JP Morgan is calling for a short squeeze in the shares of Frontline Ltd. (NYSE:FRO) ahead of earnings on this Friday:
Potentially stronger-than-expected 2Q09 rates could result in an EPS surprise . . . . SFL’s 2Q09 profit-sharing revenue came in $2.8 million above our forecast as we believe that FRO employed several of its vessels on short-term contracts throughout 2Q (likely for storage purposes) at rates that far exceeded the soft spot market levels. After backing into the implied rates earned on those vessels (and leaving all else unchanged in our model), we believe that FRO could easily exceed the recently raised average Street forecast of $0.03 and the losses estimated by many analysts (ourselves included).
. . . and lend support to FRO’s dividend-payout potential. There has been significant doubt among investors and analysts regarding the sustainability of FRO’s recent $0.25-per-share dividend distribution. Indeed, we believed that FRO might be forced to suspend its dividend in the 1Q09 release as the company had unfunded capital commitments that exceeded $1 billion. FRO has since canceled orders, removing more than half of these capital commitments, and if it has a greater-than-expected profit in 2Q and there are any potential further newbuild cancellations, we believe that FRO may be able to maintain its dividend again in 2Q, which may catch some investors by surprise.
Near-term catalyst risk outweighs reward to a short position, in our view. EPS upside to estimates across the shipping space in the 2Q09 earnings season has been greatly rewarded with large share-price gains, particularly for those stocks with material short interest. Given FRO’s 7% short interest (as a percentage of the float) and a potential EPS beat on Friday, we believe the near-term-catalyst risk outweighs the reward to a short position this week. We reiterate our longer-term Underweight rating on FRO shares given the company’s highly levered balance sheet as well as its high operational exposure to the extremely soft tanker spot market, which should result in severely challenged earnings results for the remainder of 2009.
Action: I like this call a lot, especially due to the Underweight rating JP Morgan has on the stock. Highlighting near-term catalysts contrary to their longer-term view adds credibility.
What to do with the stock? Must say tanker stocks are difficult to trade, they are bound to squeeze on downgrades & give back gains after upgrades. Frontline is also listed in Europe making the opening price dependent on European trading. So the best way to play it is probably buying right after the open unless overall market or sector collapses.