Representing the backbone of Mr Fredriksen’s oil tanker investments and spanning two decades, Frontline is still going strong after several transformational years from the verge of bankruptcy in early 2015 to the current sturdy fleet growth and pursuit of M&A possibilities. Although adding a 25% premium to underlying values, we still see significant downside to the share price given the lackluster outlook for oil tankers. We initiate coverage with a SELL rating and target price of USD 3.2 (-51%).
Liquidity: Even though oil tankers earnings have dropped significantly from the peak in 2015 and the company continues to pay dividends (USD 0.15/sh in 4Q16) ahead of a massive USD 839m capex in 2017E, we are not too concerned about liquidity as long as the cyclical trough does not drag out beyond our recovery penciled in for 2019E. Net LTV at 91% on a fully delivered basis and assuming another 10% fall in asset prices is concerning, but the company has a proven masters degree in financial engineering and there are several options available, including the abolition of dividends.
Valuation: We calculate a current NAV of USD 5.0/sh, but see significant downside due to continued falling asset prices, aging of the fleet and limited cash flow generation. Our target price of USD 3.2/sh (NOK 27/sh equiv.) is based on a weighted average of current/future NAV and mid-cycle multiples in 2019E, at a 25% premium reflecting a historical P/NAV>1 and strong sponsor.
Market overview: After enjoying a brief peak in 2015, oil tanker earnings were soon subdued again as overly eager owners contracted too many ships in the cyclical expansion, resulting in a rapidly increasing net fleet growth from 1Q16. The elevated supply growth persists, with a net fleet growth of 2.0% in 1Q17 alone. We forecast net fleet growth of 7% in 2017E, 4% in ‘18E and 2% in ‘19E. Although supply growth in 2019E implies a pivotal point in the cycle, recent increase in contracting (annualized YTD 5% of the fleet, 336% above same period 2016) could hamper a potential recovery in 2019.
We forecast a low but steady demand growth of 3% in 2017E, 4% in ‘18E and 5% in ‘19E. Although implied demand growth in 2016E was negative, US crude oil imports on a tonne-mile basis increased some 18% and has continued the trend YTD. However, we expect the tonne-mile growth to abate or even reverse going forward as consumption growth is muted while recent increase in the rig count will likely increase domestic production (see graphs below). Looking to China, crude oil imports on a tonne-mile basis increased around 14% in 2016E, but we expect the growth to subside somewhat as leading indicators point to a cooling of the Chinese economy.
In sum, we expect utilization to fall 3%p to 82% in 2017E, down another 1%p in ‘18E before the recovery starts in ‘19E with utilization rising 2%p to 83%. Given the forward-looking nature of share and asset prices, and the historical significant relationship between the two; we forecast 3Q17E-2Q18E to represent the share price trough. More specifically, we expect that increasing earnings will lead to rising asset and share prices from 2H18E, and believe just prior or just after the next winter season (circa Oct’17-Feb’18) to be an opportune moment to BUY, all else equal.