This past quarter Frontline Ltd (FRO) posted earnings and a loss that beat analyst expectations, yet the outlook is still dismal for the company. With low spot rates, a high breakeven point, convertible bonds that will come due in two years, and a bloated fleet, the future looks bleak. Frontline Ltd is a Bermuda based shipping company that manages a fleet of VLCC's and Suezmax ships run by John Fredriksen, the shipping tycoon who also oversees numerous other companies and holdings. While strategically they are in a good place, run by an industry savvy leader, current debt, future payments, and a lack of cash and revenue will ultimately doom this company.
24 months to insolvency
FRO has several hurdles going forward, the most glaring on which is the $225 million due April 2015. While this is not their only debt that is coming due or obligation they are facing, it is the largest, and the company is facing defaulting on it based on their current cash on hand and revenues.
In order to determine the outlook of the company, it is best to determine what the minimum spot rate would need to be in order to meet that obligation. Currently the company has $109M on hand. If the company should elect to use $100M to meet that obligation, they would still need $125M. While the market will not recover all at once, in order to meet the $125M, we could assume they would need to earn 35% of that during the next 12 months ($43.75M) and the other 65% during the second 12 months ($81.25M).
Based on 50 vessels, over the next 12 months, they would have to earn on average $857K per year or $2400 per vessel per day. For the VLCC's, with a breakeven point of $25,500 per day, they would need a spot rate of $27,900 per day averaged over the next 12 months. For the Suezmax ships, with a breakeven point of $18,500, they would need a daily spot rate of $20,900 per day averaged over the next 12 months.
The second 12 months looks even bleaker. For the 50 vessels, the company would need $1.625M per vessel or $4452 per vessel per day. For the VLCC's, this would mean close to $30,000 per day averaged over 12 months. For the Suezmax ships, with a breakeven point of $18,500 per day, it would translate to $23,000 per day.
While the daily spot rate has fluctuated greatly over the previous two years, the previous quarter averaged close to $14,500 per day for both VLCC's and Suezmax's. Over the next two years the spot rate would have to climb 30-50%, in spite of the oversupply of ships and slowdown in the Chinese economy.
With the ax hanging over their head, FRO still has a few options that could save it. First off, Fredriksen understands this industry very well, and has been able to build his empire through structuring and taking advantage of market conditions. During the recent conference call, the statement was made that the "market clearly lacks direction and leadership, and without that, this market will not change for the better in the short term." As one of the 50 most influential men, according to Bloomberg, he may be the driving factor for reducing the oversupply of ships and helping to raise the daily spot rates. The whole industry understands the current rates are not profitable and needs to go up.
Fredriksen could also sell off more assets and restructure the business to lean the company even more. This could benefit him in multiple ways. The assets could be transferred to another Fredriksen business that is on better footing, keeping assets in his conglomerate while improving the books of FRO. Selling off some of the older ships and building contracts could raise the necessary capital, but will then lower the earnings potential.
Another possibility, though less likely, is that the markets do recover and the daily rates go up. Without the global economy completely recovered, this possibility is remote, but still a wild card.
Frontline is in a race against the clock for the maturity of their April 2015 bonds, valued at $225 million. Based on the current rates, the company will not be able to develop enough earnings to meet that mark, and will likely have to turn to selling off assets. Although John Fredriksen will fight to save Frontline, if it comes down to it, he will allow it to go into bankruptcy in order to preserve the rest of his empire.