FSL Trust seeking mandate for buy-back of units

Move will allow purchase of up to 10% of issued units

First Ship Lease Trust (FSL Trust) is seeking unitholders’ approval for a unit buy-back mandate.

FSL Trust Management (FSLTM), the trustee-manager, said FSL Trust will hold an extraordinary general meeting (EGM) on April 8 for this purpose. The mandate would authorise the trustee-manager to buy back up to 10 per cent of the total number of issued FSL Trust units as at the date of the EGM.

A unit buy-back would cut the number of outstanding units in the market, resulting in a higher ownership stake per investor on the profits of the firm.

‘The mandate is intended to provide FSLTM with a flexible and cost-effective tool of capital management that seeks to improve the net asset value per unit of FSL Trust and return on equity for unitholders,’ the trustee-manager said.

Cheong Chee Tham, chief financial officer of FSLTM, said that the actual unit purchase, if any, would depend on the current market conditions, working capital requirements, the availability of financial resources and the expansion and investment plans of FSL Trust.

The trust would also hold its annual general meeting (AGM) on the same day to get approval for the renewal of general mandates for the issuance of new units. This includes units to be issued based on the FSL Trust distribution reinvestment scheme, under which unitholders can choose to receive their distributions in new units instead of cash or a combination of both.

‘With reference to the general mandates for the issuance of new units, FSLTM currently has no plans to raise equity for FSL Trust,’ said the trustee-manager.

It added that such mandates are ‘regular resolutions’ at AGMs and provide the trustee-manager greater flexibility to manage the trust’s capital structure.

32% ’09 yield despite lower DPU, cash conservation a positive, deep value but limited catalysts

• FSLT declared 4Q08 DPU of US¢3.08 (S¢4.63) or a quarterly yield of 10%. At the same time, the trust guided down 1Q09 DPU to US¢2.45 (S¢3.68) in a bid to conserve cash as it reduces payout ratio to about 77% of distributable cash from 100% previously. This will result in 32% dividend yield for 2009. Stock remains very deep value but with limited catalysts, in
our view. Maintain Neutral.

• MDC no more an issue. The Trust was able to obtain quoted LIBOR based interest rate resets for 1Q09. This is an important positive as the stock declined after banks invoked the Market Disruption Clause on certain interest rate resets in Oct-08. Those affected loans were charged interest rates at the lenders’ actual cost of funds rather than the quoted 3-month LIBOR, plus margin.

• Cash conservation is a positive we believe, as risks of debt covenant breach and lessee default though low, still remain. The Trust would be able to save US$4mn per quarter by lowering the payout ratio. The amount saved, it appears, is more for prudential reasons than for a specific purpose. We believe the Trust should be able to build up a buffer over next few quarters, which would allow it to navigate both covenant and default risks without triggering solvency concerns.

• Out of four key debt covenants, the one most at risk is the requirement to have a 145% collateral cover. As on last assessment in mid Oct-08, the cover stood at 175%. The ship values have declined since and in case banks do ask for an early reassessment of valuations (due Sep-Oct 09), a covenant breach cannot be ruled out. This should lead to a re-negotiation of terms. Outcomes, we believe, may include higher spreads, part amortization (its 7 year bullet now) or part repayment. As of now, we see limited possibility of complete or even substantial part debt repayment being triggered in case of covenant default. The Trust remains current on interest servicing and in our view cashflow visibility remains high on a diversified asset mix for next few years, leading to continued high credit worthiness.

• Lessee default is probably a larger risk to the underlying cashflows and stock price in 2009. Out of eight lessees, the maximum revenue exposure is 20% to Yang Ming and minimum of 6%. The Trust would be able to maintain the currently guided payout of US¢2.45 per quarter, assuming a revenue reduction by about 15% (in other words, default by one lessee). In that case, the Trust would be able to repossess vessels and would take legal action for SLV (Stipulated Lease Value), so as to maintain the economic benefits of the entire leasing period. Other than a situation in which the lessee goes bankrupt, we believe the Trust in most likelihood would be able to safeguard its economic interests even in case of default.

• Overall, we believe the stock remains deep value but lack of visibility on risks and limited near term catalysts leads to an even risk/return tradeoff.

Prudence may not be enough

4Q08 distribution of 3.08UScts was in line with guidance but in an act of prudence, management guided for lower distribution payout of 75-80% in 1Q09, vs. 100% payout in FY08. While this is a positive development in our view, causes for concern are multipronged – i) plunging asset valuations triggering technical defaults on debt, ii) customers re-negotiating charter rates, and iii) limited chances of re-rating given the depressed industry sentiments. Downgrade to HOLD at a reduced target price of S$0.50.

Results in line with expectation
Revenue was up 8%, or about US$2m, from US$23.7m in 3Q08 to US$25.7m in 4Q08 – as a result of the maiden contributions from the third Yang Ming vessel, which was delivered in Oct’08. However, higher interest expenses meant that distributable income of US$15.4m remained almost unchanged from 3Q08. Total FY08 DPU amounted to 11.52UScts, implying a trailing yield of 37.5%.

But risks are too big to ignore
While the diversified asset base provides some comfort to earnings, we estimate that portfolio valuations need to drop only about 18-20% for FSLT to trigger a technical default of the LTV covenant. What that may imply is diversion of cashflows to top-up/ repay loans, and/or higher interest spreads. The risk of counterparty default/ charter rate renegotiations cannot be ruled out either, given that not all its customers are blue chips.

Conserving cash implies prudence, but is it enough?
Lowering the payout ratio may help FSLT handle exigencies, as well as pay down the amortizing tranche of the US$65m loan, due from Sep’10. We also estimate FY09 DPU will reduce to about 9.8UScts (down 15% y-o-y). As such, we think the greater risk perceptions and weak industry sentiments will hold sway in the near term and downgrade the counter to HOLD at a reduced target price of S$0.50.

Honey, I shrunk the DPU

Lowers payout policy. First Ship Lease Trust (FSLT) recorded a 70% YoY and 8% QoQ increase in 4Q revenue to US$25.7m. The trust will pay out 3.08 US cents per unit as dividend for 4Q08, up 27% YoY and 0.9% QoQ. Significantly, FSLT’s board has decided to reduce the payout ratio to “increase financial flexibility going forward”. The trust is now guiding for a 1Q09 DPU of 2.45 US cents, or a 20% QoQ decline. This represents the payout of about 75-80%, a stark contrast from the trust’s 100% payout track record. The retained cash will be used to reduce gearing and potentially to fund new acquisitions. The trust will now provide DPU guidance on a quarterly basis “until longer term visibility returns”. We expect that the payout ratio may be further reduced after the subordination period expires on 30th June.

Right move… S-REITs and shipping trusts managers will have to realign their business model and debt tolerance with the market’s tolerance – and especially with their lenders’ tolerance. This is particularly true when the lender has the upper hand – such as with an upcoming refinancing or a loan-to-market value (LTV) covenant. As of mid-October 2008, FSLT satisfied its LTV covenants. But asset values in the shipping space are declining rapidly and lenders (on an industry-wide basis) are getting jittery. Shipping trusts do have a long-term secure income profile – but that cash is useless if it is just paid out as distributions to unitholders. We view this decision as a gesture of good faith to lenders.

…but not enough. We have commented on FSLT’s aggressive payout and debt financing strategy ad nauseum. Our valuation approach on the shipping trusts rewards (puts a premium on) sustainability. In that sense, we definitely support this decision. But we think this is a first step, at best. If the 1Q09 DPU is maintained for the full year, FSLT can pay down US$14m of debt in 2009 – a mere 2.8% of its total outstanding loans. This will not make a significant impact on its 1.35x debt-to-equity ratio. If FSLT is serious about adapting its business model to the current environment, it needs to do more. The payout ratio should (in our opinion) be even lower: Pacific Shipping Trust only pays out about 50% of cash income, for instance. An explicit debt repayment plan would also demonstrate the trust’s commitment to sustainability, in our view. Maintain HOLD with S$0.46 fair value.