Shipping Trusts – BT

Shipping trusts to gain higher proilfe

Like Reits, they will shed their low-profile status when investors get a better feel of the asset class, reports

ON THE very night when the Dow shed 294 points after the Fed cut rates, Warren Buffet came forward to comment on the possibility of the much dreaded ‘R’ word that all investors did not wish to hear, particularly during this jolly festive season – recession.

With a possible US recession looming in 2008, yield and defensive plays may possibly be the flavour of the next season. The question then is: What are some examples of local listings that provide investors with a shield from the volatile markets. Today, we take a closer look at a fairly new asset class – shipping trusts.

Concept of a shipping trust

A shipping trust is essentially a hybrid product of an equity and a fixed income asset, providing high dividend yields and accretive growth.

As a business trust, a shipping trust is made up of a legal entity (trustee) which controls and manages assets on behalf of the unit holders that effectively own the assets and receive a regular stream of payouts.

In the case of shipping trusts, the trustee manager buys and leases vessels for a period of time in return for a steady flow of lease payments from the shipping firms (lessees). The lease period is typically between five and 10 years, during which the trust will lock in the fixed charter rates, thereby providing cash flow visibility and stability to investors.

The long-term lease period also means that unit holders of the trust are shielded from the volatility of the highly cyclical shipping industry as ‘these leases will expire on a staggered basis . . . allowing the charters to take advantage of higher charter rates in the future by managing the timing of fixing of charters’, says DBS Vickers’s Jasvinder Sandhu in a recent report.

Not well understood

Despite offering some of the highest yields in the markets today – 9-11 per cent – these shipping trusts have yet to win the hearts of local investors. Indeed, the three locally listed shipping trusts – First Ship Lease (FSLT), Pacific Shipping Trust (PST) and Rickmers Maritime Trust (RMT) – have all been lagging behind the broader market ever since their respective debuts on the SGX between half and one-and-a-half years ago. In fact, all are still trading below its IPO prices to date.

SGX vice-president of listing Tan Suan Hui attributed the lackluster performance of the shipping trusts to investors’ unfamiliarity with the sector at this point in time.

‘Shipping trusts are relatively new investment instruments compared to, say, Reits. As such, it is expected that investors will take some time to learn about their features including their stable dividend yields, potential capital gains through acquisition of assets and the generally tax efficient structures which allow dividends to be distributed to investors free of tax at both the trust and individual investor level,’ she said.

Such a view is supported by a November report published by UOB Kay Hian which has attributed the underperformance of the three shipping trusts to the perception among investors that a portion of their high dividend yields is a return of capital to investors as ships are depreciating assets with a lifespan of 30 years.

The report adds that accretive acquisitions will drive a re-rating of the three shipping trusts soon. UOB Kay Hian has ‘buy’ calls on all of them.

High and stable dividend yields, potential capital gains and generally tax-free structures – both at trust and individual investor’s level. Sounds too good to be true?

Well, there are, of course, a number of risks involved as well. The fundamental risk in the trust is the credit risk of the lessees where the latter may default on payments in the event of sharp economic downturn. However, such a risk can be mitigated on the part of the trustee manager by structuring a diversified portfolio of charterers.

Says FSLT chief executive Philip Clausius in an earlier BT report: ‘The true risk is the creditworthiness or counterparty risk. We invest in various sectors because there is limited correlation between the sectors.’

When asked if he agreed that the growth of shipping trusts may be limited, Mr Clausius says: ‘It is true that the growth of the shipping trusts do not come from the existing portfolios but from acquisitions due to the typically flat long-term fixed lease rate. Therefore, the capital structure of the trust at IPO is critical.’

Citing figures from shipping yield plays in the US, Mr Clausius adds: ‘Shipping yield plays in the US have delivered annual total shareholder returns in excess of 20 per cent as distributions have grown and the yields have compressed.‘

Raising investor awareness

Looking ahead, both Mr Clausius and Ivy Lim, chief financial officer of PST, agree that the local investors’ understanding of shipping trusts is improving even though there is still much room for improvement. Both liken the current situation of the shipping trusts in Singapore to the early stages of Reits in the Singapore market and are optimistic about their prospects.

Says Ms Lim: ‘If we look towards the Reit model, when Reits were introduced in Singapore just five years ago, the yields were in the range of 6.5 to 8 per cent. However, the market has since rewarded Reits with growth stories, pricing them at much lower yields . . . it will only be a matter of time before there is a re-rating of this asset class and we (should) see yield compression.’

For now, an increase in investor awareness and a better understanding of shipping trusts is something that all three are proactively working towards to. Recently, they jointly conducted a seminar with SGX to educate investors on this asset class.

In addition, all three share the view that the possible listing of more shipping trusts on the SGX would be good for the industry as a whole, because it will mean more publicity and analyst coverage in this fairly under-researched industry.

And with more shipping trusts expected to be listed on the SGX soon, as revealed by KPMG executive director Leonard Ong at a maritime conference in September, one thing is for sure: The local shipping trusts will soon say goodbye to its low-profile status as new players add critical mass to this fledging sector – and more joint efforts are taken to raise the average investor’s awareness about this novel asset class.