Frontline Plc annual report, Q4 FY2015

Business context and reporting period

Frontline Ltd. filed this Form 20-F for the fiscal year ended December 31, 2015; it is an annual report, not a standalone fourth-quarter filing. Frontline transports crude oil and petroleum products using VLCC, Suezmax, LR2 and MR tankers. The November 30, 2015 merger with Frontline 2012 is accounted for as a reverse business acquisition: 2015 results include Frontline 2012 for the full year but Frontline Ltd. only from November 30, making comparisons with 2014—which reflects Frontline 2012 alone—limited.

Key financial metrics

Revenue increased 89.8%, primarily reflecting the merger, fleet growth and stronger tanker rates. Reported net operating income includes $108.9 million of gains on cancellation and sale of newbuilding contracts; it should not be read as a recurring operating margin. No directly comparable underlying margin is clearly provided. 2015 also included a $131.0 million discontinued-operations loss, principally related to Golden Ocean impairments and losses; total net income was $124.4 million.

At year-end, total assets were $2.89 billion and equity attributable to Frontline was $1.45 billion. Capital-lease obligations were recorded at $536.4 million, including $226.5 million of estimated contingent rental expense. The company reported a 0.9 debt-to-equity ratio, a measure that includes capital leases. Contractual obligations totaled $2.86 billion, including $1.45 billion of remaining newbuilding commitments. Of the latter, $683.1 million was scheduled for 2016 and $770.1 million for 2017.

Material changes versus the prior comparable period

• Fleet scale increased substantially through the merger. At year-end, the fleet comprised 88 vessels including newbuildings, with approximately 15 million dwt capacity; 28 vessels were under construction.
• Operating revenue rose 89.8% and TCE revenue more than doubled, driven by acquired vessels, charter-ins, deliveries and improved market rates. Voyage expenses rose only 5.8%, in part because lower bunker prices offset higher activity.
• Operating cash flow rose to $207.3 million from $58.6 million. Investing activities used $459.3 million, while financing activities provided $219.5 million.
• Reported debt increased, including through merger-related obligations and new borrowing. In December, Frontline refinanced several facilities and Ship Finance loan notes using a new $500.1 million secured term loan, due in 2020 at LIBOR plus 1.9%.
• Golden Ocean dry-bulk results were presented as discontinued operations following the June 2015 stock dividend. The 2015 discontinued loss was $131.0 million, compared with a $51.2 million loss in 2014.

Outlook, commentary, risks and unusual items

Management said market conditions improved during 2015 but emphasized that tanker rates and vessel values remain cyclical and volatile. For first-quarter 2016, estimated spot TCE rates were approximately $73,100 per day for owned and leased VLCCs, $36,700 for Suezmaxes, $26,500 for LR2s and $21,000 for MR tankers. Estimated average daily cash break-even TCE rates for the remainder of 2016 were $22,500, $17,600, $15,000 and $13,900, respectively. Break-even estimates exclude capital expenditures and contingent rental expense. Management believed cash and current and expected credit facilities would cover requirements for at least 12 months from December 31, 2015.

Newbuilding funding is a significant execution and liquidity risk: only up to $198.0 million of debt financing had been committed for six vessels, and management planned to fund the other 22 with debt and cash on hand. Loan covenants require value-adjusted equity, positive working capital and minimum free cash; vessel-value declines could trigger collateral or repayment requirements. All financial covenants were met at year-end. Other principal exposures include spot-market dependence (31 of 49 owned, leased or chartered-in vessels were on spot or index-linked employment), customer and counterparty risk, floating-rate debt, vessel impairment, environmental and safety liabilities, and refinancing availability.

The board adopted a policy targeting quarterly dividends equal to or close to earnings per share adjusted for non-recurring items, subject to board discretion and financial conditions. A $0.25-per-share dividend was paid in the fourth quarter of 2015, and $0.35 per share was declared in February 2016 for the fourth quarter. The filing also reports a February 2016 1-for-5 reverse share split.

Unusual accounting and control matters merit attention: the merger created $225.3 million of goodwill, and management noted the share price decline could prompt an impairment assessment. Management disclosed that Frontline 2012 had corrected reporting misstatements related to Golden Ocean consolidation before audited statements were issued. Frontline 2012 was excluded from the 2015 internal-control assessment because of the recent acquisition, despite representing 58% of year-end assets and 90% of 2015 revenue; the auditor’s internal-control opinion also excluded it. The auditor concluded controls were effective for the assessed company. The filing describes ordinary-course legal claims as not expected to have a material adverse effect, and an approximately $11 million guarantee of assigned property leases for which no liability was recorded.

Important facts for investors to verify

• Assess the post-merger run-rate separately from the reverse-acquisition accounting and the limited period of Frontline Ltd. results included in 2015.
• Reconcile earnings to recurring performance, particularly the $108.9 million newbuilding gains, Golden Ocean discontinued losses and other impairment or fair-value items.
• Confirm financing and liquidity for the $1.45 billion newbuilding program, including timing of installments and availability and terms of uncommitted funding.
• Review capital-lease obligations and Ship Finance profit-sharing terms, as well as covenant headroom and exposure to vessel-value declines.
• Track spot-market rates against the disclosed break-even estimates, and verify the sustainability of dividends given capital commitments and board discretion.
• Review goodwill valuation and internal-control coverage following the merger, including the acquired entity excluded from the year-end control assessment.