Time To Throw In The Towel On Frontline?

Jul.31.14 | About: Frontline Ltd. (FRO)


On April 22, 2014 I made a contrarian call on FRO beginning the long awaited "comeback.".

This did not happen. In fact FRO has lost 31% since.

The industry-wide day-rate renaissance may not materialize, or may appear too late.

It seems like just yesterday, but the first portion of 2014 saw a tremendous amount of hope in the reversal of shipping day-rates (the amount ship owners/operators charge to carry cargo). Day-rates had reached their all-time highs before the 2008 recession, and a perfect storm developed from the confluence. All types of shipping companies had been in the midst of expanding their capacity just before the economic crisis hit, and by the time they took delivery (if they weathered the storm at all), it was into a market with significantly diminishing demand, hence collapsing day-rates.

Looking at the five-year chart for Frontline (NYSE:FRO) it is hard to remember the time, back in 2009, when FRO traded in the $20s and actually moved closer to $40 by mid-2010. My own entry into the "falling knife derby" came in August 2011, right at the $7 handle. Without much caution, and a whole lot of hope, I had thought FRO was near a bottom and a recovery would be in the offing. I was right about the bottom - about five dollars ahead of time. The inevitable dividend cut came, and since mid-2012 FRO has been the poster child for "beleaguered." Chairman/CEO John Fredriksen restructured the company and spun off an entity called "Frontline 2012," the name of which reminds me more of a Hollywood disaster film more so than a company.

While Fredriksen is indisputably the owner of the biggest fleet of tanker ships in the world, of which Frontline is just a part, there was plenty of skepticism of his continuing to expand his fleet capacity as the day-rates continued to collapse. Many would make the argument he had no choice, as the contracts to build a ship are done years in advance and there are great hurdles in place to prevent a buyer from pulling out once the keel has been laid. Peer Nordic American Tanker (NYSE:NAT) also expanded its capacity, even going so far as to buy ships from operators who were dissolving at a discount. So fundamentally the sequence of circumstances that contributed to the low day-rates became more and more entrenched and impossible to surmount.

The only thing that can save FRO in the long run is a serious and sustained upturn in the day-rates for tanker ships. Each earnings season we shareholders wait for the magic words. The contrarian case for FRO back in April has only become better now, and the closing price today ($2.49 on July 29) is 22.66% above the 52-week low of 2.03. It would not take a lot of catalyst for the price to double from here - and the 10.40 short ratio (as of May 30, 2014) indicates that the bears have piled in since my original call.

If I was looking at averaging down my lot cost by buying here, I would likely liquidate my entire position once FRO reached $5 or more. My original purchase at $7 has been augmented by additional portions bought below $4, so $5 would be a relative wash for me at this point. I believe the short-squeeze that could be triggered by a positive earnings release could be enough to get there, although the holders of the 8.87M shares short are likely to disagree. Unlike NAT, FRO does not punish the shorts with a high dividend that the shorts must pay to keep their positions.

It would be hard to imagine that the level of urgency could not be much more dire for FRO, as I think the absolute floor of zero could be reached, and some would characterize FRO as being on "death watch." It has been a long death watch, though, and the patient may still recover. As J.P. often said in the movie Angels in the Outfield, "It could happen."

I created public portfolios at Reuters.com to track the progress of my picks. As of the closing price today I am liquidating FRO from the Value Growth Accumulation portfolio, as it no longer has the intended characteristic of this portfolio, and has been the worst call I have made across all 3 of my public portfolios. I have not found a replacement yet, but will be considering this over the next few days. As it stands in my real-world portfolio I am continuing to hold but would not be looking to accumulate any more shares.

Disclosure: The author is long FRO, NAT. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.