Shipping Trusts – UOBKH

Singapore shipping trusts, namely First Ship Lease Trust (FSLT), Pacific Shipping Trust (PST) and Rickmers Maritime (RMT), have underperformed the STI, Sreits and other business trusts. Their share prices have fallen below their initial public offering (IPO) prices and FY08 and FY09 dividend yields have risen to 8.7% to 10.8%. We believe Singapore shipping trusts’ underperformance is due to the perception among investors that they are self-liquidating and a portion of their high dividend yields is a return of capital to investors as ships are depreciating assets with a lifespan of 30 years. Recent weakness in the US$ has also dampened share price performance.

We initiate coverage on the sector with an OVERWEIGHT rating. Our rationale is based on the following reasons:

Limited downside from current share price levels. Notwithstanding a weak US$, we see limited downside in Singapore shipping trusts. Assuming a 3.3ppt (i.e. annual ship depreciation) of their dividend yields is a return of capital, investors would still get a decent net return ranging from 5.4% to 7.5%. In the worst case of no future value accretion, which we believe is unlikely, this is an investor’s minimum return. Shipping trusts’ long-term, fixed nature of charter contracts of 5-12 years provide stable earnings, cash flows and dividends, cushioning against the short-term cycles of the shipping industry.

Growth element is not priced in. Accretive acquisitions will drive a re-rating of the shipping trusts. A case in point is the experience of US long-term charter, ship finance peers. Seaspan Corp, a similar ship finance company, suffered share price underperformance in the initial period post-IPO (Aug 05). However, as accretive ship acquisitions gained momentum, the stock was strongly re-rated with share price appreciating by more than 50% and its 2007 dividend yield compressed from above 9% at IPO to 6.0% presently. Danaos Corp, another comparable ship finance company, also had a similar experience since its IPO in Oct 06. Danaos is currently trading at 2007 dividend yield of 5.6%.

Ship acquisitions are gaining momentum. RMT, the most aggressive among the shipping trusts, has increased its fleet by more than three-fold since its IPO in May 07. PST has enlarged its fleet by 61% with its recent acquisition of two 4,250 TEU containerships and FSLT is confident about doubling its fleet in the next two years. Ships are being acquired at asset yields (net operating cash flow/investment cost, before financing) of 9.6% to 10.5% and project IRRs of 8.1% to 9.0%. Against a cost of debt of about 6% (if funded totally by debt) or a WACC of about 7% (if funded by a mixture of debt and equity), the acquisitions should be accretive.

Ample upside. We are forecasting a share price upside of 16% to 27% in 2008 and 6% to15% in 2009, with RMT to lead the sector’s re-rating. Dividend yield is our primary valuation methodology. We expect RMT’s yield to compress on re-rating from the current level of 8.7% to 7.5% by end-08 and 7.0% by end-09. As for FSLT and PST, we forecast their dividend yields to compress from their current +10% level to 8.5% by end-08 and 8.0% by end-09. Against our DCF valuations, PST, FSLT and RMT are currently trading at 35%, 19% and 16% discounts respectively. They are also trading at a P/RNAV of 0.73x to 0.86x, based on our RNAV estimates.

Risks: Shipping trusts face the same risks as any ship owner, but to a much lesser degree as earnings are substantially protected by their long-term charter contracts. A weak US$ does not have an impact on the earnings and distributions of shipping trusts. However, the depreciation of the US$ would have a negative impact on non-US$ investors (unless their investment currency is linked to the US$).

Strategy: OVERWEIGHT. We have a BUY rating on all three Singapore shipping trusts, FSLT, PST and RMT. Among them, RMT appears to be the most aggressive in terms of ship acquisitions while FSLT reduces operational risk with a diversified fleet. PST trades at the largest discount to our DCF valuation and could achieve greater distributable cash and dividend payout if it were to restructure its debt repayment.

FSLT (FSLT SP/Target: US$1.05). We expect FSLT to derive value accretion from funding ship acquisitions with low-cost debt. Among the Singapore shipping trusts, FSLT has the lowest debt-to-equity ratio of 0.1x. It is targeting US$200m worth of acquisitions p.a. Although it does not have an acquisition pipeline from its sponsor (unlike the other two shipping trusts), the shareholders of FSLT’s sponsor are shipping heavyweights in their own right with an extensive network of global contacts. We initiate coverage on FSLT with a target price of US$1.05 in anticipation of dividend yield compression to 8.5% by end-08. We forecast a further rerating in 2009 to a compressed yield of 8.0%, translating into a target price of US$1.11 by end-09.

PST (PST SP/Target: US$0.50). PST has also set itself an acquisition target of S$200m p.a. It recently acquired two 4,250 TEU containerships from its sponsor, Pacific International Lines (PIL). These two ships are part of the 38 which PST has the Right of First Refusal to acquire from PIL. These two new ships will increase PST’s fleet from eight to 10 ships and raise its fleet capacity by 61% from 13,864 TEUs to 22,364 TEUs. PST has a conservative debt repayment of 10-12 years from IPO. We do not discount the possibility of debt restructuring though PST’s management presently has no plans to do so. This would put PST on an equal footing with FSLT and RMT. The additional distributable cash arising from a debt restructuring could be used for ship acquisitions or higher dividend payout. We value PST at a dividend yield of 8.5% by end-08 and 8.0% by end-09. This translates into target prices of US$0.50 and US$0.53 respectively.

RMT (RMT SP/Target: US$1.19 (S$1.72)). Thus far, RMT has been the most aggressive in terms of ship acquisitions. Since its IPO, the trust has grown its fleet capacity more than three-fold from 10 ships with a total capacity of 40,910 TEUs to 23 ships of 131,560 TEUs. A strong pipeline from its sponsor supports RMT’s acquisitions. It has the most competitive trustee management fee structure among the three shipping trusts, which augurs well for the long-term interests of unitholders. We initiate coverage on RMT with a target price of US$1.19 (S$1.72), as its dividend yield forecast to compress to 7.5% in FY08 and a target price of US$1.37 (S$1.98) in FY09 with further yield compression to 7.0%.