the end of 2024 but there are only 17 to come. We have, at the same time, 54 more VLCC equivalents will turn 20 years and efficiencies of tankers are reduced by age as the customer base is limited. We believe that the current age limitations imposed by traders, oil majors and national oil companies may come into question but the -- this is only likely in the case of a strong pricing. This further cements our very positive outlook to this sector. Then let's move to Slide 11. This is a new chart, but it's to try to explain what's going on in oil trading and trading lanes or at least trying to have a new view on it. Here we basically taking world quarterly net exports for crude and condensate. And when I say net exports, you're going to find that regions that import more than they export, they're going to have a deficit. And above the line, you'll find Americas, which -- which is comprised of U.S., Mexico and Latin America, together with Africa are the net exporters in this picture. The net importers and the growth in that import is happening in Asia and actually in Europe and particularly so over the last couple of quarters in relation to the disruption of Russian crude exports into Europe. Basically, what this tells us that the larger the distance between the supply and the deficit, you incur longer tonne miles. This has been going on ever since 2016. It also supports our argument that incremental demand, which at least according to every research report is going to happen in Asia. That is going to continue to extend trading lanes, further amplifying the outlook that we are advocating. Let's try and sum this up, if you move to Slide 12. We believe that we're putting Frontline in a unique position to benefit from a tight market balance. Frontline more than doubles its VLCC position in what is a very illiquid resale market. We increased operational leverage as global demand is expected to grow far beyond pre-pandemic heights. Frontline total fleet grows by 57% in deadweight terms. Looking at tanker supply, high forward visibility due to historical low order books and low [indiscernible] delivery creates a very compelling dynamics. This is a fully financed transaction with an attractive debt package and it's highly accretive to free cash flow and earnings per share. Thank you very much. And with that, I'll open for questions.

[Operator Instructions] Now we're going to take our first question. Just give a moment. And the question comes from the line of John Chappell from Evercore ISI.

Super quick clarification question first. Inger, I think you said it, but I didn't hear it. The terms on the $1.4 billion 5-year senior secured term loan, did you give the interest rate on that or the spread at least?

No, I did say it was based on SOFR rate plus margin in line with other older credit facilities. I didn't explicitly say the margin.

Okay. But similar to your current facilities?

Yes, yes.

Okay. And then the other question for you, Inger, just on the timing of some of these things. As you noted, you do have a pretty unlevered balance sheet, at least by Frontline history. So I'm guessing there's a lot of opportunity for you, to either add that to unencumbered vessels or to refinance. What's the timing on that vis-a-vis drawing down the $275 million from Hemen, which is at the 10%, I'm guessing the quicker you can get the refinancing done, the better it would look for the interest outlook in the near term.

Yes. We have already started this process. So to give you an exact time frame is a bit dangerous probably, but at least it will be something we are working on short-term wise and going on for, let's say, a year or something and maximum, I guess. Yes.

Okay. Last one, Lars, you mentioned the -- or maybe Inger mentioned the scale or the synergies, I think it was Lars of having a fleet of this size. From an operational perspective, it should give you more flexibility as well. I know you're very bullish about the outlook. There's a lot of uncertainty in the world right now, whether it's the economy or now what's happening in the Middle East. Does this acquisition give you the opportunity to have a better balance in the fleet and, therefore, maybe take advantage of some of the big time charter rates that we've seen published in the market, either with the newer vessels or with some of the Frontline's legacy fleet.

Absolutely, John. So this is obviously something we're going to look at. Now we have a fleet size that we're quite kind of happy with. We always have an opportunistic view on the time charter coverage. We'd like to kind of -- our proposition to the market is obviously to give our investors spot returns. But given the operational gearing, we might be more kind of prone to try and at least cover some of our revenues going forward, yes.

And the next question comes from the line of Omar Nokta from Jefferies.

You clearly outlined, I think, a very compelling picture for why expanding your VLCC exposure right now makes sense. And maybe just sort of touching on the last point you had with John, the deal is fully funded as you guys highlighted. How do you feel about taking on this amount of debt at this point in the cycle? It looks like your LTV probably goes back to where it was pre upturn. You've clearly got the capacity to take that on. And it's not like your LTV goes dramatically higher, but how do you think about what that then means for the use or focus of free cash flow? You outlined maybe look at the cover some of your additional vessels on -- or having just a little bit more time trying to cover on your vessels, but in terms of use of free cash flow, do you aim to delever to a certain threshold? And also, what do you think about what that means for the sort of unofficial payout of, say, 80% of earnings?

I think we are comfortable in a way to bring the leverage back to, let's say, close to 60%, which will be the case -- on the 59% I guess. And looking back historically, the average leverage of Frontline has been much higher. That's actually been more than 67% on average. So I think this is kind of comfortable for Frontline. I also think in a way that you mentioned your question with respect to payout. I don't think it will affect that since we have this capacity to, let's say, refinance the shareholder loan with releveraging of the Frontline fleet. I think that will not be affected by the dividend -- out of the dividend cost will not be affected. And also, I think other Frontline is generating significant cash flows, and we have a very good positive outlook for the future. We think that after this transaction is accretive. So both free cash flows and earnings per share is going to grow. So in sum, I think that should be supporting for the dividend going forward.

But Omar, I would like to add one point, which I really -- we haven't really put it in any presentation yet because it's -- some call it kind of a bit speculative, but some of the analysts have this slide in the deck. If you look at LTV and the V in the LTV, we are -- it's a big question whether if we're high, low or mid-cycle. We -- if we look back to kind of the highest point on resales, assume resales are now hovering between $125 million and $130 million on the VLCC. In 2008, we saw a print at $160 million. Since then, and if you compare it to Korea, which is actually the country where most of the ships are built, we have had an accumulative inflation of more than 30% since then. So you could actually argue that the V in LTV is closer to $98 million to $100 million, and then we're actually not high in the cycle. We're actually a little bit below mid in the cycle. So I think you need to kind of keep that in mind as well. And this is also why we're not really too afraid of levering up and also, we have 100% visibility of what's going to happen on the supply side for the next 2 to 3 years. And that gives us kind of decision support in order to go out a little bit on the linear.

That makes sense, Lars. One follow-up, just sort of you mentioned perhaps selling ships if you wanted to, whether they were noncore or maybe old or non-ECO. Any color you can give into that? Obviously, you have critical mass now with the VLCCs. You've had it with the Suezmaxes and I guess to an extent, you've also had it with the LR2s. What do you think about the LR2 fleet from here? Is that something you think you would focus on perhaps monetizing that and maybe refocusing Frontline towards pure crude transportation? Or do you want to still keep the product exposure?