|Shares Out. (in M):||0||P/E|
|Market Cap (in $M):||677||P/FCF|
|Net Debt (in $M):||0||EBIT||0||0|
|Entry||10/14/2001 08:06 PM|
|I can't say I understand how this translates into dollars per day, but I know that tanker rates are measured on something called "worldscale rates." Looking at a ten year monthly chart of these rates on Bloomberg (specifically Persian Gulf to Japan, a route that I presume uses VLCC's), it appears that rates have probably averaged about 60 to 80 for all that time period, and the sharp spike in late 2000 to 180 may have been a fluke, which was quickly reversed.|
What made it so strong last year - just the strong world wide economy? Now that rates are back to their usual range, is there anything other than a war that might send them back up again any time soon? If rates stay here for another couple of years, what do you see as the upside for FRO? How much cheaper is it than the other tanker stocks like TK and OMM, for example? Finally, how does one translate from Worldscale to dollars per day?
Thanks. Nice write up.
|Entry||10/15/2001 01:15 AM|
|This is an amazing company, thanks for the write-up. Let me play devil's advocate for a second with a couple comments/questions:|
It seems that the biggest issue with this stock is its massive debt load. Just as there is optionality in FRO generating 600mm in cash flow, The market seems be factoring in the optionality that if VLCC rates do in fact go below the floor you described, this company could potentially face bankruptcy. Can you elaborate on the "floor."
As I try and get comfortable with the debt load, I am happy to see that the debt associated with Golden Ocean is non-recourse to the parent. But should the company be distributing cash like it did in the form of its $1 dividend last quarter if there is in fact a real probability of a bankruptcy? Lets not forget that the average rate FRO recieved in 1999 was $20,000 a day for its VLCCs. We are definitely seeing better demand for double hulled younger ships but at $20,000 a day would FRO be able to pay interest expense?
I think if you can minimize the potential risk of a liquidity crunch and display that this company can without a doubt survive a prolonged depressed rate environment then you are absolutely right, this company is a steal. Will debt covenants allow FRO to sell ships to pay interest expense should they need the cash to pay interest?
With the incredible volatility in day rates, how did you calculate NAV? What is the NAV / enterpise value? Isn't it more prudent to look at this % since the company is so extremely levered? instead of looking at NAV-Debt/equity?
Can you comment on why VLCC rates have underperformed relative to the smaller pears, Suezmax etc.? Are VLCCs too large for many routes?
Is this company cheaper than TK on an NAV to enterprise value basis? Is there a reason why an investor would rather place a long term bet on VLCCs vs. Aframax?
Thanks for the great write-up.
|Entry||10/15/2001 12:00 PM|
|Thanks for the comments. |
Other rates you might look at is Persian Gulf to US Gulf, also look at Persian Gulf to Japan and australia for 80kdwt to see aframx rates relevant to TK. My bet is that after last years spike in rates, given the fundamentals in the sector, rates will bove to a higher base than the previous 10 years. There may be a shakeout before that happens, but that would be a positive for the leaders in the sector, such as FRO and TK. Here are some thoughts related to your points:
1) What made it so strong last year - just the strong world-wide economy?
* Erika spill created the two tiered market I mentioned, effectively reduced supply charterers were willing to accept.
* A switch from OPEC cutting production in 1999 (after the price of oil had collapsed to $10) to increases in production.
* At the same time US stocks of Crude were at 27 year lows, so refineries needed crude, and that continued through the spring of 2001 as refiners refined like crazy to take advantage of the favorable refining margins in anticipation of the summer driving season.
2) Now that rates are back to their usual range, is there anything other than a war that might send them back up again any time soon?
* US inventories are still low by historical standards. A cold winter could keep them low or even push them lower, setting the stage for refiners scrambling for supplies in the spring. If the economy picks up in the spring, that would add further fuel to the fire.
* But remember, if demand continues to fall, we have a warm summer, OPEC continues to cut production, then not only will rates not rise, but they will fall. Rates are currently at the $40,000/day level.
3) If rates stay here for another couple of years, what do you see as the upside for FRO?
* If rates stayed at these levels for a couple of years, then FRO would continue to generate strong cash flows, repay debt, and opportunistically acquire vessels from weaker competitors.
* My feeling here is that time is FRO’s side. As time passes, more of the 1970’s built VLCCs will be scrapped as global oil demand continues to grow (as economic growth resumes in the developed world, as as emerging markets continue to catch up in terms of their per capita energy consumption.)
* As the positive trends continue in the sector, as FRO continues to deleverage and become a more stable company, the valuation should reflect these trends. Could FRO trade at 1x book? Yes. Could it trade at 1.5x book? Yes.
* I think that as these companies become larger and more stable, they will be perceived as more similar to Oil Services companies and they should be able to move from an asset based valuation to an earnings based valuation.
4) How much cheaper is it than the other tanker stocks like TK and OMM, for example?
* About 20% and 30% cheaper than OMM and TK on a NAV basis.
* By the way, TK is my favorite stock in the group. It has far less debt than FRO, and is much better positioned for a downturn in the tanker market. They have less leverage to the upside in a tanker boom, and the orderbook/pipeline for Aframaxes looks more full than VLCCs, but TK is definitely the blue chip in this space, has a lot of fixed rate businesses (ie long term time charters for their vessels) and management is very conservative. TK was my original application recommendation (it was not published).
5) Finally, how does one translate from Worldscale to dollars per day?
* Unfortunately I do not have a quick answer on this one. Worldscale is an arcane system, but very useful in ‘scaling’ rates so as to take into account different vessel sizes as well as different route distances. I have not figured out a way to quickly translate from worldscale to $/day. What I do is look at the $ rates over time as they become available, and use those for analysis, and then use the worldscale rates for a particular class of vessels and voyages, to get a sense for the short term direction of the markets.
|Entry||10/15/2001 03:33 PM|
|1) It seems that the biggest issue with this stock is its massive debt load. Just as there is optionality in FRO generating 600mm in cash flow, The market seems be factoring in the optionality that if VLCC rates do in fact go below the floor you described, this company could potentially face bankruptcy. Can you elaborate on the "floor."|
* Good point. I would agree with you in that the market must be factoring bankruptcy.
* FRO shows a chart (calculated by research firm Platou Research, which you can see at their website under ‘presentations’) plotting the different rates achieved by old versus new tankers. The relationship seems pretty strong. Additionally, it seems that whereas up until May there was minimal scrapping activity, in the May to July time frame scrapping picked up substantially. Interestingly, just today I read that 3 more 1970’s VLCCs were scrapped.
* The other factor to keep in mind is utilization rates. At some level of rates, older tonnage will basically sit idle. Not only do we have to take into account the rate differential between old and new tonnage, but also the different utilization. It is this higher level of utilization (per given level of rates) which translates into TK and FRO earning “premium rates” over the market averages. Thus, when rates fall charterers will opt for new tonnage, and although the market rate for an old tanker might be $15,000/day, the reality will be that the older vessels will simply not be employed. This adds tremendous pressure for older vessels to be scrapped.
* I’d like to add another thought here: just as it seems to be in OPEC’s favor to have oil prices oscillate fairly widely around a high average point (so as to make it difficult, risky and hence unlikely for new capacity to be added), I believe it is in TK and FRO’s interest that rates not stay too high for too long. I think that in certain cases when FRO could hold back capacity to try to sustain prices, sometimes FRO actually “floods the market” by accepting lower rates. Their intent is to scare the smaller operators into scrapping and/or not ordering new vessels.
2.1) But should the company be distributing cash like it did in the form of its $1 dividend last quarter if there is in fact a real probability of a bankruptcy?
* I agree with you that perhaps it would have been wiser to keep the cash. FRO’s management is the opposite of TK’s. Whereas TK is extremely cautious and conservative, FRO’s is aggressive and bullish. They are either foolhardy, and/or have a very strong conviction that 1) the above mentioned ‘floor’ will hold, 2) the outlook for the VLCC trade will pick up more quickly than the market anticipates, 3) IMO scrapping will pick up at a quicker pace given the cost of special surveys and given any weaker rate environment. In any case FRO’s money is where their mouth is.
2.2) at $20,000 a day would FRO be able to pay interest expense?
* At $22,000 a day FRO could pay interest expenses, lease requirements and installments. So the quick answer to your question would be no.
* In 1999 the average TCE rate on modern VLCCs fell to $21,900 with a low of $16,400 touched in August. The corresponding rates for old tankers were $14,900 and $8,300, respectively. The Erika disaster only happened in December 1999, and that definitely slowed down the recovery in rates for older tankers in January 2000 as modern rates picked up.
* Also, currently a larger proportion of VLCCs is over, or approaching, 25 years of age. This would lead me to assume that if rates got weak these would get scrapped sooner as they are faced with mandatory scrapping.
* Again, as I mentioned above, when rates get weak for older tonnage their utilization also drops, further hurting the owners and making the scrap decision more appealing.
2.3) Will debt covenants allow FRO to sell ships to pay interest expense should they need the cash to pay interest?
* My guess is that FRO’s covenants might FORCE them to sell ships should they need cash for interest payments.
More to follow on next post.
|Entry||10/15/2001 03:34 PM|
|3) With the incredible volatility in day rates, how did you calculate NAV? What is the NAV / enterpise value? Isn't it more prudent to look at this % since the company is so extremely levered? instead of looking at NAV-Debt/equity?|
* NAV is calculated by taking the value of second hand vessels (and the market value of options on newbuild contracts), adding cash and subtracting debt.
* It is a volatile calculation, because the price of the vessels change during the cycle. Also, if you would have to liquidate a fleet (which would usually only happen in a weak environment) the price of second hand vessels would fall further.
4) Can you comment on why VLCC rates have underperformed relative to the smaller pears, Suezmax etc.? Are VLCCs too large for many routes?
* Like all tanker rates, VLCC rates are very volatile. They can rise far more than the rates for the other classes of tankers due to the economies of scale they can achieve (lower transportation cost per barrel). In the very short term they can also fall more. It all depends on where they happen to be located and on the demand at those locations. If there are too many ships in the gulf, and no demand there, rates plummet. But the following week might be the opposite. If business is very slow in their normal Arabian Gulf routes, they will move to other trades, particularly to the West Africa- US gulf routes, traditionally dominated by Suezmaxes. When this happens, Suezmax rates fall dramatically. I think we saw this in the second and third quarters this year. In fact, from Q2 to Q3, VLCC rates have fallen less than Suezmax rates. Aframax rates in the US gulf are probably the most volatile rates (in the very short term, ie from week to week), given the shorter distance of the voyages.
* I would say that that Suezmax business is the trade where rates are most at risk. This is because they can face competition from VLCCs when times are tough, and as Aframaxes get biger and biger, they can encroach on Suezmax turf as well.
* Yes, VLCCs are too big for many routes. For example Caribbean to US Gulf , Northern European trade, and some of the shorter indo-pacific routes (which TK dominates with its Aframaxes). And this does insulate Aframax owners from some of the VLCC competition. But when oil needs to be shipped from the Arabian Gulf, the VLCCs take over and have fantastic upside. So part of your decision on VLCC vs. Aframax investments has to with your judgement on the longer term ‘call’ on OPEC (AG) oil. My bet is that this is where the largest quantity of ‘cheap-to-lift’ oil is, and that hence over the medium to long term, VLCC fundamentals remain solid.
Hope this helps.
|Entry||10/15/2001 04:21 PM|
Thank you for the thoughtful response.
Great Idea. Great write up.
|Entry||10/15/2001 09:16 PM|
|Thanks for the write-up!|
When I was an economics student in college (a number of years ago I might add) my professor used this industry as an exmple of a "perfectly competitive marketplace". What he meant was that the industry had low barriers to entry and exit, all competitors were price takers, the product/service was homogenous, prices were transparent, and the prospect for any competitor sustaining revenues above its total average costs were remote.
I think we might all agree that this is not an ideal industry in which to be a long-term equity investor, but we might also agree that trading profits can be made here for aggressive investors.
I'd look for absolute lows in day rates to jump into the equity and wonder whether, in your opinion, we are there yet.
You refer to a "break even" day rate for the company on a net income basis. My experience with businesses in industries like this one is that products/services get offered at prices as low as the direct cash marginal cost of supplying the product/service. For example, in the paper industry mills often produce product at a loss as long as the product price covers the cash direct costs required to keep the mill running (wood, chemicals, labor, energy etc). When you slap on overheads, depreciation, and accruals the business actually looses quite a bit of money at the direct cash breakeven point.
I wonder whether in this perfectly competitive industry day rates might not fall substantially below the net income breakeven you refer to. If so, should we wait until we get to that point to buy the stock, regardless of the current trading multiples?
|Subject||Circle of competence|
|Entry||10/15/2001 11:32 PM|
|Very interesting write-up. I too am looking at TK -- could you post your write-up on this that you mentioned?|
The main problem I have with investing in this personally is that I don't have any expertise or contacts in this industry, and a lot of reading isn't going to help much I fear. One of the quickest ways to lose money is to invest in an indebted company in a commodity, cyclical industry when the P/E is the lowest -- which often reflects earnings at a cyclical peak. If I were to buy the stock tomorrow, I would have to assume that the seller knows a lot more than I do. Is there any argument for why this would be a prudent investment by someone from outside the industry?
|Entry||10/16/2001 05:33 PM|
|1) When I was an economics student in college (a number of years ago I might add) my professor used this industry as an exmple of a "perfectly competitive marketplace". What he meant was that the industry had low barriers to entry and exit, all competitors were price takers, the product/service was homogenous, prices were transparent, and the prospect for any competitor sustaining revenues above its total average costs were remote. |
I think we might all agree that this is not an ideal industry in which to be a long-term equity investor, but we might also agree that trading profits can be made here for aggressive investors.
* Your professor was/is correct. (and I too remember with fondness my college days) This is/was a market best described by perfect competition. Many small, weak, leveraged competitors. These competitors have an information disadvantage vs. the few, strong, charterers. Indeed tanker owners are price takers. Low barriers to entry. But a number of factors are impacting this sector, particularly regulation, environmental concerns and consolidation.
* Regulation is impacting the supply side. Over time many more new, double hull ships will be built. But the good news is that the forced scrapping is putting a lid on supply for the next several years.
* Consolidation is also changing the industry structure. TK and FRO are getting to a scale (FRO thanks to its participation in the TI pool) where they begin to have an information advantage over the charterers, and definitely over the smaller competitors. Also, TK and FRO actually do generate “premium” rates, thanks to their scale, triangulation opportunities and the fact that charterers are far more sensitive to ecological concerns/risks, and hence require modern ships they are familiar with. As these leaders emerge, they are in a position to negotiate longer term contracts with charterers.
* Consolidation is also leading to stronger balance sheets and a reduction in reliance on covenant heavy bank debt (particularly true for TK). This will make it possible for companies like TK to really take advantage of a market downturn and further build their lead. TK right now has the ability to borrow $1bln! They are just waiting to take advantage of a downswing.
* So I agree that an aggressive investor can make trading profits in this group, but I think that over the next 5 years there is the possibility that the leaders in this group rationalize this business. So I think that the current market is providing a positive risk-return for a long term investor.
2) I'd look for absolute lows in day rates to jump into the equity and wonder whether, in your opinion, we are there yet.
* No I do not think we are at the absolute lows on day rates. Absolute lows will be made when owners of older tonnage are losing money (at $15,000/day). At current $40,000/day, Frontline is earning strong profits. The equity market is discounting rates well below $20,000/day.
rest of answers to follow
|Entry||10/16/2001 05:35 PM|
|3) You refer to a "break even" day rate for the company on a net income basis. My experience with businesses in industries like this one is that products/services get offered at prices as low as the direct cash marginal cost of supplying the product/service. For example, in the paper industry mills often produce product at a loss as long as the product price covers the cash direct costs required to keep the mill running (wood, chemicals, labor, energy etc). When you slap on overheads, depreciation, and accruals the business actually looses quite a bit of money at the direct cash breakeven point. I wonder whether in this perfectly competitive industry day rates might not fall substantially below the net income breakeven you refer to. If so, should we wait until we get to that point to buy the stock, regardless of the current trading multiples?|
* Frontline’s Cash breakeven rate is $22,000/day for VLCCs. Yes, again I agree with you that in a perfectly competitive industry rates can and do fall to marginal cost. That cash breakeven rate is around $15,000/day for an old VLCC. The rates for these tankers will reach that level in a weak market. If they do, given that 1) expensive capital investments are required to upgrade an old vessel (of which there are many given that there was a building boom in the 70’s), and 2) that regulation imposes that the vessels be scrapped when they reach 25 years: owners will be even more likely to scrap, as they only have a short time frame to hope for rates to pick up. So the bet we are making is that if rates do fall to marginal cost, economic forces will reduce supply, and that owners of modern vessels will be shielded from the downturn given the premium rates they can achieve in the market.
* I don’t know where the bottom is on Frontline. Rates may very well drop to the marginal cost for the marginal user (remember that when rates fall that low, the marginal user will not only earn lower rate, but will also have a low utilization, while TK and FRO can keep earning day rates). And at that point these stocks may be even cheaper. But it would seem to me that the market is already discounting those marginal rates, and the question becomes: what happens when they get to that level? Do they stay there for a long time? Will FRO go bankrupt? Will OPEC keep reducing production? Or will demand pick up, and OPEC increase production, shortly after weaker owners, under heavy debt loads, scrapped their ships, or sold them to one of the industry leaders for a bargain price?
|Entry||10/16/2001 09:42 PM|
|Hey...thanks for making your thinking explicit for me. I'm a bit leary on this idea given my personal risk tolerance but wish you well with it.|
A final thought...I have on very few ocassions (the one exception I can think of is Nucor in steel) witnessed a competitor transform a structurally poor industry or develop a business model that shines on an absolute basis (consistently high returns on capital, solid balance sheet, reasonable rates of growth, moderate capital requirements). As an alumnus of the paper industry, I've watched the big guys get bigger to no avail...little value has been created for shareholders in the industry over the past number of years.
The winners in poor industries change the rules dramatically or respond to external factors (regulation etc) uniquely. Perhaps FRO will succeed, but I'm not ready to bank on it.
Otherwise, what you have is a trading call requiring good timing on purchase and sale as industry conditions fluctuate.
|Subject||Modern VLCC Premium?|
|Entry||10/19/2001 01:59 PM|
|Hi, Potato559 --|
It seems that a good chunk of your investment thesis is
that there is floor roughly at break-even for FRO's fleet
because they have a cost advantage relative to older VLCCS.
If rates go much below break-even, then old ships will be
TankerWorld, however, indicates that there is possibility
that older vessels could be paid higher rates:
Any thoughts on how likely this is? Does this change your
thinking on the relative merits of different segments of the
|Subject||Fredriksen setting up a squeez|
|Entry||10/24/2001 07:46 AM|
|John Fredriksen, who controls 46% of Frontline, has lent 700,000 of his own shares to short-sellers. This will certainly allow the company's (off-b/s through Scotia)repurchase plan get a better price on FRO shares. Is Fredriksen also potentially setting up a short-squeeze? Any thoughts on what might be going through Fredriksen's head?|
|Subject||Tanker Rates---old vs. new|
|Entry||10/24/2001 07:08 PM|
|There is almost no chance that this will hold up if indeed it is presently true on even one route. The overriding fact is that single-hull tankers break apart more easily and the owners/charterers of those tankers take tremendous risk in using them. |
In fact right now the charterer of the Erica, which busted up off France 12/99, is now under prosecution for having used this single-hull vessel. We should expect more of the same in the future and this will deter the use of older ships.
|Entry||10/24/2001 07:13 PM|
|The management of Frontline are savvy people and have the most capital market smarts of all the tanker companies we follow. I think your suggestion of an eventual squeeze could be accurate as Frederiksen clearly doesn't need the interest (if he needs money, he likely will need huge amounts in the future and not 5% yearly). |
The buyback proceeds daily and, because it is listed in Norway, we can read about it as it happens practically. Frontline provides a lot of bluster about the future of the VLCC market but they also seem to be smart about taking risks. If the risk were very large that the company would be likely to fail shortly (as the equity price is close to implying), I can't see the company buying back the stock as they have.
|Subject||valuation/ day rates|
|Entry||08/15/2002 05:53 PM|
|Hi- nice writeup. I am surprised to see that day rates have fallen so much (to the 10-15K/day range). Why has this happened? I don't get it.|
A recent sell side report mentioned expectation of 1-2% net tanker growth for both 02 and 03. I find this surprising given the mandated scrapping you mentioned. Is newbuild activity that strong? If so, does the fact that so many tankers are being ordered tell us that the industry does not expect current day rates to stay this low, since one requires rates of 30K/day for new tanker investment to make sense?