FSL – OCBC

Acquisitions bump up 2Q

Strong 2Q, as expected. First Ship Lease Trust (FSLT) posted a strong set of 2Q results, largely in line with our estimates. The trust saw strong gains in 2Q revenue, up 63.1% YoY1 and 24.4% QoQ to US$20.7m. Net profit came in at US$1.99m, above our estimates due to a lower than estimated depreciation charge and the inclusion of exchange gains worth US$775k. The trust posted a distributable income (net profit plus noncash charges) of US$14m, in line with our expectations. FSLT will pay out 2.8 US cents for the quarter, up 22% YoY and 8% QoQ.

Acquisitions were the kicker. The strong gain in earnings was driven by the acquisition and delivery of four vessels worth US$280m over 2Q. The full impact of these four vessels on the trust’s earnings will be felt in 3Q, and we consequently expect next quarter’s DPU to rise by about 5%. Meanwhile, a fifth vessel costing FSLT US$70m will be delivered in 4Q – the trust is still in the midst of securing financing for the deal. If the acquisition is successfully completed, it will bump up earnings in 4Q and 1Q (full impact).

Debt-to-equity has hit self-imposed 1x target. The aggressive spate of acquisitions also means that FSLT’s debt-to-equity level has shot up from 0.36x last quarter to 1x in 2Q, and will further increase with the fifth vessel buy. Its current debt is on bullet repayment terms. More debt-funded buys on current equity levels may not be as DPU accretive as seen previously as lenders may now require the new debt to be on immediately amortizing terms or at a higher cost of debt. Meanwhile, an equity infusion to continue growing DPU could be dilutive as FSLT continues to trade at prohibitively high yields.

High DPU yield due to aggressive payout strategy. Unlike the other SGX-listed shipping trusts, FSLT does not retain any cash to replenish depreciating assets or to pay down debt. So the distribution paid out consists of both a return on asset and a fair compensation for the loss in value of the unit-holders’ invested capital. FSLT also pays out the depreciation on its leveraged assets. This is similar to the return of unitholders’ capital, except that FSLT is paying out the loss in value of debt-funded assets to unit-holders. This boosts payout in the earlier years, but ultimately debtors will have to be repaid the full principal amount. Maintain HOLD and S$1.20 fair value estimate.