FSL – JPM
32% ’09 yield despite lower DPU, cash conservation a positive, deep value but limited catalysts
• FSLT declared 4Q08 DPU of US¢3.08 (S¢4.63) or a quarterly yield of 10%. At the same time, the trust guided down 1Q09 DPU to US¢2.45 (S¢3.68) in a bid to conserve cash as it reduces payout ratio to about 77% of distributable cash from 100% previously. This will result in 32% dividend yield for 2009. Stock remains very deep value but with limited catalysts, in
our view. Maintain Neutral.
• MDC no more an issue. The Trust was able to obtain quoted LIBOR based interest rate resets for 1Q09. This is an important positive as the stock declined after banks invoked the Market Disruption Clause on certain interest rate resets in Oct-08. Those affected loans were charged interest rates at the lenders’ actual cost of funds rather than the quoted 3-month LIBOR, plus margin.
• Cash conservation is a positive we believe, as risks of debt covenant breach and lessee default though low, still remain. The Trust would be able to save US$4mn per quarter by lowering the payout ratio. The amount saved, it appears, is more for prudential reasons than for a specific purpose. We believe the Trust should be able to build up a buffer over next few quarters, which would allow it to navigate both covenant and default risks without triggering solvency concerns.
• Out of four key debt covenants, the one most at risk is the requirement to have a 145% collateral cover. As on last assessment in mid Oct-08, the cover stood at 175%. The ship values have declined since and in case banks do ask for an early reassessment of valuations (due Sep-Oct 09), a covenant breach cannot be ruled out. This should lead to a re-negotiation of terms. Outcomes, we believe, may include higher spreads, part amortization (its 7 year bullet now) or part repayment. As of now, we see limited possibility of complete or even substantial part debt repayment being triggered in case of covenant default. The Trust remains current on interest servicing and in our view cashflow visibility remains high on a diversified asset mix for next few years, leading to continued high credit worthiness.
• Lessee default is probably a larger risk to the underlying cashflows and stock price in 2009. Out of eight lessees, the maximum revenue exposure is 20% to Yang Ming and minimum of 6%. The Trust would be able to maintain the currently guided payout of US¢2.45 per quarter, assuming a revenue reduction by about 15% (in other words, default by one lessee). In that case, the Trust would be able to repossess vessels and would take legal action for SLV (Stipulated Lease Value), so as to maintain the economic benefits of the entire leasing period. Other than a situation in which the lessee goes bankrupt, we believe the Trust in most likelihood would be able to safeguard its economic interests even in case of default.
• Overall, we believe the stock remains deep value but lack of visibility on risks and limited near term catalysts leads to an even risk/return tradeoff.