Frontline Floundering as Rates Sink

| About: Frontline Ltd. (FRO)
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Frontline Ltd (NYSE:FRO) owns and operates the largest fleet of tanker ships in the world. The company transports oil throughout the world, attempting to capitalize on the spot market rates for oil transport, rather than signing long term charters. When combined with Frontline's strategy to pay out excess earnings as dividends, this has created wild dividend swings for shareholders. After reporting Q1 earnings, shares of FRO fell hard, both on management's comments and comments from others in the industry. Shares currently trade in the mid $11s, barely above a 52-week low, and 2/3 below the 52-week high of $33.95. With the dividend at a dime, down from $0.75 in the first quarter of last year and from $5 in Q1 of 2005, has Frontline fallen far enough or will shares of this tanker company continue to sink?

The tough reality facing Frontline is that the tanker market is in oversupply, with too many ships having been built to transport too little oil between continents. This has caused the day rates for VLCC and Suezmax tankers to plummet, falling back down below $20,000/day for both types of ship at the end of Q1. These rates are well below the average of the last five years; however, the $20,000/day line has been supported for the better part of the last decade. Unfortunately, Frontline projected at the end of Q1 that the breakeven rate for its VLCC ships would be $29,700/day and for the Suezmax would be $24,700/day. Rates are currently at less than half those rates, trending lower on slowing growth in the US and uncertainty in the EU.

While the company sees higher oil demand coming from Japan as rebuilding ramps up in that nation, I'm not sure that economy on its own will be large enough to pull rates back to a profitable level for Frontline. Disruptions in Libyan production have also caused a drop in demand for oil tankers, although Saudi Arabia has been increasing production to make up for the shortfall. With new shipbuilding programs slowe but not stalled, it seems for the next year or two that the shipping market will remain weak. It would take a rapid rise in global growth to soak up the excess tanker capacity, as well as absorb the new tankers scheduled to be built over the next three years. Longer term, massive offshore oil fields off the coast of Brazil and rapidly increasing consumption of oil in both India and China should allow Frontline to reclaim profitability and raise its dividend, but near term the headwinds are strong.

While shares have fallen low enough that shares of Frontline currently yield 3.5%, it is still too early to dip a toe into the name. Falling charter rates caused by an industry oversupply will pressure earnings of Frontline, limiting the firm's ability to raise the dividend, and possibly calling the dividend into question. Investors looking for high yielding names in the shipping space can look to names such as Teekay LNG Partners (NYSE:TGP) for exposure to energy transportation in a much more balanced tanker market. Frontline will make it though this impasse, but it will take time for market conditions to improve, and investors can find better names to wait in as Frontline rights its ship.

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