Seeking Alpha
Portfolio strategy, short ideas, value approaches, global shipping and trade
Profile| Send Message|
( followers)  

When the first fossils for the Hypsilophoden was discovered in 1849, several misconceptions and illogical comparisons were made. Scientists erroneously believed that this dinosaur was a juvenile version of another species, and failed to realize that this was an entirely new genus for twenty years. Nineteenth century scientists also incorrectly speculated that the Hypsilophodon lived in tree branches. In 1974, scientists discovered that this dinosaur was no more capable of climbing an oak tree than a comparably sized dog.

I believe that a similar misconception has been made about the future prospects of Frontline, ironically in a Seeking Alpha article that begins with a story of dinosaur misconceptions.

The Differences/Misconceptions

In late July of 2011, Frontline was presented as a "historical 10-bagger" that was under-rated due to lack of focus on dividends and spinoffs. In an outlook conclusion, a comparison was made to the FRO of 2001, which also faced a rough tanker market, and then went on to be a decade 10-bagger. However, a vast difference existed that the author failed to mention: debt-to-equity ratios (including obligations) and breakeven numbers.

The FRO of 2001 had a breakeven of $21,100 per day for VLCCs and $13,400 per day for Suezmaxes. The TCE for 2001 was $40,800 for VLCCs and $30,700 for Suezmaxes. This was a surplus of $19,700 per day for VLCCs and $17,300 for Suezmaxes. 2001 FRO had a Debt/Equity ratio of 135% and Debt/Assets of 56%.

The FRO of 2011 has a breakeven of $29,800 per day for VLCCs and $24,000 per day for Suezmaxes. The TCE for 2011 (first 6 months) is $27,400 for VLCCs and $16,500 for Suezmaxes. This is a deficit of $2,400 per day for VLCCs and $7,500 per day for Suezmaxes. 2011 FRO has a Debt/Equity ratio of 369% and Debt/Assets of 76%.

This is not the same Frontline that succeeded as a 2000s 10-bagger; although this is the same company, the traits are different. Just as the Hypsilophoden was proven incapable of climbing a tree, I believe that this Frontline is incapable of a turnaround. Frontline is hurtling towards bankruptcy, and has breakeven levels that are far above industry competitors including Nordic American Tankers (NYSE:NAT) and Knightsbridge Tankers ((NASDAQ:VLCCF)).

Weak Market Projections

Based upon Frontline's own reports, the supply/demand market is projected to worsen into 2012. Jens Jenson, CEO of Frontline Management, recently proposed that tanker operators should collectively scrap their oldest vessels in an attempt to alter the supply/demand outlook. The free rider flaws, resulting non-action by other companies, as well as hypocritical action by Jenson himself, are well outlined in this article by Adjusted Return.

The Sinking Ship

With a fleet of 21 Suezmax ships and 46 VLCCs, based upon the figures reported in 2Q-11, Frontline is losing roughly $268k per day of operation ($24.4M per quarter). With only $173M in unrestricted cash on hand, this pattern cannot continue for long. Vessel sales (at sinking prices) and equity dilution, both of which will be disastrous for shareholders, might be the only solution to afford bankruptcy. There are rumors that John Fredriksen, who established FRO and owns a majority of FRO's debt, both directly and indirectly, will intervene to "save the day;" however, this is pure speculation, and any trades should only be made AFTER such an event occurs. If Fredriksen decides to boost his equity stake, he would likely wait as long as possible in order to ensure a rock-bottom equity entry-point. What better opportunity exists than days before a pending liquidation?

Smarter Plays?

If a reader had purchased FRO based upon the aforementioned "10-bagger" article, they would have lost 53% of their market value investment to date. Meanwhile, although their performance has also been poor, competitors VLCCF and NAT have lost 21% and 28% of their market value respectively. Obviously, 10-year results are far more important than 3-month results, so a comparison of break-even/TCE levels and a comparison of debt-load are in order.

Break-even/TCE:

  • Frontline: $29,800 VLCC & $24,000 Suez // TCE: $27,400 VLCC & $16,500 Suez
  • Nordic American: $11,000 Suez // TCE: $16,600 Suez (Q2-11 & completely spot)
  • Knightsbridge Tankers: $16,200 VLCC // TCE: $31,500 VLCC (long-term charters- likely to drop)

Projected Quarterly Gain/Loss:

  • Frontline: Loss of $24.4M
  • Nordic American: Gain of $8.7M
  • Knightsbridge Tankers: Gain of $5.6M from tankers & gain of $10.3M from drybulk operations

Debt Levels:

  • Frontline: 369% D/E; 76% D/A
  • Nordic American: 9.5% D/E; 8.5% D/A
  • Knightsbridge Tankers: 42% D/E; 29% D/A

Best Investment Choice?

Knightsbridge has locked-in long-term charters for its tankers of which two expire in 2012 and one expires in 2015. The average age of its tankers is 15.75 years, and the 4 newest vessels are in the dry bulk market, so Knightsbridge does not represent a strong long-term tanker play.

Frontline is a long bet on either a tanker market recovery prior to bankruptcy/drastic capital changes, or an "angel investment" by Jenson. The results of this bet will likely be known within the next year; however, the odds of FRO existing in 10-years are small in my opinion, much less performing as a decade 10-bagger.

Nordic American is the best long-term choice in my opinion. With a fleet of 20 Suezmax vessels online by 2011 at an average age of 9.5 years, little debt to speak of, and strong spot-market exposure NAT is well positioned for a future tanker market resurgence. In the meantime, with an industry-low breakeven rate (due to virtually no debt), NAT is poised for long-term strength. NAT, like the Frontline of the 2000s, has also rewarded shareholders with 56 consecutive quarters of dividends.

Disclosure: I am long NAT.

Source: Frontline Is A Sinking Ship