A Perfect Income Storm: Shipping Companies

12/26/2011 9:00 am EST


Jim Trippon

Editor-in-Chief, China Stock Digest

There are some important lessons to be drawn from the woeful tale of shipping companies during the past couple of years, notes Jim Trippon of Dividend Genius.

With the recent news from shipper Frontline (FRO) that it would not only pay no dividend for the quarter but that the company would likely run out of cash in the first quarter next year, it was a vivid investing illustration of risk come to life.

The earnings report issued by the crude oil transporter was a stark reminder of just how quickly things can change in investing, including dividend investing. Frontline, as have many of the water transportation companies, has run into a difficult global business environment and may have run aground with its latest results.

The sobering quarterly report released by Frontline gets to the heart of things on page 5. The financial highlights for the third quarter stand out boldly: a net loss, excluding impairment charges, of $44.7 million, which is a net loss per share excluding impairment of 57 cents. The recognized impairment loss is $121.4 million, with the overall net loss for the quarter of $166.2 million.

According to Frontline’s company press release, it posted a $12.3 million profit in last year’s third quarter, or an EPS of 16 cents. On this year’s report, beneath the income data was a line that dividend investors hate to see: "Dividends declared per share Q3-11: $0."

Flip over to the last page on the report, page 23, and take in the following chilling note: "Cash situation worsening, unless market recovers, expecting to run out of cash during Q1-12." The cryptic line beneath doesn’t provide much reassurance: "Working on various solutions/scenarios."

Frontline has paid dividends since 2002, recently paid an annual dividend that yielded more than 15%, and has averaged an annual yield in the last few years of roughly 18%. Its stock traded in the last 52 weeks at $27.76 a share, but recently closed at $2.95 per share.

It has a market cap of more than $220 million, which has shriveled as the stock has lost 90% of its value. Operating revenues for the third quarter in 2011 fell to $173 million from $251 million in the third quarter of 2010, while operating revenue for the January to September period, the first three quarters of 2011, fell to $628 million from $940 million.

The company listed $191 million in cash on its balance sheet with $2.3 billion in long term liabilities as of the just reported third quarter.

Some of Frontline’s difficulties are immediately apparent beyond the numbers and the company’s own warning about its future prospects. Frontline sketched out the bleak outlook for its industry with its market update, which notes that although world oil consumption is up, US crude shipments are declining in the face of the slowing economy.

The company mentioned the possibility that China has of building new ships on the horizon, in a market that has become oversupplied as it is. Frontline succinctly summarized these market difficulties as simply too many ships, reduced mile-ton scenario, reduced US imports, and importantly, confidence loss.

There is a combination of industry issues with weaker demand now and for the near term, so this is something that all the crude transporters are facing. Others in the sector, such as Overseas Holdings (OSG), Nordic American Tankers (NAT) and Ship Finance International (SFL) are all feeling similar pressure.

But Frontline has had chronic fundamental issues with its high debt, and now with declining margins and the cost and availability of capital pressuring the company, these issues have become acute, so its prospects aren’t good. The potential remedies or moves that might have alleviated some of that pressure—such as selling vessels sooner, not paying out the extravagant dividend, and slashing operating costs—may not be viable anymore.

The Story for Investors
Perhaps CEO John Fredriksen will be able to engineer some moves that will pull Frontline out of its tailspin, or perhaps industry conditions will improve. Neither case looks likely.

The message for investors is that Frontline shareholders have taken a punishing loss of equity value as the stock has spiraled downward, and those holding it for its dividend have seen that payment erased. It’s likely that investors may end up with nothing, if Frontline goes into a complete death spiral.

Nobody’s happy about this—only the shorts, perhaps. For any investor, though, to come away with something positive from this would be to study the run-up to what went wrong in the industry and the company, learn from that, and be able to apply it to other potential investments.

An immediate application is to dig into the financials of any shipping stocks you might hold right now, as well as to watch your dividend stocks for unsustainable payout levels. Part of the necessary work of pointing out profitable opportunities is also the important task of identifying things to avoid, to show what could and did go wrong.

In that sense, pain aside for shareholders, Frontline can be an important lesson for all investors.

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