Frontline: How Geopolitical Shifts Are Steering Growth For Tanker Operations

seekingalpha04-23

Frontline's dividend offers a strong 9.4% yield, thanks to strong growth and favourable market conditions.Frontline's strong revenue and EPS growth should help in reducing debt risk.Geopolitical ...

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SHanscheInvestment Thesis In my opinion, looking at the global outlook for 2024 and 2025, and how Frontline plc (NYSE:FRO) stands to benefit as a result, I believe the company is a buy. The last 12 months (LTM) for Frontline has seen revenue and profitability grow considerably which has resulted in a dividend with a great yield. The company has seen heightened demand across the board which I believe is the result of geopolitical events and is something I will believe will continue to fuel the company’s growth for the foreseeable future. Having done a valuation of the company, it suggests there’s a fair bit of upside potential and therefore I believe it’s a buy. Introduction With my goal of becoming financially free in the back of my head, I keep telling myself that I have to stay patient and focused on picking stocks that I can understand. Doing this should allow me to beat the market in the long run. On top of that, it’s also about making sure I’m not overpaying for them which can sometimes be the most challenging part. With the world of geopolitics seemingly changing every week at the moment, there are certain industries which stand to benefit from uncertainty. A company that has seen its price soar since the turn of the decade is Frontline which has grown more than 200% since the start of 2022. And given that global instability seems set to continue, it has got me thinking that there’s potential for more upside with FRO stock. Company Profile Frontline is an international shipping company which is headquartered in Limassol, Cyprus since 2022 that specializes in the transportation of crude oil and refined petroleum. The company operates a global fleet which contains very large crude carriers ((VLCCs)), Suezmax and LR2 / Aframax. The company’s business revolves around the operation of their tankers within both spot and time charter markets to transport crude oil and refined petroleum around the world. Several global events over the past few years such as the war in Ukraine, Red Sea crisis and Israel-Palestine conflict, has sent shockwaves through the global supply chain and appears to have massively changed the operating environment for FRO, pushing up the stock price. For example, in the last 3 years, the stock has grown 221.3%, from $7.38 to $22.89 today, a very impressive (CAGR) of 47.8%. Dividend Discussion As I’m a dividend investor, I’m always looking to invest in businesses that pay a sustainable dividend as I see it as an excellent way to build passive income and believe it’s also a telling sign of a company’s financial health. Given my investment strategy, one of the first things that struck me about FRO was their impressive dividend. Frontline has a choppy dividend track record which I believe reflects its cyclical nature. The company has seen dividend raises on an annual basis in the last 2 years and has two years in the past decade where they did not pay a dividend. In the last 10 years the (CAGR) of FRO’s dividend is approximately 17.7%, even when considering the cuts and pauses that have happened during that period, although it’s worth noting much of this dividend growth has come in the last year. Today Frontline’s (LTM) dividend is $2.17 which, based on the current price of $22.89, equals a very enticing dividend yield of 9.4% which is far more than the S&P500 average dividend yield of 1.35%.   Frontline's Dividend growth rate visualized (Division One Dividend)Additionally, Frontline has a payout ratio of 97.3% which is a sustainable payout ratio in my opinion and leads me to believe that they can maintain this dividend amount so long as the company can continue growing. Interestingly, Frontline’s dividend policy differs from that of most companies which pay the same quarterly dividend each quarter for a year. Frontline aims to pay quarterly dividends to shareholders equal to or close to adjusted earnings per share ((EPS) and is at the discretion of the Board of Directors. When compared to some of its competitors that also pay a dividend like Teekay Tankers (TNK) and SFL Corporation (SFL), Frontline has a more sustainable dividend payout ratio than SFL but not as sustainable as TNK. FRO’s dividend yield compared to the aforementioned competitors is more attractive, yielding 9.4% as I mentioned against 1.8% and 7.7% for TNK and SFL respectively. Financial Discussion In my opinion, Frontline, has had a solid financial performance over the past decade. Despite the typical highs and lows, the company has managed to generally trend higher across its top and bottom lines. On the revenue front, it rose from $240 million in 2014 to $1.8 billion in the (LTM), a (CAGR) of 25%, although it should be noted that this revenue experienced several year-on-year drops of more than 10% during this period. FRO has also grown its bottom line at a respectable rate, the (EPS), an important profitability metric in my opinion, has grown from $1.60 in 2014 to $2.95 today. During the last decade, the company had multiple years of negative (EPS) which I believe highlights the cyclical nature of the business and is definitely something investors need to be mindful of when considering Frontline.   Frontline's Revenue growth visualized (Division One Dividend)As for the balance sheet and the company’s liquidity, it seems to me to be in a manageable position despite its large debt positions. Frontline has a net debt position of approximately $3.14 billion compared to $308 million of cash and cash equivalents. The company also has a negative free cash flow (FCF) of $775 million, which upon initial inspections raises concerns for me. However, much of the company’s negative (FCF) yield is the result of growth capital expenditure, used to further expand the business which should result in increased revenue and profitability in the future. Additionally, the company has no newbuilding commitments and no meaningful debt maturities until 2027, which encourages me that the company will be able to pay down its debts to a more manageable level over the coming years. Turning to more recent events, the latest quarterly earnings highlighted the impressive year FRO has experienced, being that it’s their strongest full year result in 15 years, despite a slow Q4. For Q4 2023, management reported full year revenues are up 26% compared to the year prior, while (EPS) was reported to be up nearly 33% for the year. Additionally, the company announced the sale and refinancing of a number of vessels which enables the company to further pay down debt and I believe slightly reduces the debt risk of the company. On the dividend front, the company announced its Q4 dividend but did not provide any indication on their 2024 plans, nor did they provide any guidance for their upcoming year or earnings. I believe that given the current market conditions which has seen trade routes disrupted and energy demands altered, we will likely see further growth in 2024 as much of these changed conditions result in increased tanker demands in my opinion. Strong Tanker Demand Fuelling Further Growth As I mentioned before, there have been a number of geopolitical events in the past few years that have impacted demand and supply chains for commodities such as crude oil and refined petroleum. These events, while not good for the world as a whole, have seen the demand for tankers rise as it has changed trade routes, meaning that ships are having to travel further to reach their destinations. I believe that these unique supply and demand dynamics will fuel the growth of Frontline out until at least 2025. Looking specifically at the demand side of the industry, BIMCO’s Chief Shipping Analyst estimates that crude tanker demand will increase by 6.5-7.5% in 2024 and 2-3% in 2025, while the rise in sailing distances caused by the Red Sea crisis is anticipated to boost demand in the months of 2024. Additionally, the ongoing trend of shifting supply to the Americas and crude demand to Asia will contribute to average sailing distances in both 2024 and 2025. I believe that this is a positive for FRO as it results in an increase in tonne-miles and freight rates which generally translates into higher-utilization and higher-revenue per voyage. Furthermore, we are in a unique situation where customers are unable to seek alternative markets or methods of transporting crude oil and refined petroleum, whether through choice or necessity. For example, the EU’s sanctions on Russia following their invasion of Ukraine have resulted in Russian oil exports to the EU falling more than 90% which has resulted in the EU needing to find new markets to obtain oil, whilst Russia has needed to find new customers. The resulting outcome has been that the Europe now buys much of its oil from Norway, Kazakhstan and most notably the U.S., while Russia now sells most of its oil to India and China. The thing to note here in my opinion is, while it obviously it increases travel distance as I mentioned, there is no alternative transportation method like there was prior, so when shipping prices soar for whatever reason, pipelines and land transportation cannot help to meet demand.   Russian energy exports to the EU (Bruegel)Valuation Frontline’s previous decade of growth has been strong in my opinion and suggests that the business has successfully leveraged debt to become a major tanker operator. While the company has been on a remarkable run over the past few years, being that it’s up more than 200%, the current Seeking Alpha valuation grade of a B+ suggests that the business may be somewhat undervalued. This sentiment is reflected by Wall Street which has assigned a buy rating, although its current (PE) ratio indicates it’s probably close to its fair value being that its slightly above its 3-year average PE ratio. For me to determine the valuation of Frontline I have decided to value the company using their (EPS). FRO's (EPS) for 2023 was reported at $2.95. If we assume a variable growth rate, starting at 17% in year 1 and slowing to 2% by year 5, an average of 6.8% per year, in line with their historical (EPS) growth rate, Frontline’s (EPS) is estimated to be $3.95 by 2028. I believe this growth projection, seems reasonable given Frontline's fleet modernization and expansion and the favourable market conditions. The estimated share price in 2028, considering a (PE) ratio of 7.5 would therefore be around $24.32. This suggests that a (CAGR) of 13% is possible for investors if buying at today’s share price. Based on the expected return from the valuation model and considering the outlook of the business I believe that at the current price of $22.89, FRO is a buy.   Valuation of Frontline (Division One Dividend)Risks To Consider There’s a fair bit of risk associated with my investment thesis. To start with, a lot of Frontline’s success in the coming years depends on the global economy and consequently the demand for crude oil and refined petroleum products. Should we experience at recession or other event which causes a collapse in the demand for oil then we would likely see a drop in demand for oil tankers as a result. I believe this would reduce the revenue and profits for FRO and would put them in a difficult financial position as the company has recently completed a massive fleet modernization, much of which was financed by debt. Repaying this debt would then become harder to achieve without seriously impacting the financial health of the business, not to mention that we would likely see a significant decline in the stock price. Takeaway  What I take away from looking into Frontline is that the company has experienced a very strong last 12 months which has led to an explosion in the stock’s price and the company’s dividend. In my opinion, the company can expect further growth over the next year as I expect the geopolitical environment to keep tanker demand high. So long as the global economy remains resilient and oil and petroleum demand stays healthy, I believe that FRO is a buy, given the potential return it offers.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2429116194"}