FSL – OCBC

In Limbo

Good 1Q results. First Ship Lease Trust (FSLT) posted a 10% QoQ gain in 1Q revenue to US$16.6m as the trust’s November acquisitions made their first full-quarter contribution to income. It is paying out 2.59 US cents as DPU, up 7% QoQ and 21.6% over the base DPU promised at listing. We hesitate to call that a 13% return though, as a significant component of that DPU is a depreciation payout which is a return of capital rather than a return on capital. This is reflected in the 4% QoQ decline in NAV to 88 US cents thanks to FSLT’s aggressive depreciation strategy.

Acquires two crude oil tankers. FSLT also announced the acquisition of two crude oil tankers for US$140m. Bought from Turkey-based Geden Lines, the tankers will be chartered back to them for ten years, with early buyout options attached. The charter rate will be on a floating rate basis, linked to the US$ Libor, and acting as a natural hedge for FSLT’s debt. Basically, instead of the typical shipping trust M.O. of taking on a fixed charter rate and then fixing debt using an interest rate swap, FSLT has eliminated the extra swap counterparty. FSLT has said that the acquisitions will add US$0.16 to 2Q DPU and US$0.28 to every full quarter thereafter. The transaction highlights FSLT’s flexibility in moving between different shipping sub-sectors.

Half-way through 2008 target. With this transaction, FSLT has exhausted its credit facility from IPO (3-month US$ Libor + 100 bps) and moved on to its new facility (Libor + 120 bps). In terms of its acquisition target for the year, FSLT has US$160m – or to be conservative, the US$150m remaining in its debt facility – left to burn. Deal flow is not a problem as management says the credit tumult has churned up some choice acquisitions. The problem is what happens once FSLT hits the 1x debt-to-equity point. Because of its aggressive payout strategy, FSLT is on a relatively shorter leash (which we like) in terms of debt. The plan has always been to issue equity once that 1x target is hit. For now, FSLT is saying it will not issue equity at 12% yields – too dilutive. But how quickly the sector will re-rate to more attractive levels is still an unknown. For now, we’re reducing our fair value estimate to S$1.20 to reflect the weakening US dollar. We will review our ratings on the asset class as a whole after Rickmers Maritime posts its results. BUY.