joeygil
I like checking in with (major) shipping companies, whether I own them or not. It is a volatile industry, with long periods of subpar or terrible earnings and a rare incredible quarter. Occasionally, these are strung together into a few incredible years. Big picture, these companies are in a pretty good place because of the ongoing energy transition. Uncertainties around environmental standards make it harder to invest in transport capacity that is likely up to standard (meaning companies are careful about it) and there is much more potential for volatile regional demands for certain types of liquids. Product tankers greatly benefitted from some of that volatility caused by the war in Ukraine.
At the same time, that war has really been throwing me for a loop in some respects. On one hand, there are major sanctions in place, but meanwhile, the existence of a huge shadow fleet is tolerated. An environmental disaster waiting to happen if you ask me. The latest Frontline (NYSE:FRO) earnings call presentation included a slide claiming as much as 23% of the global fleet is engaged in sanctioned trade.
Shadow fleet dynamics (Frontline Earnings Presentation)
These sanctioned vessels are generally much older, and it has somewhat increased global supply in the short term. The shadow fleet is much less concerned with environmental regulations and safety, which allows them to operate for longer while still profitable. I also believe these ships are often not bothering with insurance as it is much more expensive compared to the regulated market.
Frontline is currently trading around ~$22. Analysts, keep in mind there are only 3 covering the stock, have consensus 24′ earnings at $2.66 and 25′ earnings at $3.14. The 24′ earnings have disappointed so far. There is some cause for optimism for the tail end of the year.
Tanker seasonality (Frontline Earnings presentation)
It is certainly possible the market will be a bit better over this quarter, but this should be priced in as well. Quite a bit of the fleet is under contract already, so it isn’t going to make a huge difference to the company’s immediate earnings or whether I’d consider it attractive.
The current stock price isn’t all that demanding. At $22, Frontline trades around 7x forward earnings. Tanker rates are notoriously volatile. Yet, the firm is profitable as-is with room to spare. FRO’s break-even rates in the mid-twenties (for the fleet) look solid to me. It is most likely for rates to disappoint mildly. Yet, there is plenty of upside possible in rates. Obviously, the fleet ages over time, but on average, ships are six years old and are either eco-vessels or equipped with scrubbers.
In my previous article I highlighted the Ukraine war, Houthi Red Sea activity, Dangote refinery and TMX pipeline as things that could continue to or start to help/hurt rates. The Dangote refinery is still getting up to full capacity and could still impact the market. The TMX pipeline does not appear to have moved the needle for VLCC’s, but the additional ton-mile demand could still trickle up towards the largest tankers.
While the shadow fleet probably hurt the regulated market in the short term, this could start impacting the market in reverse in the coming years. On the supply side, the order book should be around ~6% of the global fleet and mostly coming into the market between 2026. The source I linked says 2026 while FRO, on its latest call, said this was moved towards 2028.
Either way, that supply growth is not worrying me, especially given the delayed scrapping we’ve seen because of the dark fleet expansion. A recession could lead to terrible returns, but the debt maturity profile should give the company until around 27′ to weather ultra-low rates.
Finally, as reiterated on the last call, the company plans to pay out all excess cash flow and isn’t looking to acquire assets. It has quite a bit of liquidity, between $500-$600 million, and is done absorbing the large Euronav acquisition. To me, this still seems like a decent stock to hold. There is not really a particular imminent catalyst that screams buy now. Over time, an earnings spike, caused by some surprise event, could lead to very strong returns. If nothing happens and tanker rates disappoint slightly, this shouldn’t be an amazing investment, but it could still be reasonable.
