Frontline's Earnings

Frontline reported its earnings for the third quarter 2008 today. I wrote about a week ago that I would be surprised if the report were not a good one. Whether the report was a good one depends on how you look at it.

Earnings per share were $1.39, $0.20 lower than the analyst consensus and around 67% lower than last quarter. However, earnings per share this quarter were over 4.6 times higher than the same quarter last year.

Daily rates averaged $74,700 for VLCCs. This is down from $86,300 a day last quarter, but up significantly from the $36,000 daily rate recorded in the third quarter of 2007. Average Suezmax daily rates were $62,700 in the third quarter of 2008, down from $72,000 in the second quarter, but up from $25,000 recorded in the third quarter last year.

Besides the analyst earnings miss (if one looks at what the analysts say at all, it's probably better to look at the lowest estimate), the disappointing news is that the dividend will be $0.50 a share for this quarter. Some will view this as a dividend cut. That's one way to see it. But the company does not have a stable dividend, and determines its payout each quarter based on earnings and future outlook. If the recession does not turn into a depression and/or the demand for oil eventually increases, dividend payments will be higher in the future.

For November, the company reports that its costs are $34,700 for VLCCs and $24,800 for the Suezmax fleet daily. As this does not include capital expenditures and loan repayments, costs can increase if FRO is unable to refinance its loans as they mature--a possibility with today's fragile credit market. Costs can also increase if docking fees, etc go up. Avoiding Somali pirates, for example, may make trips longer and more expensive.

Lower demand for oil and more tankers competing for transporting that oil will probably lower daily rates in the coming year. Daily rates in the third quarter were very volatile. VLCC rates were as low as $29,500 per day (below current costs) and as high as $164,000 per day. Suezmax rates were as low as $41,500 a day and as high as $153,000. If rates average at the lower end of these ranges, as is likely, the dividend may be lower in the coming year.

Frontline owes around $1.4 billion for new builds that it'll pay for over the next four years, having already paid almost $400 million. The company expects to receive 18 new build ships (10 VLCCs and 8 Suezmaxes) by the second quarter of 2012. "If credit market doesn't improve before 2012 [the company's] dividend capacity [may be reduced] temporarily," Frontline stated in its most recent report.

The outlook is grim, and the share price can certainly go lower. The company's average P/E for the last five years is around 4.7. The high estimate for 2009 is $6.17 a share. The low estimate is $2.10. If FRO continues trading around 4.7 times earnings, earnings estimates suggest a share price range of around $10 to $30. Investor pessimism/optimism can, of course, alter the P/E dramatically. For example, the trailing P/E right now is under 3.

I hope the share price falls, because I want to buy some shares. I'll look to start buying small amounts after the ex-dividend day, which is December 5, 2008, but will hold off on any big purchases until the economic picture is bleaker (which would potentially signal a turnaround).


1929 and Now

I previously wrote about how we got into this mess here. A number of articles have since sprung up, comparing 1929 and the 1930s to now, and arguing that we shouldn't be that worried. Things will be tough, they say, but they won't be depression tough. I thought I'd go over a few of their points that I didn't find very reassuring.

A depression is unlikely for the reasons in the bullet points, according to the articles:

  • With no deposit insurance, people lost around $140 billion in savings as about 9,000 banks failed in the 1930s. Today, by contrast, we have the FDIC. Of the bank failures so far, all insured deposits have been recovered, along with about half of people's uninsured deposits (and this figure could well rise).
FDIC is certainly helpful. But here are some potential problems. If more banks fail, as is expected, the FDIC will require more funds. Congress will, of course, recapitalize the FDIC. Meanwhile, all the bailouts (what's the total now? $7 trillion?) are putting a serious strain on the government's already stressed balance sheet. It's possible, and getting likelier with each new bailout (the latest $800 billion plan to buy mortgages, credit card debt, etc apparently doesn't even need Congress to pass anything), that the United States could itself go bankrupt. Our losses by way of currency devaluation can easily offset any benefits from deposit insurance.

Moreover, how much do Americans actually have in savings? The savings rate has been at historic lows, and has even been negative in recent years.

It is true that capital gains are not part of the calculation. However, our markets have lost trillions of dollars. A lot of the money that went into the stock market rather than savings accounts in the last few years has evaporated. Far more Americans own stocks today than did in the 1920s. There haven't been very many capital gains on houses recently either.

Add to the low savings rate a massive amount of debt. Before the Great Depression, total debt was 260% of GDP. As of the end of June 2008, total debt was 356.5% of GDP. Before the US fell into the Great Depression, it was a net creditor nation and ran trade surpluses. Today, we are the world's largest debtor nation, and are running trade deficits. We are also involved in two expensive wars, which was not the case in the 1930s (until World War II came along).

  • Before the great depression, most households had only one wage earner. Today, on the other hand, most households have two wage earners. One spouse's paycheck makes the family's burden a little less as the other spouse searches for work.
Real wages have declined for years. In many cases it now takes two wage earners to adequately support the family. It certainly helps that one spouse still works, but it may not be enough for many families. Looking for work is becoming more difficult with each passing day.

  • Before the Great Depression, there were no safety nets. Today, by contrast, in addition to FDIC, we have things like unemployment insurance, Social Security, Medicare, and private pensions.
That's true, but how long do these things last? Some states are already running out of unemployment insurance money. According to the National Employment Law Project, as of November six states don't have enough to cover a year of payments, eight states have about six months of reserves left, and five states have less than three months of reserves left--they are insolvent. As unemployment grows (remember, we're probably only at the start of this thing with regard to job losses), more states will experience trouble.

Those unemployment insurance trusts in trouble now are forced to borrow from the Federal government, which is itself running huge deficits. They are also considering decreasing unemployment benefits and increasing unemployment taxes on those still fortunate enough to be working. Both of these will curb consumer spending, resulting in more job losses. It sucks when the bad things reinforce each other.

Social Security and Medicare have been in trouble for years, but will probably continue to function. Social Security income will probably be taxed more.

Private pensions are worrisome. With businesses going bankrupt or being otherwise unable to pay benefits (which were under funded to begin with and have suffered more losses as stocks have crashed) to retired workers, the responsibility of paying pensioners falls on the Pension Benefit Guaranty Corporation (PBGC). The entity was established by Congress in 1974 to protect pensioners whose employers cannot pay their pensions. It's supposed to protect around 44 million US workers.

As pretty much all government agencies, the PBGC has been run by idiots. Early this year, it was estimated that the entity had a deficit of $14 billion. To make up for this shortfall, the PBGC doubled its stock allocation to 45% of its portfolio and added another 10% to such investments as hedge funds. I guess that plan didn't work very well. Sooner or later, the PBGC will have to be bailed out by the Federal government, have to lower benefits, and/or increase premiums for those companies (decreasing in number) that still pay it to insure their pensions.

So yes, we do have a safety net. It seems, though, that it has holes big enough for many people to fall through.

  • Stocks have not declined as much in value as they did during the great depression. Foreclosures and the unemployment rate are not yet up to Depression era levels either.

That's true. But that's not an argument for why we won't have a depression. It only indicates that we're not there yet (and let's hope we won't ever get there).

  • While the government at the start of the Great Depression did boost spending and brought emergency relief to companies and individuals, it also raised taxes, raised interest rates, and imposed tariffs on imports, starting a trade war that collapsed global trade. By contrast, our leaders have learned much from history. They have acted quickly with a stimulus package (and more to come), bailed out Fannie Mae, Freddie Mac, AIG, and Citigroup (more to come), and have cut rates to historic lows (not much more to come).

Our leaders are idiots (I'm not claiming to be any smarter than them), and if our economy's health depends on them, we're probably screwed. The same people who got us into this mess are the ones who are in charge. Obama's appointees are cut from the same cloth, more likely to bail out their Wall Street friends than do what is right. Does it make sense to try to solve a problem caused by excessive borrowing by borrowing more?

While he may change his mind, two of Obama's big promises were protecting American workers from globalization (another Smoot-Hawley Act perhaps?) and raising taxes (on capital gains, and the rich).

Supposing Obama won't follow through on these potentially destructive policies, what's he going to do? More bailouts, more government spending, and the like? I hope it makes everything all better. But will it? (And what's to prevent other countries from putting up their own tariffs and walking away from trade treaties?)

The system is clogged. Consumers can't borrow anymore. Their credit lines are maxed out, and they owe more on their mortgages than their houses are worth. Banks are now wary of lending, and there's a good possibility they don't really have any money left to lend. An estimated 72% of our economic activity comes from consumer spending, much of it with borrowed money. That percentage will shrink, and not because of growth in other areas of the economy.

It's plain that we don't manufacture very many things anymore. Cars are one of the few major things that we do produce here. But sales are plummeting. The troubled big three employ around 355,000 American workers. Ten percent of US workers, however, are employed in a related industry (suppliers, dealers, local businesses, media companies that depend on auto advertisements, etc). Either the big three automakers go bankrupt, and an estimated 5.5 million jobs are lost over the next two years (estimated by GM, so the real number will hopefully be much smaller), or the government pays their expenses (because sales sure won't pay for them) and we have zombie car companies.

As the banks have lined up, so have the automakers. The homebuilders are right behind them with their hands out. Who's next? Bailing these companies out prevents others from taking their place, because of too much supply. Japan, which kept its banks from failing by stuffing them with money, still hasn't recovered from its housing bubble. It's taken 20 years.

It all comes down to this: the more bailouts, the more the government has to borrow. The more it borrows, the more likely it will go bankrupt and/or the dollar will collapse. All the current solutions aim to return us back to business as usual. If they succeed, we'll have a small boom, as fake as our last boom, and then another, more painful bust.

Some, like famed investor Jim Rogers, argue that if we stop trying to prevent the collapse--stop bailing out the gamblers, the irresponsible, and the incompetent at the expense of those who saved and followed the rules, we will have a major recession from which we come out stronger. Pain is inevitable. Taking it later rather than now will be far more painful. South Korea, for example, let its corporations fail in its last financial crisis. Now it's one of the world's fastest growing economies.

I don't know who's right, but things look grim no matter how one looks at them. I hope Ben Stein is right and there's only a few billion dollars worth of troubled assets out there.

It will soon be time to start shorting long term Treasuries (TLT). The ETF just made a new 52 week high. It seems that interest rates will have to rise, either because of attempts to lower the coming bout of inflation or because of a collapse in bond prices. US government bonds are pretty much the only asset class that has held up during the crisis. Sooner or later its bubble will burst too.