FSL – OCBC

Quasi-debt instrument with attractive yields

Basic attraction is distribution yield. First Ship Lease Trust (FSLT) is a listed shipping trust. Its shipping income is tax-exempt and distributions are also tax-exempt for all investors. Based on its existing assets, FSLT offers an annual distribution of 10.332 US cents for FY08. With its current price at S$1.13, this amounts to a whopping yield of 12.9%. In comparison, the Singapore 10-yr government bond yields 2.3%.

Distribution payout not just return on asset. Part of FSLT’s high distribution payout consists of a return on the unit-holders’ invested capital. Vessels are depreciating assets and FSLT fully pays this amount out every year. So while the payout is high, the value of assets has declined correspondingly. FSLT also pays out the depreciation charge (or part of the principal) on its leveraged assets. This is similar to the return of unitholders’ capital, except that FSLT is paying out the debt principal to unit-holders. This boosts payout in the earlier years, but ultimately unitholders have to repay debtors in the later years.

Acquisition plans. FSLT is targeting US$300m worth of acquisitions every year. It is aiming for an average asset yield of 10.5% and a target IRR of about 7.5%. There is no regulatory ceiling on its gearing, and FSLT’s longterm debt-to-equity target is 1x. Since listing, it has made about US$158m worth of debt-funded and DPU accretive acquisitions. We believe that once FSLT hits the 1x debt-to-equity target, it would look to raise new equity – which based on its yearly US$300m target could be as early as 2009.

Initiate coverage with BUY rating. Our DCF valuation only looks at the value of the unitholders’ stake in the trust – that is, the remaining value after repayment of debts. Our valuation assumes another US$330m worth of acquisitions over FY08-09 based on debt-to-equity of 1x. Using above, our DCF value is S$1.25, or a 10.6% upside from the current price. This assumes that the investor sticks with FSLT until the end, when all debts would have to be repaid (we estimated 2015 but FSLT plans to refinance as and when its facilities mature). However, for the next 1-2 years, we acknowledge that FSLT offers much higher returns based on the estimated DPU from its existing assets and its intention to continue making various DPU accretive acquisitions. We are initiating coverage on FSLT with a BUY rating.