Is Frontline's 20% Dividend Yield Sustainable?

| About: Frontline Ltd. (FRO)

Summary

Frontline delivered better than expected first quarter results, and according to the company, it is in a unique position to take advantage of a strong tanker market.

FRO's stock is trading below book value, and the trailing P/E is extremely low at 4.43, the third lowest among all energy companies with market cap greater than $1 billion.

FRO's stock is an excellent candidate to be included in a high-yielding stock portfolio. The company is paying a generous dividend yielding 20% a year.

I believe that as long as the crude tanker market fundamentals remain positive, the company will continue with its high dividend payment policy.

Click to enlarge

Image source: company presentation

In my view, the stock of Frontline (NYSE:FRO) is an excellent candidate to be included in a high-yielding dividend stock portfolio. The company delivered better than expected first quarter results, and it is paying a generous dividend yielding about 20% a year.

The Company

Frontline is a shipping company which engages in the seaborne transportation of crude oil and oil products worldwide. As of December 31, 2015, the company operated a fleet of 88 vessels, including VLCC, Suezmax, LR2, and MR tankers. It is also involved in the charter, purchase, and sale of vessels. The company is based in Hamilton, Bermuda. Frontline is a subsidiary of Hemen Holding.

Since the beginning of the year, FRO's stock is down 46.6% while the S&P 500 Index has decreased 0.3%, and the NASDAQ Composite Index has lost 6.0%. Moreover, since the beginning of 2012, FRO's stock has lost 62.8%. In this period, the S&P 500 Index has increased 62%, and the Nasdaq Composite Index has risen 80.7%.

FRO Daily Chart

Click to enlarge

FRO Weekly Chart

Click to enlarge

Charts: TradeStation Group, Inc.

Latest Quarter Results

On May 31, Frontline reported its first-quarter 2016 financial results, which beat earnings-per-share expectations by a big margin of $0.16 (44%).

First Quarter Highlights

  • Achieved net income attributable to the Company of $78.9 million, or $0.50 per share, for the first quarter of 2016.
  • Announces a cash dividend of $0.40 per share for the first quarter of 2016.
  • Obtained commitments for up to $603.4 million of new financing in May 2016 comprising of $328.4 million in bank financing for eight newbuilding contracts and a senior unsecured facility of up to 275.0 million from a company affiliated with our largest sh areholder, Hemen Holding Ltd.
  • Took delivery of four LR2 tanker newbuildings in the first quarter and one LR2 tanker newbuilding in May 2016.

In the report, Robert Hvide Macleod, Chief Executive Officer of Frontline Management, commented:

We are very pleased to report yet another strong quarter with net income attributable to the Company of $78.9 million or $0.50 per share. Significantly, this was Frontline's first full quarter following its merger with Frontline 2012 Ltd. Our performance, particularly in the VLCC segment was strong, despite some market weakness in February and March.

In the table below, Frontline showed the average daily time charter equivalents ("TCE") earned by the company in the last two-quarters compared to the spot prices. In addition, it gave guidance spot prices for the second quarter of 2016, the percentage of covered contracts, and the cash cost breakeven rate [BE].

Click to enlarge

In the table below, I have calculated the expected operating gain for each vessel category in the current quarter. For the calculation, I used the average spot price for the current quarter, the same Frontline discount to the spot price of the first quarter, the percentage of covered contracts, and the cash cost breakeven rate. According to my calculations, the VLCC category will show a very high operating gain of almost 80%; the SMAX vessels will show about 30% operating gain and the LR2 about 20%. Only the MR category will show a negative operating gain of about 7.5%. However, Frontline has only eight MR tankers, compared to 21 VLCC, 14 SMAX, and eight LR2 tankers. All in all, we can expect that the company will show a considerable profit also in the current quarter.

Click to enlarge

What's more, 35% of Frontline's operating fleet is currently covered on time charter.

Source: Presentation Q1 2016

Strategy and Market Outlook

According to the company, record crude production and oil prices, which are expected to be relatively low, coupled with steadily increasing demand for crude oil, have significantly tightened the crude tanker market and continued to generate strong freight rates. Frontline said that it outperformed the market in the first quarter, which saw periods of significant strength and the market continued to show high levels of volatility. However, in the second quarter earnings have softened, but the company expects forward tanker demand to be strong.

Frontline also said that crude oil demand continues to increase from China and India. Notably, in April, China imported 7.96 million barrel per day of crude oil, and Chinese crude oil imports rose 11.8% over the first four months of 2016 compared to the same period in 2015. Incremental demand is being generated by Chinese teapot refineries, a trend that is expected to continue in the coming months, according to IEA forecasts. Growing Chinese car sales and healthy refinery margins have also been a positive for the product tanker market. According to the company, increasing near-term OPEC supply and declining U.S. production supports tanker demand by increasing voyage lengths, which has the effect of reducing available supply.

Risk

Frontline believes that the primary downside risk for tanker demand relates to decreasing global oil production. Rising oil prices is another factor which can affect its markets negatively through a fall in oil demand and rising fuel cost for its vessels. Specifically, a decline in non-OPEC and non-U.S. production also has the potential to adversely affect tanker demand. However, the company believes that it is unlikely that OPEC will cut production as Iranian production is increasing and Saudi Arabia has indicated an unwillingness to reduce production.

Dividend

Frontline increased its quarterly dividend in the first quarter of 2016 to $0.40 per share from $0.35 in the fourth quarter of 2015. The current annual yield is very high at 20.05%, and the payout ratio for the last four quarters is only 14.1%. However, in the last quarter, adjusted earnings per share were $0.57 which makes the last quarter payout ratio at 70%. The company explained that the payout ratio inched a bit lower in the recent quarter as some cash was earmarked for corporate purposes and growth. According to Frontline, its policy, with respect to dividend payout, has not changed, but in the last quarter, it has specifically stated that it thought that it will have very attractive possibilities of acquisitions in the market which led it to reduce the dividend payout a bit in the quarter.

FRO Dividend Chart

FRO Dividend data by YCharts

Is this high dividend payment sustainable? According to my calculations, it is sustainable at least for the second quarter of 2016, and I believe that as long as the crude tanker market fundamentals remain positive, the company will continue with its high dividend payment policy. Examining Frontline's balance sheet, the company had cash of $272 million at the end of the first quarter and long-term debt of $852 million. The total debt to equity ratio was pretty high at 0.97. However the company generates strong cash flow; price to cash flow ratio is very low at 3.09.

Click to enlarge

Source: Presentation Q1 2016

Valuation

Frontline's valuation is excellent; FRO's stock is trading way below book value, price to book is at 0.85. The trailing P/E is extremely low at 4.43, the third lowest among all the 191 energy companies with a market cap greater than $1 billion. Furthermore, the forward P/E is very low at 8.87, and the Enterprise Value/EBITDA ratio is also very low at 7.54.

The 10 energy stocks with a market cap greater than $1 billion with the lowest P/E ratio

Source: Portfolio123

Summary

Frontline delivered better than expected first quarter results, and according to the company, it is in a unique position to take advantage of a strong tanker market. Due to the size and diversity of its fleet, as well as its very low cash breakeven rates, the company believes that it will continue to generate solid high returns for its shareholders. Frontline's valuation is excellent; FRO's stock is trading way below book value, and the trailing P/E is extremely low at 4.43, the third lowest among all the 191 energy companies with a market cap greater than $1 billion. FRO's stock is an excellent candidate to be included in a high-yielding stock portfolio. The company is paying a generous dividend yielding 20% a year, and I believe that as long as the crude tanker market fundamentals remain positive, the company will continue with its high dividend payment policy. All in all, In my opinion, FRO's stock is a good value at the current price.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.