I said that if an alien came to visit, I’d be embarrassed to tell them that we fight wars to pull fossil fuels out of the ground to run our transportation. They’d be like, ‘What?’ − Neil deGrasse Tyson
Crude transporter Frontline (FRO) operates VLCCs, Suezmaxes, and Long Range 2 (LR2) tankers. Though the company reported the strongest results in a decade in Q2 2020, its tanker booking rates for Q3 2020 witnessed a drop. Despite the fallen Q3 2020 rates, the company is expected to perform at a steady pace in 2021–22.
In Q2 2020, FRO’s VLCCs earned $75,800/day, Suezmaxes earned $51,100/day, and LR2s made approximately $37,000/day. For Q3 2020, FRO has booked 76% of its VLCCs at $61,000/day, 77% of its Suezmaxes at $29,500/day, and 66% of its LR2s at $14,500/day. The bookings are made for 6 months and do not include long-term time rates.
The fallen Q3 2020 rates are more than adequate to cover the average cash breakeven number of $19,100/day.
Image Source: FRO’s Q2 2020 Earnings Call
In the near term, FRO may bounce around because of its solid Q2 2020 results and a not so bad Q3 2020 outlook. In the long run, everything depends on how the crude tanker demand shapes up. Here is an analysis of FRO’s current valuation and prospects, along with my recommendation:
Image Source: FRO’s Profitability Grade
FRO is a sector outperformer from the profitability point of view. A TTM EBITDA margin of 43.99%, TTM Return on Equity of 18.89%, and a TTM Return on Total Assets of 6.64% as compared to the sector averages of 32.65%, −9.01%, and −2.51%, respectively, suggest that FRO is efficiently managed and ahead of its peers. These numbers are as of August 27, 2020.
Because of the reduced tanker booking rates in Q3 2020, as discussed earlier, the company’s revenues and profits will witness a drop. As the bookings are for 6 months, we can expect profitability in Q3 and Q4 2020 to be muted.
FRO’s Prospects in 2021
As per FRO’s management team, the freight market is sailing in uncharted waters even though there are signs of recovery as economies reopen. The estimate is that demand will be choppy from here on until the virus is contained.
Crude tanker freight rates have been sliding downhill since the middle of April 2020. Oil demand destruction, refineries running at reduced capacities, the global slowdown, and the OPEC production cuts have combined to pressurize the rates. However, the demand will spike in the winters and OPEC will most likely relax the cuts. Also, the world may get to hear some positive news on virus containment or herd immunity by the end of 2020 or early 2021.
Image Source: Simpson, Spence, Young Website
There’s another factor working in FRO’s favor – the global crude tanker fleet numbers are shrinking. By the end of 2021, the company’s management team estimates that globally there will be 65 vessels aged 20+ years and another 85 vessels aged 17.5+ years. These tankers will likely not be used thereafter. The reduced transportation capacity will help increase the rates. FRO owns the youngest fleet in the industry and has the lowest cash breakeven rates in the sector. It estimates to do very well in 2021–22.
FRO’s Cash Flow Management
In Q2 2020, the company generated operating cash flows of $204.7 million. It borrowed $544 million to pay for new tankers worth $561 million and repaid its unsecured facility of $59 million. It also refinanced two loans worth $349 million due in December 2020 and March 2021. At the end of Q2 2020, the company has $462 million in cash and cash equivalents.
The company will invest $161.1 million in four LR2 tankers in 2021, two of which will be delivered by February 2021, and the rest are expected in August 2021.
The cash balances are adequate to help the company pass through any rough patch, which it will not have to because most of its fleet is booked for Q3 and Q4 2020.
From the information available as of August 27, 2020, I estimate that FRO will experience reasonably steady earnings from Q3 2020 to Q4 2021. In the very long run, oil production is likely to take a hit because the transition to EVs will pick up pace. So, FRO does not qualify as a long-term investment pick.
The company has declared $1.20 divided in H1 2020 and is on track to pay a total of $2 for the whole year. The payout will result in a monster dividend yield of 25.74% based on its closing price of $7.77 as of August 27, 2020.
Dividend investors can consider buying the stock for the medium term because it is expected to perform steadily in 2021–22. And who knows, an oil market contango can crawl out of the woodwork and help investors make some capital gains as well.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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