Shipping Trusts – OCBC

Victims of the cycle

More turbulence ahead… The last several years have seen major export growth as well as a commodities boom. This drove a boom in shipping – manifested in both an increase in rates as well as a demand for increased capacity, and led to increased asset prices and the construction of more ships. Asset prices soared at ‘bubble speed’ in the past couple of years, partly because of an aggressive use of leverage. The global economy then turned in early 2008 and the shipping industry was caught with a huge capacity and a large order pipeline. The industry has already seen a sharp reduction in charter rates. Asset values are expected to fall as the cycle corrects. We expect this decline to be steep in line with the deleveraging cycle.

2008 was about growth. Investors and managers of yield instruments in a bull market (rising asset values) and a cheap market (easy credit) were caught in a growth trap. The focus was on who could ramp up leverage and consequently, who could grow the fastest. The three Singapore-listed shipping trusts were all formed at, or very near, the peak of the shipping cycle. Consequently, their ships were priced at high valuations. They then continued to grow aggressively (at those same stratospheric price levels) – the sector has invested some US$1.3b since listing, more than doubling their IPO portfolio, in a space of less than two years. This growth was achieved through an aggressive use of leverage.

2009 is about survival. We believe valuations in 2009 will be driven by the health and strength of the three trusts, with the main focus on survival. Technically, shipping trusts are structured as long term, cash generating entities that have the ability to ride out short-term cycles. Unfortunately, the sector’s hunger for higher leverage has made them victims of those
same cycles. The biggest threat to the sector is the loan-to-market value (LTV) covenant. An LTV breach, not outside the realm of possibility, triggers a technical default. The ultimate outcome, possibly lower (or zero) distributions or distressed asset sales, depends on the health and risk appetite of the trust’s lenders. Pacific Shipping Trust is the only trust without LTV requirements. We expect capital commitments to be another overhang on valuations in 2009 – Rickmers Maritime has US$1.1b in new vessels coming in from now until 2010. This level of growth, previously a positive, has now become a burden. We have a NEUTRAL rating on the sector.