Shares of oil tanker shipping company Frontline Ltd. (FRO, Financial) are down 50% this year. The stock is currently trading at a trailing 12-month price-earnings ratio of 2.77. This indicates a potential case of massive undervaluation based on the Peter Lynch chart:
However, when we look a little forward, it becomes clear why this stock may not be undervalued. Its forward 12-month price-earnings ratio of 10.33 suggests that earnings per share are expected to decrease over the next 12 months.
Frontline operates in an industry that has stagnated over the past couple of years amid the increasing use of pipelines rather than tankers for oil transportation. The company had the largest oil tanker fleet as of 2008, when it peaked to trade at an all-time high price of $350 per share. However, unlike some of its peers, it has never really adapted to the future of the oil industry or recovered from the financial crash that occurred in 2008.
Highlights from fiscal 3rd-quarter results
The company reported its most recent quarterly results last week, which beat predictions on revenue but missed on earnings. Frontline posted earnings per share of $0.29 on revenue of $247.4 million. This compares to Wall Street estimates of $0.32 in earnings per share and $184.4 million in revenue.
The company decided not to pay dividends to shareholders, despite posting a positive bottom line, a decision that was met with questions during the earnings conference call. Frontline's interim CEO Lars Barstad responded, "Q3 earnings were good but our visibility looking into Q4 doesn't look great. We are in the middle of a global pandemic. We decided to keep the cash."
The company's stock price is up 22% this month amid surging oil prices, but there are still uncertainties on output going into 2021. OPEC is still in discussions to determine whether to extend the ongoing output cuts to next year amid bottlenecks created by the pandemic.
Total global fleet capacity for oil tankers continues to slow amid changing shipping technologies. Frontline acknowledged in a presentation that tanker orderbooks are at 20-year lows as more vessels reach retirement age.
While this may be good for the bottom line in the long-term because they will be posted as impairment write-downs, it could become more difficult to grow the top line. Acquiring new vessels will require more financial outlay, which could have negative consequences on the bottom line.
Conclusion
Frontline appears to be trading at incredibly attractive valuation multiples. However, this could be a value trap given the expected slowdown in the global oil tankers business and the short-term unpredictability of oil prices.
Disclosure: No position in the stocks mentioned.
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