FSL – DBS

Prudence may not be enough

4Q08 distribution of 3.08UScts was in line with guidance but in an act of prudence, management guided for lower distribution payout of 75-80% in 1Q09, vs. 100% payout in FY08. While this is a positive development in our view, causes for concern are multipronged – i) plunging asset valuations triggering technical defaults on debt, ii) customers re-negotiating charter rates, and iii) limited chances of re-rating given the depressed industry sentiments. Downgrade to HOLD at a reduced target price of S$0.50.

Results in line with expectation
Revenue was up 8%, or about US$2m, from US$23.7m in 3Q08 to US$25.7m in 4Q08 – as a result of the maiden contributions from the third Yang Ming vessel, which was delivered in Oct’08. However, higher interest expenses meant that distributable income of US$15.4m remained almost unchanged from 3Q08. Total FY08 DPU amounted to 11.52UScts, implying a trailing yield of 37.5%.

But risks are too big to ignore
While the diversified asset base provides some comfort to earnings, we estimate that portfolio valuations need to drop only about 18-20% for FSLT to trigger a technical default of the LTV covenant. What that may imply is diversion of cashflows to top-up/ repay loans, and/or higher interest spreads. The risk of counterparty default/ charter rate renegotiations cannot be ruled out either, given that not all its customers are blue chips.

Conserving cash implies prudence, but is it enough?
Lowering the payout ratio may help FSLT handle exigencies, as well as pay down the amortizing tranche of the US$65m loan, due from Sep’10. We also estimate FY09 DPU will reduce to about 9.8UScts (down 15% y-o-y). As such, we think the greater risk perceptions and weak industry sentiments will hold sway in the near term and downgrade the counter to HOLD at a reduced target price of S$0.50.