FSL – OCBC

Honey, I shrunk the DPU

Lowers payout policy. First Ship Lease Trust (FSLT) recorded a 70% YoY and 8% QoQ increase in 4Q revenue to US$25.7m. The trust will pay out 3.08 US cents per unit as dividend for 4Q08, up 27% YoY and 0.9% QoQ. Significantly, FSLT’s board has decided to reduce the payout ratio to “increase financial flexibility going forward”. The trust is now guiding for a 1Q09 DPU of 2.45 US cents, or a 20% QoQ decline. This represents the payout of about 75-80%, a stark contrast from the trust’s 100% payout track record. The retained cash will be used to reduce gearing and potentially to fund new acquisitions. The trust will now provide DPU guidance on a quarterly basis “until longer term visibility returns”. We expect that the payout ratio may be further reduced after the subordination period expires on 30th June.

Right move… S-REITs and shipping trusts managers will have to realign their business model and debt tolerance with the market’s tolerance – and especially with their lenders’ tolerance. This is particularly true when the lender has the upper hand – such as with an upcoming refinancing or a loan-to-market value (LTV) covenant. As of mid-October 2008, FSLT satisfied its LTV covenants. But asset values in the shipping space are declining rapidly and lenders (on an industry-wide basis) are getting jittery. Shipping trusts do have a long-term secure income profile – but that cash is useless if it is just paid out as distributions to unitholders. We view this decision as a gesture of good faith to lenders.

…but not enough. We have commented on FSLT’s aggressive payout and debt financing strategy ad nauseum. Our valuation approach on the shipping trusts rewards (puts a premium on) sustainability. In that sense, we definitely support this decision. But we think this is a first step, at best. If the 1Q09 DPU is maintained for the full year, FSLT can pay down US$14m of debt in 2009 – a mere 2.8% of its total outstanding loans. This will not make a significant impact on its 1.35x debt-to-equity ratio. If FSLT is serious about adapting its business model to the current environment, it needs to do more. The payout ratio should (in our opinion) be even lower: Pacific Shipping Trust only pays out about 50% of cash income, for instance. An explicit debt repayment plan would also demonstrate the trust’s commitment to sustainability, in our view. Maintain HOLD with S$0.46 fair value.