Shipping Stocks: I'd Wait To Buy Frontline and Overseas

Over the next several years, as emerging economies continue to grow and developed economies (hopefully) get back on track, demand for oil should continue to rise. Frontline, Ltd. (FRO) and Overseas Shipholding Group (OSG) are two of the largest crude tanker operators in the world. Both companies have bright futures, but now may not be the best time to buy their shares.

Reasons to Wait to Buy Frontline

Frontline is highly leveraged to tanker spot rates. While rates have been high recently (factors include China getting ready for Olympics, Iran using some of its tankers for purposes other than oil transport), they are likely to drop next year. FRO, along with its competitors, has been busy investing in new ships. While some of these will replace existing ships, the first half of 2009 is expected to see a large net gain. Tanker oversupply may lead to a fall in spot rates, even if demand for oil remains constant.

While high, the dividend yield is probably below the 19% currently advertised. Frontline has never had a stable dividend. So don't buy the stock expecting $2.75 per quarter. It may be higher next quarter, but as earnings mostly depend on spot rates and asset sales, the dividend will likely decline next year.

The high analyst estimate for 2009 earnings is $6.66 per share. As of the recent close of $55.90, Frontline is trading at 8.39 times the highest 2009 earnings estimate. The stock has had an average P/E of 4.7 over the last five years. If it trades close to its average P/E, the share price will be substantially lower.

In addition to the short term concerns above, investors in FRO always run the risk of share dilution. The generous dividend policy leaves the company with little cash. Acquisitions and unexpected expenses are likely to be financed by issuing new shares or taking on more debt (debt/equity is already over 5.9).

Frontline's fleet list can be found here.

While FRO may not get that low, as John Fredrksen runs a tight ship, I would wait until the stock goes below $40 a share before buying.

OSG May Be a Better Buy Right Now, But It Can Go Lower Too

Overseas Shipholding Group faces similar earnings pressures for 2009. However, the company is less leveraged to the spot rate market. As of June 30, 2008, non-cancelable term charters amounted to $1.6 billion. Locked in future revenues also include $1.8 billion from OSG's natural gas operations.

OSG is trading at a substantial discount to its Net Asset Value (estimated at $110 to $120 per share). Frontline has made buyout overtures, and OSG is receptive. The US Jones Act, which provides, among other things, that foreign investors cannot own more than 20% of a US shipping company, seems to be preventing a deal. Frontline is incorporated in Bermuda. Whether a deal materializes or not, the prospect of one can provide additional downside protection for investors (although it doesn't seem to prevent the stock dropping over 7% in one day).

While there aren't any significant barriers to entry in the crude shipping market, OSG enjoys the protection of the Jones Act from foreign competition. The company expects earnings before taxes and expenses in its US operations to grow by 65% over the next three years. Future projects include shuttling oil from deepwater drilling in the US Gulf. (Interested investors might want to take a look at OSP, OSG's master limited partnership.)

While OSG's dividend yield is not nearly as high as FRO's, it is stable, and may rise in the future (it was recently raised by 40%). OSG has good cash flow, and its debt/equity ratio is 0.66. The company's clean balance sheet will enable it to take advantage of future opportunities.

While the share price looks attractive compared to OSG's estimated NAV, the company may trend lower in 2009. Analyst consensus for 2009 earnings is $7.37 a share. Over the last five years, the company's P/E has been 7.46 on average. As of the recent closing price of $66.33, OSG is trading at 9 times 2009 earnings consensus. Keep in mind that OSG has a knack for failing to meet Street estimates, sometimes to the upside and sometimes to the downside, usually by double digit rates (who's to blame, the company or the analysts?). The low analyst estimate is $2.21 a share. If this turns out to be correct, OSG is trading at nearly 31 times 2009 earnings.

A list of OSG's fleet can be found here. (Note that the link is an Excel spreadsheet.)

Expect lots of volatility and keep an eye on the tanker rates (here and here are good places to get started). I would look to buy a small speculative position in OSG if it falls below $60, and then see what happens in 2009.

Disclosure: I don't own any of the stocks mentioned in this post, but I used to own OSG.

Comments

[Ed, Sidney,...:]

You raise several good issues, but having sailed the high seas in the Middle East, I can assure you the threat to shipping remains constant, and Iran's ongoing shadow dancing with their nuclear energy program is surely one of International concern and remains a strong threat to the region. Should the Iranian's revert to days of old by straffing oil tankers in the Persian Gulf out of Farsi Island, then your shipping companies would be great investments.

2008 Aug 08 10:12 AM

[Ed, Sidney,...:]

You raise several good issues, but having sailed the high seas in the Middle East, I can assure you the threat to shipping remains constant, and Iran's ongoing shadow dancing with their nuclear energy program is surely one of International concern and remains a strong threat to the region. Should the Iranian's revert to days of old by straffing oil tankers in the Persian Gulf out of Farsi Island, then your shipping companies would be great investments.

2008 Aug 08 10:12 AM

[golds:]

I would pass on OSG and buy high dividend paying tanker companies like FRO, NAT and TNK. If times get really ugly these guys have a downside of paying decent income. So far oil shipping has totally escaped the world economic downturn. In fact rates have hit record highs recently. No matter how bad the down turn gets we will still be shipping the same amount of oil. From here in we will use ever increasing amounts of the black liquid each year until we can't produce more.

Best Regards,

2008 Aug 08 10:13 AM

[grbn:]

... so don't buy the stocks, don't receive the very high dividends for three or four quarters while waiting for the price to come down someday maybe ........ and don't take gains during price spikes ........
I guess I've been doing it wrong all these years.....

2008 Aug 08 11:59 AM

[User 232593:]

i bought fro @ around $30.have been smiling a long time.the dividends have almost paid for the stock.no.one has figured a way to pave over the ocean,i emailed the ceo to compliment him & he answered personally.i think he is not paid but by dividend only.this stock was hardly mentioned by the "smart" financial analysts for a long time.think for yourself.i have no connection to wall stnor do i have any agenda.

2008 Aug 08 04:47 PM

[transportfan:]

I also bought my FRO in the $28-40 share range and have never been disappointed with the dividend. During times when the dividend is less than what the CEO wants to give, he spins off shares of other stock....like SFL, which in addition to costing us nothing, also pays a regular dividend. I bought when no one was covering FRO, and if anything at all was said about it, it was a warning to be suspicious of companies paying large dividends.

Google John Fredriksen and read about his philosophy....he treats shareholders as co-owners. We get the same dividend he gets. Find me an American company or CEO who thinks this way about the shareholder! Those of us loyal to JF do not share the concerns of the author of this article. We are into JF companies that are successful and share the wealth. We don't scare easily, and are in for the long haul. The price of the stock is not really material to us...other than offering another low point at which to buy more.

2008 Aug 08 07:29 PM

[Doon:]

If I had a nickel for every think written why FRO should go down or below 40. This was the same message over a year. FRO has earned and deserves a $60+ price. Companies that print cash (minimum $1.50 dividends per quarter i.e. $6.00 minimum per year deserve a P/E of at least 10. FRO is a $60 plus stock and rising. The divididend this next quarter will be $4.00 or over - Book a tanker on it!!!

2008 Aug 08 10:16 PM

[zenman:]

Buy FRO at $40, thats a big drop from 70 last june. I would like to see some stats to support such a theory.

2008 Aug 09 02:24 AM

[Lee 99:]

if more corps were ran like JF's the dow would be at 25000. The typical weenie ceo gets a big boost even if the stock tanks. Hardly a good business model, IMO.
FRO will hitting 40 may not be that good a bet as it has a lot of visibility these days as opposed to 4 yrs ago.
I've been long FRO for about 5 yrs and have been amply rewarded. other JF cos like Seadrill, golden ocean and ship finanace are also based on the high div model and have been behaving similarly.
the PE was low for quite some time, but the stock was paying out high teen bucks per year w/ the spinoffs. Analysts were really down on it, like the Citi guy. I don't think he ever got it right. Still hasn't.
JF is looking to do a 5:1 split some time in the future increasing shares held by co from 125 mil to 625. Not sure what the motive is, but it should be interesting. Currently 74 mil in circulation w/ JF owning 34 mil or so.
Time to stop rambling. They say don't fall in love with a stock, but this one is hard not to.

2008 Aug 14 08:50 PM

[Banked my p...:]

Bought FRO the day it was mentioned on MM in passing in the lighting round, Cramer sounded iffy, but the caller was right on with the earnings and the malarky of changes in oil policy. Jumped out at $65, I do not think the traders of this stock have the patience to let the stock get to $40 or $80 with the DD bankability. Entry point is $50~ trade at $65~ next round post DD kicker. Down side to below 40 is a possible rough air strike though I do not think this is the author's theory..

2008 Aug 29 05:29 PM

[einstein p ...:]

Bought FRO and NAT yesterday for the dividend. Too hard to figure out this volatile market, so it's best to get paid while you wait for things to settle down.

2008 Sep 18 12:47 PM

[User 202981:]

it's around 30 now. this article is very sensible and objective.

2008 Oct 16 12:23 PM

[Ruffcut:]

Quarter date dividend
Q2 2008 3.00 21.08.2008 02.09.2008 19.09.2008
Q1 2008 2.75 22.05.2008 02.06.2008 25.06.2008
Q4 2007 2.00 14.02.2008 22.02.2008 10.03.2008
Q3 2007 1.50 15.11.2007 26.11.2007 12.12.2007
Q2 2007 1.75 02.10.2007 10.10.2007 24.10.2007
Q2 2007 1.50 01.10.2007 10.10.2007 24.10.2007
Q1 2007 1.50 30.05.2007 06.06.2007 22.06.2007
Q4 2006 2.05 27.02.2007 06.03.2007 22.03.2007
Q3 2006 2.50 28.11.2006 5.12.2006 21.12.2006
Q2 2006 1.50 22.08.2006 29.08.2006 18.09.2006
Q1 2006 1.50 26.05.2006 08.06.2006 26.06.2006
Q4 2005 1.50 17.02.2006 02.03.2006 20.03.2006
Q3 2005 1.50 14.11.2005 25.11.2005 13.12.2005
Q2 2005 2.00 24.08.2005 01.09.2005 (NYSE)
02.09.2005 (OSE) 20.09.2005
Q1 2005 3.10 31.05.2005 08.06.2005 24.06.2005
Q4 2004 3.50 22.02.2005 03.03.2005 18.03.2005
Q3 2004 2.50 15.11.2004 23.11.2004 17.12.2004
Q2 2004 1.60 19.08.2004 26.08.2004 13.09.2004
Q1 2004 5.00 28.05.2004 03.06.2004 16.06.2004
Looks pretty consistent to me, but during type of market a lot babys may be thrown out with the bath water. Picked up a couple hundred shares and bought some 35 feb calls. The main concern is the bouncy historic chart. It is always a risk. No guts, no glory and maybe no brains and no money.

2008 Oct 18 10:45 AM