PST – OCBC

Debt 2.0 – Changing the Game

Attractive distribution yield. Pacific Shipping Trust (PST) 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 only, PST offers an estimated distribution of 4.41 US cents for FY08. With its current price at US$0.40, this amounts to a mammoth yield of 11%. In comparison, the Singapore 10-yr government bond yields 2.4%.

Preserves value of the assets. Vessels are depreciating assets so the value of unitholders’ ownership (equity) is eroding constantly. Each shipping trust has its own strategy for addressing the asset erosion problem. PST has pegged its debt repayment to its depreciation charge, reducing the trust’s liabilities by as much as its assets erode. This preserves the net asset value, or the value of what the unitholders own.

Debt model key differentiator. PST’s NAV preservation strategy – while a sustainable business model – is not our preferred strategy for dealing with asset erosion. However, this conservative debt repayment pattern does allow unitholders to enjoy accretion from far greater leverage. PST’s debtto- equity will jump to a staggering 2x after it completes its US$222.2m worth of contracted acquisitions for this year. However, this ratio will decline as PST repays its debts. By only paying out net profits to unitholders, PST protects the principal invested by the unitholders and debtors – ensuring that the borrowed asset can pay for itself.

Debt Model 2.0. PST is currently using some of its net profit and the entire depreciation component of its cash income to repay debt (the balance is distributed to unitholders). However, we believe its new 2008 acquisitions will be made on a debt repayment pattern that is more favorable to unitholders. We estimate that DPU will increase sharply from 4.3 US cents in FY07 to 4.68 US cents in FY08 (+9% YoY) and 5.74 US cents in FY09 (+33% from FY07 and +23% YoY).

Target price US$0.55. Our DCF value of the unitholders’ share in the trust is US$0.55, a 37.5% upside from the current price. Our valuation reflects the steep jump in DPU we expect after the four new acquisitions this year. The sharp absolute increase in DPU will also make PST’s DPU yield more competitive relative to the other shipping trusts. This could very well be a catalyst for price appreciation in the nearer term. We are initiating coverage on PST with a BUY rating.