Why restructuring concerns weigh down Frontline's stock

Part 3
Why restructuring concerns weigh down Frontline's stock (Part 3 of 7)

Why Frontline’s high cash breakeven could mean underperformance

High breakeven cost

While rates in 2014 are expected to average above 2013, and Frontline could still perform well from here, its performance could lag. It’s also a riskier investment than its peers, Nordic American Tanker Ltd. (NAT), Tsakos Energy Navigation Ltd. (TNP), Teekay Tanker Ltd. (TNK), and the Guggenheim Shipping ETF (SEA).

Cash Breakeven CostEnlarge Graph

This is because Frontline has a high cash breakeven cost (the revenue it has to generate in order to cover estimated cash payments to run the business), which management estimates will be ~$25,200 a day for a VLCC vessel and $17,800 for a Suezmax tanker for the rest of 2014. The company’s higher cash breakeven costs are mainly due to interest and bareboat hire payments the company has to make to Ship Finance International Ltd. (SFL) and third parties.

High leverage

These lease contracts with SFL are generally considered financing activities. Under the accounting rule or common analyst practices, the present value of the contractual payments are recorded as assets, as if the company purchased the vessels. The same amount will be recorded as lease obligation–similar to debt. Given Frontline’s substantial amount of chartered-in vessels, it has one of the highest leverage in the industry. If rates soar, Frontline would tag along. But when rates are weak and the crude tanker industry’s recovery is slow, Frontline will likely burn more cash and trail peers with stronger financials.

Cash flow

Note the breakeven rates exclude nine VLCCs and Suezmax vessels under Frontline subsidiary ITCL following the recent sale of Ulysses. In a separate press release, ITCL estimated a cash breakeven rate of ~$32,600 per day for its three spot-trading VLCCs, and $21,300 per day for two VLCCs on bareboat charter (when just the vessel is chartered out without the provisions for crews).

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