Frontline Stock: Large Fleet, Great Specs, and Attractive Yields (NYSE:FRO)

Note: I covered Frontline plc (NYSE: FRO) in January 2024. We appreciated the company’s large fleet, strong balance sheet and reasonable valuation. At the time, tanker market fundamentals were supportive. The order book of crude oil vessels was below 5% and the number of vessels older than 20 years was increasing. On the other hand, tonne-mile demand was resilient due to the Red Sea crisis and stable oil demand.

In conclusion, we give FRO a Buy rating. In May, FRO’s stock price reached $28.6/share, only to return to $21.8/share as a result of the weak season.

In today’s article, I discuss FRO 2Q24 results and review the crude oil market.

Introduction

When when we talk about tanks, 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 equipped with scrubbers.

The company reported good results in T224 given the seasonality of daily rates. FRO continues to pay dividends with attractive yields and, unlike its smaller peers DHT Holdings ( DHT ) and Okeanis ECO Tankers ( ECO ), maintains a payout ratio below 80%.

Tank rates have more room to grow in my opinion. Therefore, investing in crude oil tanks are still attractive, especially given dividend yields. In short, FRO once again receives a Buy rating.

Fleet

Let’s start with the company’s fleet. In the 2Q24 report, FRO stated a fleet of 82 vessels, 41 VLCCs, 23 Suezmax tankers and 18 LR2/Aframax tankers, with a total capacity of approximately 17.9 million DWT. 56% of ships have ships equipped with scrubbers. The average age of the fleet is 6.2 years.

99% of the company’s ships are ECO. This means that the triad – engine, hull and propeller – is optimized for fuel efficiency. Usually in ECO, ships are installed with larger but reduced engines. The hull is designed with an optimal hydrodynamic shape that matches the engine speed and propeller specifications.

FRO is proactively renewing its fleet. In January 2024, the company agreed to sell its five oldest VLCCs, built in 2009 and 2010, for a net price of US$290.0 million. Three vessels were delivered to the new owner in 1Q24, and the others in 2Q24. After repaying the existing debt facilities for those tankers, FRO realized net cash proceeds of approximately $208.0 million.

As of early 2024, FRO has sold three of the older Suezmax tankers and buildings since 2010. The first two sales have closed, and after paying off the vessel’s debt, FRO has generated net proceeds of $25.6 million. Net proceeds of the latest transaction of $18.0 million are expected in the 424th quarter.

The image below from the FRO 2T24 presentation shows the characteristics of the company’s fleet.

The VLCC segment has the second highest percentage of scrubber vessels at 63% or 26 vessels in total. The Suezmax segment has 15 scrubber vessels, representing 65% of the total. Only four of the company’s Aframax/LR2s have scrubbers.

The graph on the right shows the cost effectiveness of FRO. It illustrates the company’s daily OPEX and cash breakeven by segment and fleet level.

Breakeven at the fleet level is $25,700/day. This is higher than the VLCC-only DHT figure of $23,600/day or the TNK (Aframax and Suezmax Shipowner) $15,000/day. However, TNK and DHT have much smaller debts. 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 charges. The result is an increase in the break-even point.

On the other hand, daily FRO OPEX is competitive due to the age profile of the vessel. The fleet 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 lower debt service expenses and lower operating expenses. FRO favors the latter over the former.

Let’s see now how profitable FRO tanks are. The table is from the FRO 2Q24 report.

In the second quarter, FRO achieved average TCE for VLCC, Suezmax and LR2/Aframax tankers of $49,600, $45,600 and $53,100 per day respectively. Not bad if we count weaker 2Q rates. For 3Q24, FRO contracted 79% of its VLCCs at $47,700/d, 85% of its Suezmax tankers at $41,900/d and 65% of its Aframax tankers at $50,100/d.

Funding of quarter 224

The table below shows the results for 2Q24 and 2Q23.

FRO reported revenue of $607.5 million for T224, compared to $522 million in T223. The improved revenue is due to the net vessel receipts, which were discussed in the previous section. Travel expenses increased by $41 million to $197 million in Q224, offsetting higher revenues. Net operating income was almost unchanged from last year at $255.9 million in Q224. EPS fell from $1.04/share to $0.84/share over the same period.

FRO posted better QoQ EPS performance at $0.84/share for 2Q24 versus $0.81/share for 1Q24. Revenue and operating income fluctuated in a narrow range, $556 million versus $578 million and $204 million versus $208 million.

FRO has improved its balance sheet in recent months by restructuring debt. In May 2024, the company entered into a US$606 million secured debt facility with China Exim Bank and DNB to refinance eight Suezmax tankers and eight Aframax/LR2 tankers. The facility matures over nine years and has an interest rate of SOFR plus a margin in line with FRO’s existing borrowing facilities. In June, the company drew $306 million from the facility. The remaining $300.2 was drawn 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 deal matures in 10 years and carries a SOFR +1.8% interest rate. A portion of the proceeds were used to repay the $275 million credit facility with Hemen.

The FRO maintains an adequate balance sheet taking into account the company’s liquidity and solvency. The company has 159% total debt/equity and 62.4% total debt/total assets. For 2Q24, it reported operating income of $204 million and operating cash flow of $237 million. Gross interest expense in the same period was $73 million. In other words, FRO covers its debt service costs many times over.

Frontline declared a dividend of $0.62/share for 2Q24. This equates to 9.59% trailing LTM yield. The payout ratio is 78%, lower than the company’s competitors with similar yields. ECO and DHT distribute almost 100% of their net income. This is good for shareholders when daily rates are strong, although there is no margin of safety. During market contraction, FRO has spare firepower to keep yields attractive.

ASSESSMENT

To estimate FRO NAV, I use data from Fearnley’s weekly reports. The inputs to 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. On a NAV basis, FRO is cheaper than ECO, the only competitor with a younger fleet.

Meanwhile, FRO’s NAV is the same as Nordic American (NAT) and DHT. The former is a Suezmax-only company, while the latter is a VLCC-only company. Both companies have old fleets with an average age of 10.5 years for DHT and 12.6 for NAT respectively.

First line trades at high multiples. The chart below compares EV/Sales and EV/EBITDA for crude oil tanker owners.

FRO has a large fleet with excellent specifications and the market knows it. Only Euronav NV (CMBT) trades at a higher EV/EBITDA.

However, Euronav is no longer an oil play. The company acquired CMB.TECH earlier this year. Now its fleet includes 161 vessels from different segments: dry bulk, containers, product tankers, crude oil tankers and ferries.

Last year, Frontline bought 24 VLCCs from Euronav. In my opinion, the timing of the purchase was right. However, Euronav’s move to become a diversified shipowner is questionable. To recap, Frontline’s valuation is still attractive at current NPV and multiples.

risks

Oil tankers face well-known risks. The first is weaker demand for oil based on global economic performance. The supply side in shipping cannot respond quickly to economic fluctuations. Combined with weaker demand for oil, it could lead to a supply glut. However, I believe this is not the case.

Sourcing can work for us too. Compared to demand, ship supply is inelastic. Building a ship takes 12-18 months in most cases. On the contrary, demand for ton-miles is very irregular. As a result, supply is always too late to meet new demand, leading to vessel shortages or oversupply. I think we are still in the first half of the tank cycle. We have a shortage of tankers 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, up 1.0 mbpd from 1Q24. Demand is expected to accelerate in 2H24, potentially reaching 104.9 mpbd in December 2024. The Red Sea crisis is still affecting supply chains. With increasing oil demand and limited shipping routes, ton-mile demand will likely continue to rise.

FRO is one of the most leveraged companies. This adds liquidity risk when contracting daily rates. The company’s operating figures adequately cover interest expenses. Moreover, FRO has $367 million in cash, more than double its annual gross interest expense of $170.5 million. That said, FRO maintains a solid liquidity cushion for rainy days.

Investor Takeaway

Frontline is the most popular tank stock for good reason. The company owns 82 tanks, which are 6.2 years old. In addition, more than half of FRO vessels 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. In summary, the tank cycle still has room to grow, and Frontline is among the best ways to expose yourself to this theme. I give FRO a Buy rating.