Frontline To Be Pressured By Lower Tanker Spot Rates

JP Morgan rates Frontline (NYSE:FRO) shares Underweight and continues to recommend selling the stock. Although two recent spin-offs and vessel sales will likely enable FRO to boost its near-term dividend payouts significantly, they believe that the medium-term (through 2008) earnings and dividend impacts from the asset sales and an unfavorable 1H07 fundamental tanker outlook will place material pressure on the shares once the company distributes all of its financial engineering cash flow as dividends, likely as early as next month.

Financial engineering may add as much as $3.50 per share to near-term dividends. Firm estimates the Sealift and Sea Production transactions will provide a net cash inflow of roughly $260 million, which could be paid as dividends as early as March.

JPM's 2007 and 2008 EPS estimates now stand at $2.35 (down from $2.50) and $0.50 (down from $0.80), respectively, reflecting the sale of the FPSO asset. However, they note these estimates do not include any potential equity in earnings from FRO's minority stakes in its recent spin-offs.

Given their belief spot rates will fall nearly 30% in 2007, the firm believes stocks of those companies with heavy spot-market exposure (like FRO) will underperform this year.

Firm's Underweight rating on FRO is based on belief that tanker spot rates will continue to decline this year and next from the peak levels earned in 2004 driving unfavorable year-over-year earnings and dividend comparisons through 2008. As one of the tanker companies with the most leverage to the spot markets, they believe that FRO is heavily exposed to the rate weakness they forecast through 2008 and would expect the stock to underperform the peer group over the 9-12 month investment horizon owing to the 58% EPS decline they project in 2007.

On valuation, FRO is trading at 14.4 times new 2007 EPS estimate of $2.35, representing an 11% premium to the peer group average, while its forward EV/EBITDA multiple of 8.7 times represents a 10% discount to the industry average.

Notablecalls: I suspect JPM's comments may create some selling pressure in FRO.

FRO 1-yr chart: