Frontline's First Quarter Results Show Continuing Weakness in Shipping

| About: Frontline Ltd. (FRO)
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Frontline Ltd (NYSE:FRO) announced its first quarter results on May 25, 2011. Here are the highlights from this report:

  • Net income of $15.5 million. This gives the company a first quarter EPS of $0.20 per share.
  • A quarterly cash dividend of $0.10 was declared.
  • Frontline sold off its entire stake in Overseas Shipholding Group. The company took a loss of $3.3 million on this sale.
  • Frontline exercised an option to buy the VLCC tanker Front Eagle and promptly sold it for an immediate gain of $4.2 million. Frontline will also receive a gain of approximately $13 million over the next two years because of this deal.
  • Frontline received $8.8 million due to a market value adjustment on a funding contract.
  • Frontline agreed with Ship Finance International to terminate the agreements for Front Leader and Front Breaker. Frontline took a $17.3 million loss for this action. The financial impact from this agreement will be taken in the second quarter and not the first.

I have written about the weakness in the shipping sector a few times over the past few months. Overall, these financial results showed that weakness. Frontline's chairman, shipping magnate John Fredriksen, believes that the shipping sector will get even weaker over the next few years.

Frontline had a small profit for the quarter, earning $15.5 million or $0.20 per share. This profit does not appear to be generated through operations as Frontline had a negative operating cash flow for the quarter. The company lost $7,092 thousand on its operations during the first quarter. This compares poorly to the $24,000 that Frontline lost on their operations in the first quarter of last year. A look at the statement of cash flows reveals that the company generated much of their cash from selling off vessels and other assets.

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Selling off assets in order to generate income is never a sustainable way to operate a business. At some point, it is inevitable that the business will run out of assets to sell. For this reason, it is advisable for investors to be cautious when presented with a cash flow statement like the one that Frontline had for the first quarter.

Frontline saw both improvement and disappointment in its operating environment during the quarter. The spot market charter rate for a VLCC tanker increased slightly to WS58 from WS 57.7 in the fourth quarter of 2010. This is still a large decrease from the market average of WS89 in the first quarter of 2010. WS58 is equivalent to $20,200/day for one of these tankers on the standard "TD3" route. Overall, the increase from the fourth quarter of 2010 was a fairly small one. The size of the worldwide VLCC fleet increased during the quarter from 548 vessels to 565 vessels. No new orders were placed during the quarter but the orderbook still counted 167 vessels at the end of the quarter. The current estimate is that 79 vessels will be delivered during the 2011. This will exert downward pressure on prices.

The spot market rate for a Suezmax tanker decreased to WS82 in the first quarter of 2011 from WS114 during the fourth quarter of 2010. This is a decrease to approximately $19,800/day from $21,700/day for a tanker on the standard TD5 route from West Africa to Philadelphia. This was only a decrease of WS11 points, from WS93, from the first quarter of 2010. This price decline only serves to illustrate the continued weakness in the Suezmax shipping market. At the end of the fourth quarter of 2010, the worldwide Suezmax fleet totaled 410 vessels. Eleven vessels were delivered during the quarter and one was decommissioned, bringing the total to 420 vessels at the end of the first quarter of 2011. As was the case with the VLCC tankers, no new orders were placed during the quarter. Even so, the orderbook counted 135 vessels and an estimated 62 vessels are expected to be delivered this year. All of these new vessels will be added to a fleet that already has significant surplus capacity. This will continue to exert further downward pressure on Suezmax tanker charter rates.

For obvious reasons, higher spot prices for tanker charters would benefit Frontline and the entire shipping industry in general. Higher spot prices will generate more revenues for shipping companies and this should translate into higher profits (and dividends). This scenario shows no signs of happening at present. One of the primary reasons for the current troubles in the shipping industry is surplus capacity. As I detailed above, worldwide tanker fleets are expected to increase in size by a double-digit percentage this year. This large increase will be coming to a global fleet that is already plagued with excess capacity and demand that shows no signs that it will increase enough to absorb this increase in supply. This certainly has the potential to push charter prices down further, just as Frontline's chairman predicts.

Frontline looks like it is facing strong headwinds in the industry and while the company is well-managed, I cannot see a compelling reason to invest in the firm at this time. Frontline's management themselves state that they cannot see any recovery in the shipping market for a minimum of one to two years. As I stated in my previous article (linked above), Frontline's strategy at this time is to ride out the weakness in the industry and position the company to grow as the sector eventually strengthens. This could be a multi-year process and the stock price could fall further if this sector grows weaker. At this point, I am going to sit on the sidelines and watch this company and the industry for any signs of improvement before jumping in.

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