New acquisitions boost distribution yield to 14.8%

First Ship Lease Trust (FSLT) has announced that it has entered into a conditional agreement to acquire three 4,250 TEU container vessels from a wholly owned subsidiary of Taiwan based Yang Ming Marine Transport Corporation (YML) for a consideration of US$210m. The three vessels are scheduled for delivery to FSL Trust by end May, end June and end October this year. The vessels will concurrently be leased back to YML on a fixed basis for 12 years.

Acquisitions significantly boost DPU. FSLT has guided that the acquisition of the initial two vessels will be significantly accretive to FSL Trust’s distribution per unit (DPU) and projects that the acquisition will increase the distribution for 2Q08 to 2.77 US cents (from 2.05 US cents) and from 3Q08 onwards to 3.05 US cents (from 2.87 US cents). This translates into a FY09 yield of 14.8%.

Vessel acquisition price fairly attractive given recent transactions. Other recent market purchases for 4,250 TEU vessels also average in the US$73m to US$77m range. As such, the average acquisition price of US$70m per for these new acquisitions seems fairly attractive. Based on management’s DPU guidance, we estimate the bareboat charter rates for these vessels to be slightly less than US$20,000/ day, fairly reasonable given current market rates.

No guidance on third vessel as funding not secured. While FSLT has not provided guidance on the DPU accretion for the third vessel at this time as financing has yet to be secured (US$60m required), we estimate the potential accretion to be in the region of 0.07 US cents per quarter from 1QFY09 onwards, translating into a yield of 15.1% (assuming similar debt financing and similar charter terms as the first two vessels). However, as the acquisition of this third vessel is conditional upon FSL Trust securing financing, we have not factored potential earnings and DPU accretion for this vessel into our forecasts and target price as yet.

The paradox: Rising DPU but falling EPU. We continue to like FSLT for its stable and visible distributions which are supported by its long bareboat charters which have an average remaining lease term of approximately 9.2 years. FSLT offers investors an interesting paradox due to its aggressive depreciation policy which depreciates its assets at between 5-7% per year. As such, while this latest acquisition is DPU accretive, EPU has declined sharply as earnings after interest for these vessels is less than the associated depreciation (FY08: -44%, FY09: -87%, FY10: -87%). However, we remind investors that distribution yield should be the focus for FSLT and maintain our BUY recommendation on FSLT with a target price of US$1.24 (S$1.61).

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.

First Ship Lease Trust to pay out US$12.95m in Q1

DIVERSIFIED shipping trust First Ship Lease (FSL) Trust has announced a distribution of US$12.95 million for the first quarter ended March 31, 2008 – working out to 2.59 US cents per unit.

There were no comparative figures for the previous corresponding period as FSL was constituted and listed in March last year. Compared with the preceding fourth quarter’s 2.42 US cents, the Q1 DPU of 2.59 US cents was 7 per cent higher. This came as FSL added ships to its portfolio.

Q1 revenue rose 10.1 per cent from Q4 to US$16.6 million as the impact of the purchase and concurrent leaseback of two product tankers from Groda Shipping and Transportation in November was fully realised during the quarter.

The distribution translates into an annualised DPU of 10.36 US cents, 7 per cent higher than the annualised DPU of 9.68 US cents in the preceding quarter. Based on FSL Trust’s closing unit price of S$1.10 on April 22, this translates into a distribution yield of 12.7 per cent per annum.

Trustee manager FSL Trust Management (FSLTM) said it will continue to pursue acquisition opportunities as part of its strategy to grow the trust. To support this effort, it has broadened the transaction origination platform by hiring a head of sales (East of Suez), who is joining the management team next month.

FSLTM is confident of achieving the previously announced acquisition target of US$300 million for financial year 2008. In fact, with the recent US$140 million Geden Lines transaction involving two Aframax class crude oil tankers announced earlier this week, about 50 per cent of the acquisition target has already been achieved.

‘In view of the greater difficulty in raising conventional bank financing in the current tight credit environment, ship operators are turning increasingly to alternative financing solutions such as leasing. We are bullish in meeting the balance of the acquisition target of US$160 million over the next eight months of this year,’ said FSLTM chief executive officer Philip Clausius.

Funding for these future acquisitions will be from the newly secured US$200 million credit facility, of which about US$150 million remains undrawn.

1Q08 DPU in line with expectations; acquisitions to boost future DPU

First Ship Lease Trust (FSLT) has announced its 1QFY08 results. Charter income came in at US$16.6m, accounting for 25.2% of our forecasts, in line with expectations while distributable cash was US$13.0m, accounting for 25.0% of our full year forecasts. Likewise, Distributions Per Unit (DPU) was within expectations at 2.59 US cents, accounting for 24.9% of our full year DPU forecast.

Earnings below expectations: Tripped by depreciation. Earnings for the period came in at US$1.7m accounting for 14.4% of our full year earnings forecasts. This is because depreciation for the period was US$11.2m vs. our estimated US$10.0m. After factoring in the higher depreciation, earnings for the period would have accounted for 25.2% of our FY08 forecasts. FSLT’s depreciation policy is to depreciate the cost of the vessel over the life of the base
lease term to an expected residual value which has not been disclosed. As the residual value for FSLT’s fleet is not disclosed, our estimated depreciation estimate was 10.7% below the actual value.

Acquisition of 2 crude tankers from Geden Lines, Turkey’s largest shipping company. On 21 April, FSLT announced the acquisition of 2 115,000 DWT crude tankers for a total consideration of US$140m. The acquisition prices are in line with recently transacted sales (US$70m for 105,000 DWT). Built by Samsung Heavy Industries, the two vessels are both less than a year old. The two vessels have been concurrently leased back to Greden for a lease term of 10 years. Lease payments are on a floating basis resettling on a quarterly basis in line with changes in the 3-month US$ Libor rate.

Management guidance on DPU accretion seems reasonable. FSLT has guided that the vessel acquisitions will generate an additional 0.16 US Cents for 2QFY08 and an additional DPU of 0.28 US Cents for each full calendar quarter thereafter. Based on the DPU guidance, we estimate the bareboat charter rate at present to be about US$20,000/ day which seems reasonable as it is at a discount to the current three-year timecharter rate of US$28,000 for vessels of this class as reported by Clarksons. The implied asset yield is about 10.0%.

Stable and visible distributions: Maintain BUY. We continue to like FSLT for its stable and visible distributions which are supported by its long bareboat charters which have an average remaining lease term of approximately 8.6 years. With an undrawn credit facility of US$150m, FSLT can continue to fund most of its remaining US$160m acquisition targets with low cost debt. We maintain our BUY recommendation on FSLT and raise our target price to from US$1.22 to US$1.24 (S$1.61) based on a FY09 yield-based target of 9.0%. We have also reduced our earnings forecasts to account for FSLT’s aggressive depreciation policy (FY08: -43%, FY09: -37%, FY10: -37%).

FSTL SP
Share price: S$1.10

FSL Trust has just announced that it has acquired two crude oil tankers from Turkey-based Geden Lines (“Geden”) for a total consideration of US$140 million. The acquired vessels have been concurrently leased back to the seller for a lease term of 10 years. The acquisition of the two crude oil tankers will be significantly and immediately accretive to FSL Trust’s distribution per unit (“DPU”) and will generate an additional DPU of US0.16¢ for 2Q FY2008 and an additional DPU of US0.28¢ for each full quarter thereafter. As a reference, the full quarter DPU of US0.28¢ represents an additional 11.6% compared to the DPU of US2.42 cents paid for 4Q FY2007. With the purchase of its first crude oil tankers, FSL Trust has successfully diversified its customer base further, and has achieved close to half of its acquisition target of US$300 million for FY2008.

We will provide more details after the analyst briefing on Thursday. Our call on the stock remains a BUY with a target price of S$1.72.