Frontline's Dividend Yield, Tanker Demand Compelling Indeed

Oct.16.06 | About: Frontline Ltd. (FRO)

By Carla Pasternak

Shares of oil tanker stock Frontline (NYSE: FRO) are starting to rebound. After bottoming out at around $30 per share in May, the shares have gained over 30% in the past few months. Despite the rise, the stock still carries a monster yield of 16.6% based on Frontline's $6.00 per share dividend.

The current rally has been driven by a recent surge in tanker rates for Frontline's very large crude carriers (VLCCs). Tanker companies like Frontline lease out their ships to major oil firms in exchange for a daily rental rate. During the months of July and August, these rates ran about +50% higher than last year, according to the company. In fact, rates for July and August topped out at about $80,000 per day. And going forward, the best might be yet to come, as the fourth quarter is generally the strongest for tanker firms. That's when oil demand increases as refineries rebuild their inventories for the winter.

The latest oil supply/demand outlook also bodes well for tanker stocks. Chinese oil demand, which grew +2.6% last year, is expected to climb +6.1% this year and another +5.5% next year, according to the International Energy Agency. To meet this demand, more large oil tankers will be needed to ship oil from the Middle East to China.

Meanwhile, single-hull tankers are being phased out to meet environmental and safety requirements, thereby keeping the supply of tankers flat. This tight supply/demand situation should keep tanker rates firm and should support stable cash flows and dividend payouts.

Suggested action: We would not be surprised to see FRO shares rally as we move into the seasonally strong period of November through February. That said, investors should remember that VLCC day rates can be extremely volatile.

Also, while some tanker companies lock in their day rates under long-term contracts, Frontline leases its tankers according to the going rate, which changes daily on the spot market. That makes FRO's earnings and distributions more volatile than most. As such, the stock is suitable only for aggressive investors who can move in and out of a position quickly.

Disclosure: Author has no position in stocks mentioned