Antony Velikagathu
In conclusion, I gave FRO a Buy rating. In May, FRO’s share price reached $28.6/share, only to return to $21.8/share, following weak seasonality.
In today’s article, I discuss FRO 2Q24 results and review the crude oil tanker market.
Introduction
When we talk tankers, Frontline comes to mind. The company owns a fleet of 41 VLCCs, 23 Suezmax, and 18 Aframax tankers. Financially, FRO maintains a leveraged balance sheet for a large shipping company with 159% Total Debt/Equity. Its fleet has an average age of 6.2 years, and 56% of the vessels are scrubber-equipped.
The company reported good 2Q24 results, considering day rates' seasonality. FRO keeps paying dividends with attractive yields, and unlike its smaller peers, DHT Holdings (DHT) and Okeanis ECO Tankers (ECO), it keeps the payout ratio below 80%.
Tanker rates have more room to grow, in my opinion. Therefore, investing in crude tankers is still attractive, especially considering dividend yields. In summary, FRO again gets a Buy Rating.
Fleet
Let’s start with the company’s fleet. In the 2Q24 report, FRO declared a fleet of 82 vessels, 41 VLCCs, 23 Suezmax tankers, and 18 LR2/Aframax tankers, with an aggregate capacity of approximately 17.9 million DWT. 56% of the ships have scrubber-fitted vessels. The fleetwide average age is 6.2 years.
99% of the company’s vessels are ECO. This means the triad—engine, hull, and propeller—is optimized for fuel efficiency. Typically, in ECO, ships are installed with larger but derated engines. The hull is designed with optimal hydrodynamic form, matching engine rate and propeller specs.
FRO proactively renews its fleet. In January 2024, the company agreed to sell its five oldest VLCCs, built in 2009 and 2010, for a net price of $290.0 million. Three vessels were delivered to the new owner in 1Q24 and the other in 2Q24. After repaying the existing debt facilities for those tankers, FRO realized net cash proceeds of approximately $208.0 million.
Since the beginning of 2024, FRO has sold three of its older Suezmax tankers and 2010 buildings. The first two sales are complete, and after repaying vessel debts, FRO generated net proceeds of $25.6 million. The last deal's net proceeds of $18.0 million are expected in 4Q24.
The image below from the FRO 2Q24 presentation shows the company’s fleet's characteristics.
FRO 2Q24 presentation
The VLCC segment has the second-highest percentage of ships with scrubbers, 63% or 26 ships total. The Suezmax segment has 15 ships with scrubbers, representing 65% of the total. Only four of the company’s Aframax/LR2 have scrubbers.
The right chart shows FRO's cost efficiency. It illustrates the company's daily OPEX and cash breakeven per segment and fleetwide.
Fleetwide breakeven is $25,700/day. It is higher than the VLCC-only DHT figure of $23,600/day or TNK (Aframax and Suezmax-only shipowner) $15,000/day. Nevertheless, TNK and DHT have much lower debt. Let’s take gross LTV as a measure: 3% for TNK, 21% for DHT, and 48% for FRO. The Frontline fleet is superior, given its specifications, but this comes with a price, a higher LTV, and debt service expenses. The result is rising cash breakeven.
On the other hand, FRO daily OPEX is competitive due to the ship's age profile. The fleetwide figure is $7,600/day, 10.5% lower than TNK’s $8,523/day. TNK has an average age of 14.7 years and a DHT of 10.5 years. The trade-off is between low debt service expenses and low operating expenses. FRO favors the latter at the expense on the former.
Let’s see now how profitable FRO tankers are. The table is from FRO 2Q24 report.
FRO 2Q24 report
In the second quarter, FRO achieved average TCE for VLCCs, Suezmax tankers, and LR2/Aframax tankers of $49,600, $45,600, and $53,100 per day, respectively. That is not bad if we count weaker 2Q rates. For 3Q24, FRO contracted 79% of its VLCC at $47,700/day, 85% of its Suezmax tankers at $41,900/day, and 65% of its Aframax tankers at $50,100/day.
2Q24 financials
The table below shows the 2Q24 and 2Q23 results.
FRO 2Q24 report
FRO reported a revenue of $607.5 million for 2Q24, compared with $522 million in 2Q23. Improved revenues are due to vessels' net proceeds, which were discussed in the previous section. Voyage expenses increased by $41 million, reaching $197 million in 2Q24, offsetting higher revenues. Net operating income remained nearly unchanged YoY, $255.9 million in 2Q24. EPS declined from $1.04/share to $0.84/share over the same period.
FRO recorded better EPS performance on a QoQ basis, $0.84/share for 2Q24 vs $0.81/share for 1Q24. Revenues and operating income fluctuated in the narrow range, $556 million vs. $578 million and $204 million vs $208 million.
FRO improved its balance sheet in the last months by restructuring its debt. In May 2024, the company entered into a $606 million senior secured debt facility with China Exim Bank and DNB to refinance eight Suezmax tankers and eight Aframax/LR2 tankers. The facility matures in nine years and carries an interest rate of SOFR plus a margin in line with FRO’s existing loan facilities. In June, the company drew down $306 million from the facility. The remaining $300.2 was drawn down in August 2024.
In July 2024, the Company secured a $521 million commitment from CMB Financial Leasing for a sale-and-leaseback to refinance 10 Suezmax tankers. The agreement matures in 10 years and carries an interest rate of SOFR +1.8%. Part of the proceeds were used to repay the $275 million credit facility with Hemen.
FRO maintains an adequate balance sheet considers the company’s liquidity and solvency. The company has 159% Total Debt/Equity and 62.4% Total Liabilities/Total Assets. For 2Q24, it reported $204 million operating income and $237 million operating cash flows. Gross Interest expenses over the same period were $73 million. In other words, FRO covers its debt service costs multiple times.
Frontline declared a dividend of $0.62/share for 2Q24. This equals 9.59% trailing LTM yield. The payout ratio is 78%, lower than the company’s competitors with similar yields. ECO and DHT distribute nearly 100% of their net income. This is good for shareholders when the day rates are strong, although there is no margin of safety. During market contraction, FRO has some spare firepower to keep yields attractive.
Valuation
To estimate FRO NAV, I use data from Fearnley’s weekly reports. Inputs for the NAV equation are:
- Fleet replacement value: $8,100 million
- Current assets: $859 million
- Total Liabilities: $4,003 million
- Total Debt: $3,860 million
FRO’s market capitalization is $4,850 million, while its net asset value is $4,956 million, resulting in 98% PNAV and 48% LTV. Based on NAV, FRO is cheaper than ECO, the only competitor with a younger fleet.
In the meantime, FRO’s NAV is the same as Nordic American (NAT) and DHT. The former is a Suezmax-only company, while the latter is VLCC-only. Both companies have aging fleets with average ages of 10.5 years for DHT and 12.6 for NAT, respectively.
Frontline trades at high multiples. The graph below compares EV/Sales and EV/EBITDA for crude oil tanker owners.
Koyfin
FRO owns a large fleet with excellent specifications, and the market knows it. Only Euronav NV (CMBT) trades at higher EV/EBITDA.
However, Euronav is no longer crude tanker play. The company acquired CMB.TECH earlier this year. Now, its fleet includes 161 vessels across various segments: dry bulk, container, product tankers, crude oil tankers, and ferries.
Last year, Frontline bought 24 VLCC from Euronav. In my opinion, the timing of the acquisition was right. However, Euronav's move to become a diversified shipowner is questionable. To recap, Frontline valuation is still attractive at the present NAV and multiples.
Risks
Oil tankers face well-known risks. The prime one is weaker oil demand as a function of global economic performance. The supply side in shipping cannot respond quickly to economic fluctuations. Combined with weaker oil demand, it could lead to a supply glut. However, I believe this is not the case.
Supply can work for us, too. Compared to demand, the vessel’s supply is inelastic. Building a ship takes 12–18 months in most instances. On the contrary, tonne-mile demand is very erratic. Therefore, supply is always too late to respond to new demand, resulting in vessel shortages or supply glut. I believe we are still in the first half of the tanker cycle. We have a tankers deficit due to a low order book, an aging fleet, and a lack of shipyard capacity.
Global oil demand is still resilient. The Energy Information Administration (EIA) reported that it averaged 102.8 mbpd in 2Q24 of 2024, 1.0 mbpd higher than 1Q24. Demand is expected to accelerate in 2H24, potentially reaching 104.9 mpbd in December 2024. The Red Sea crisis still impacts supply chains. With growing oil demand and constrained shipping routes, tonne-mile demand will likely keep rising.
FRO is one of the most leveraged tanker companies. This adds a liquidity risk in case of contracting day rates. The company's operating figures adequately cover its interest expenses. Moreover, FRO has $367 million in cash, more than double the gross annual interest expense of $170.5 million. That said, FRO maintains a solid liquidity cushion for rainy days.
Investors Takeaway
Frontline is the most popular tanker stock for a good reason. The company owns 82 tankers, which are 6.2 years old. Besides that, more than half of the FRO’s ships have scrubbers installed.
Financially, FRO is in a strong position, holding adequate cash reserves and delivering solid operating figures. Its relatively new fleet results in lower daily OPEX compared to its peers with older fleets.
Another reason to like FRO is its dividend yield and relatively low payout ratio. To recap, the tanker cycle still has room to grow, and Frontline is among the best ways to get exposed to that theme. I give FRO a Buy rating.
