FSL – OCBC

Reinvestment scheme in play for 1Q09 distributions

Results in line. FSL Trust (FSLT) posted US$24.8m in revenue, down 3.3% QoQ and up 49.5% YoY thanks to acquisitions made over the course of 2008. Note that, as previously guided, this is the first quarter where FSLT will not distribute 100% of cash earnings. Instead, the trust will distribute about 73% of cash earnings, or 2.45 US cents per unit, down 5.4% YoY and 20.4% QoQ because of the lower payout. The results were in line with our expectations. The trust guided for a 2Q09 DPU of 2.45 US cents as well.

Voluntarily prepaying loans. FSLT used US$4m of the retained US$4.6m to voluntary prepay loans. We have noted previously that shipping trusts have to re-align their debt tolerance and business model in light of a ‘new world order’ of falling asset values and low lender risk appetite. FSLT’s decision to voluntarily reduce its payout ratio is in that vein – a preemptive gesture of good faith to lenders. FSLT is geared at a still high 1.38x debtto- equity. A US$4m per quarter prepayment is a small number compared to the absolute US$509m outstanding loan amount. This is a gesture – not a game-changer, in our view.

Reinvestment scheme in play. The distribution reinvestment scheme (DRS) will apply in 1Q09, giving unitholders the option to receive 1Q09 distributions in units instead of cash. Any proceeds from the DRS (that is, the saved cash earnings) will also be used to prepay loans. This scheme is an attempt to balance the needs of investors demanding cash yield against concerns of sustainability and gearing. But it is unclear just how many investors will voluntarily “do the right thing” for the trust and elect to receive units instead of cash. The success of the scheme in 1Q09 may significantly affect FSLT’s course of action going forward – if the DRS fails and market conditions persist, FSLT may ultimately have to cut the distribution payout further, effectively making the “right” choice for unitholders.

Valuation. FSLT has a diversified portfolio with exposure to different shipping sub-sectors, and with no charterer contributing more than 20% of annual revenue. Our key concern is counterparty performance and any resulting disruption of cash flows. The current share price is quite clearly pricing in a distressed scenario, in our opinion. However, we would prefer to wait
until the shipping industry shows concrete signs of stabilizing before we turn buyers. Our fair value estimate is S$0.45 (previously under review).
Maintain HOLD.