FSL – OCBC

Downgrade to HOLD

FSLT has achieved our fair value estimate. First Ship Lease Trust (FSLT) has done well since our last report dated 25th April, up 12% despite broader market weakness. This recent recovery is on account of an increase in DPU – we are projecting FY08 DPU of 11.6 US cents (+27% YoY) and FY09 DPU of 12.53 US cents (+8% YoY). FSLT is offering a high 12.5% FY08 DPU yield1, a whopping 900 basis points premium over the 10-year Singapore government bond. In contrast, the S-REITs are trading on average at 400 bps over the 10-yr rate.

Acquisition spree in 1H08. The DPU spurt we estimate for FY08 and FY09 has been achieved through a larger than expected acquisition spree. In 1H08, First Ship Lease Trust (FSLT) announced the acquisition of two crude oil tankers and three containerships worth US$350m. Four of the five vessels have already been delivered. Financing for the fifth vessel, a US$70m containership, with an expected delivery in end October, has yet to be arranged. We have updated our estimates to reflect the higher than expected capex at a higher finance cost. We estimate asset yields to be lower than previous buys however, making this round of acquisitions less accretive.

Reaching limits to gearing. We estimate that with the completion of this round of acquisitions, FSLT will have overshot a sustainable debt-toequity level of 1x by the end of this year. We believe there is reduced prospect for further gearing at current equity levels. Unlike S-REITs, shipping trusts do not see positive rent reversions in the near term. DPU is therefore capped at FY09 levels. An equity infusion to continue growing DPU could be dilutive as FSLT continues to trade at prohibitively high yields.

Downgrade to HOLD. We remind investors that because of its aggressive payout strategy, FSLT’s high yield consists of both a return on capital (income) and a return of capital (depreciation). It is consequently important to look at both yield and net asset value, which has been falling in tandem with DPU growth (see chart). FSLT is currently trading at S$1.23, 2.5% above our fair value estimate and FSLT’s 1Q08 NAV of 88 US cents. As it is now trading close to our fair value of S$1.20, and has outperformed with a 12% gain over a 2-month period in a slowing market, we downgrade FSLT to HOLD.