FSL Trust: LTV covenant clouds dissipate

Secures covenant waiver. FSL Trust has secured a two-year waiver for the loan-to-market value covenant in its credit facility. The waiver, subject to documentation, will extend until the end of 2Q11. During this period, the minimum coverage ratio of the charter-free fair market value of the trust's portfolio over its outstanding indebtedness will be reduced from 145% to 100%. In return, FSLT must repay US$8m per quarter during the two-year period (or US$64m in total). The trust has already prepaid US$12m voluntarily. Margins over US$ LIBOR also increase by between 50 and 70 basis points (bps) during the period. The margin increase is reduced to a 25-bp hike after the waiver period.

Re-affirms DPU guidance. The manager estimates that the additional interest expense during the waiver period averages US$0.7m per quarter. The manager re-affirmed its DPU guidance of 1.5 US cents per quarter. We estimate this works out to a payout of less than 50% of cash earnings. We note there might be some one-off expenses (both cash and non-cash in nature) in 3Q09 as FSLT is likely to re-align its interest hedges to reflect the new amortization schedule.

T&Cs as expected with some positives. The conditions and pricing were in line with our expectations. We were expecting US$35m annual payment (versus US$32m actual). We were off by about 5 bps in our cost of debt assumptions. The positive surprise was the lower margin increase postwaiver period (we were not so optimistic). The new minimum coverage ratio is fair in our view, especially with outstanding indebtedness falling as quarterly loan repayments are made. The 'official' current fair market value of the portfolio was not disclosed.

Remains our top sector pick. A major overhang has eased, taking pressure off the manager and the stock. Industry concerns remain but we like the new, more sustainable payout model and FSLT's diversified vessel mix. We reiterate that unitholders should constrain their expectations regarding DPU growth; with the new payout model, a significant DPU increase would require acquisitions (and fresh equity) in our view. Note this is a revolving credit facility, so FSLT has the option to tap into the undrawn amount as it grows with each periodic repayment. Our discounted FCFE value is up from S$0.84 to S$0.86, incorporating actual waiver terms. Our fair value estimate edges up a cent to S$0.77, reflecting an "industry uncertainty" discount of 10%. Maintain BUY.

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First Ship Lease Trust - Placement to fund acquisitions

FSLT proposed a placement of up to 100m shares (19.3% of existing share capital) at an issue price of between S$0.525 and S$0.575/share to fund its vessel acquisitions. Maintain HOLD. Yields are intact but bullet payments are not too far away.

First Ship lease Trust (FSLT) has proposed a share placement of up to 100m new units at an issue price of between S$0.525 and S$0.575 each, or not more than a 20% discount to S$0.59. Assuming 100m units (19.3% of existing share capital) are issued at S$0.59 each, the proceeds of S$59m will be used for vessel acquisitions.

FSLT has recently reaffirmed a quarterly DPU of 1.5 US cents from 3Q09 onwards. Based on a placement price of S$0.59, we estimate cost of equity at 14.6%, which seems high. While it is difficult to estimate the effect of FSLT’s proposed vessel acquisitions, shipping trusts generally do not undertake acquisitions that are not accretive. However, the management is targeting for a gross asset yield of 15% p.a.

While FSLT’s lessees have been making lease rental payments promptly, we do not rule out the risk of default by its charterers.
Although FSLT did not apply the distribution reinvestment scheme (DRS) for 2Q09, the scheme has a dilutive effect on its DPU and yields. No change to our earnings forecast as the placement price and the number of new units to be issued have not been determined.

Reiterate HOLD and maintain our fair price of S$0.64 based on 0.8x 2010F P/B of the container shipping sector. We suggest entering at S$0.52. Reasons for maintaining HOLD.

FSLT raises S$41m via private placement at S$0.525 per unit

Pursuant to the placement, First Ship Lease Trust (FSLT) will issue 80m new units (15% of existing issued Units) at S$0.525/share.

The net procceds of about S$40.9m, after the placement fee and estimated offering expenses, will be utilised to fund vessel acquisitions.

FSLT has not identified any specific assets to be acquired with the net proceeds.

FSLT has recently reaffirmed a quarterly DPU of 1.5 US cents from 3Q09 onwards which implies an annualised yield of 14%.

While it is difficult to estimate the effect of FSLT's proposed vessel acquisitions, shipping trusts generally do not undertake acquisitions that are not accretive. However, the management is targeting for a gross asset yield of 15% p.a.

Reiterate HOLD and maintain our fair price of S$0.64 based on 0.8x 2010F P/B of the container shipping sector. We suggest entering at S$0.52.

Reasons for maintaining HOLD:
a) EBITDA yield of 36% p.a. is still intact.
b) Accretive acquisitions will boost its distributable cash.
c) However, although FSLT has begun repaying part of its loans on a quarterly basis, it still has outstanding loans of US$400m due for balloon payments in 2012 and 2014. It will either have to refinance or raise equity. The latter would likely lead to a yield dilution. If FSLT were to raise US$400m at the current share price of S$0.61, this would imply a mere yield of 5.6% p.a. (before accretive acquisitions).

FSL Trust: HOLD on covenants and counterparties

Watch for DPU guidance next week. FSL Trust (FSLT) will announce 2Q results next week on 21 Jul. We do not expect any big earnings surprises, and accordingly our attention will be on DPU. The trust had previously guided for 2Q distributions of 2.45 US cents per unit. Two key pieces of information to look out for: 1) whether the distribution reinvestment scheme (DRS) will apply this quarter; and 2) guidance for 3Q DPU. FSLT changed its '100% payout' model in 1Q09, by scaling back payout and instituting the DRS. We have previously noted that the relative success of the DRS in the last quarter may protect the trust's distribution payout ratio from further cuts.

Pre-paying loans may not be enough. Of course, this depends on the trust's lenders reaction to FSLT's attempts to voluntary prepay loans. Last quarter, a total of US$7.8m (roughly 46% of 1Q cash earnings) was earmarked to voluntarily prepay debt. US$3.8m stemmed from DRS proceeds, while US$4m was from retained cash earnings. We note that this amount is still small compared both to total loans and to our expectations of the quantum of the decline in vessel values.

Possibly seeking covenant waivers. We estimate that FSLT's next vessel valuation will be in the Oct/Nov period (but lenders can call for a revaluation at any time). We believe the question here is not really if the loan-to-value (LTV) covenant has been breached but the tolerance level of lenders to such a breach. Peer Rickmers Maritime [SELL, fair value: S$0.39] had previously announced it is negotiating for LTV covenant waivers with its lenders, while US peers such as Danaos [NOT RATED] and Global Ship Lease [NR] have recently announced successful grants/extensions of such waivers. We expect FSLT to also negotiate for the same - in our opinion, it should be able to secure such waivers but our concern is with pricing. A possible cost structure could be a combination of one-time fees along with higher interest margins over the waiver period.

Covenants and counterparties. We have a NEUTRAL view on the shipping trust sector. We like FSLT's diversification but the shipping industry is undeniably facing tough times. As such, our concerns on covenants and counterparty health remain unchanged. Securing an LTV covenant waiver could be an important next step for FSLT. Maintain HOLD with S$0.58 fair value estimate. This values FSLT at a 30% discount to our 'normal' case discounted FCFE value of S$0.83 (10% discount rate).

First Ship Lease Trust (FSLT) is distributing 2.45 US cents per unit for 2Q09, which represents 74% of net cash generated from operations. Retained cash and proceeds of US$3.8m raised from the distribution reinvestment scheme (DRS) in May 09 will be applied towards a voluntary loan repayment of US$8m.

All of FSLT's lessees have been making payments of lease rentals monthly in advance including those in Jul 09. Remains in compliance with loan covenants. 3Q09 DPU guidance of 1.50 US cents. DRS will not be applied for 2Q09.

FSL Trust: Reinvestment Scheme results

Distribution Reinvestment Scheme (DRS) results. FSL Trust (FSLT) announced that unitholders holding around 155.5m units or 30.9% of the total number of issued units have elected to receive 1Q distributions in the form of units. FSLT has issued about 15.6m units, increasing the total outstanding unit base to around 518.7m units. The manager said that this level of participation was stronger than expected.

Prepaying loans. Proceeds (or retained cash) from the DRS amount to US$3.8m, have been earmarked for voluntary debt repayment. Recall that FSLT had already retained US$4.6m or 27% of 1Q cash earnings, of which US$4m was used to repay debt (also voluntary). In aggregate, FSLT will prepay US$7.8m, or roughly 46% of 1Q cash earnings and 1.5% of total loans. Using 1Q data, its gearing post-prepayment comes to around 1.37x debt-to-equity. Retained cash in 2Q09 will again be used to prepay loans.

Implications for LTV. Loan-to-value covenants are a key concern for the shipping trust sector in light of the 'new world order' of falling asset values and low lender risk appetite. The manager's decision to launch the DRS and to voluntarily reduce FSLT's payout ratio is a pre-emptive gesture of good faith to lenders. In FY09, FSLT could potentially pay off US$16-31.2m (annualized, without and with the DRS) or 3.1-6.1% of total loans. We note that this amount is still small compared both to total loans and to our expectations of the quantum of the decline in vessel values. But whether this level of prepayment is a gesture, or a game-changer, is up to the trust's lenders. The ball is in their court, now.

Implications for DPU. We had previously suggested that outcome of the 1Q09 DRS may affect FSLT's course of action going forwards. The DRS was a success, relatively speaking. FSLT now has more options, in our opinion - we believe it may prefer to keep the scheme in play rather than making further cuts in the distribution payout. Deterioration in the external environment, or adverse feedback from the lenders, could of course tilt this decision the other way. Our updated earnings estimates assume the DRS will apply for the whole of FY09. Our new fair value estimate is S$0.58 (up from S$0.45 previously). This values FSLT at a 30% discount to our 'normal' case discounted FCFE value of S$0.83 (10% discount rate). We believe this is a fair reflection of the shipping environment today. Maintain HOLD.

Shipping Trusts: Concerns easing selectively

First Ship Lease Trust : Provides leasing services on a long term bareboat charter basis to the international shipping industry. Currently owns a fleet of 23 vesse

Pacific Shipping Trust : Shipping Trust with a portfolio of 10 container vessels on charter to sponsor PIL and CSAV

Rickmers Maritime : Business trust fund to own and operate containerships under long term, fixed rate charters to container liner shipping companies

Liner companies looking to push rate hikes. Most of the leading container carriers, including Maersk and NOL are now looking to arrest the free fall in container freight rates through coordinated rate increases. While the problem of lower trade volumes, idle capacity and a huge orderbook will still need some solving, we may be seeing some stability in rates for the rest of 2009. This, combined with the improving sentiment about a global economic recovery in 2H09, should spur renewed confidence in container shipping stocks, and consequently, shipping trusts.

Visibility improving bit by bit. FSLT has a more diversified fleet than peers – with about 38% exposure to containers and 65% to tankers (oil, chemical, product). With the oil price in recovery mode, counterparty risk may be reduced. Moreover, FSLT has no big refinancing risks before 2012. Elsewhere, with the US$360m lifeline thrown to CSAV by German owners last week, PST’s fortunes may be looking up as well. However, RMT has to contend with unfunded capital commitments and an upcoming bullet loan repayment in FY10 and the picture still looks hazy.

FSLT is our top pick, upgrade to BUY. Given the healthy response to the 1Q09 dividend re-investment scheme, investors seem to be giving the thumbs up to FSLT’s attempt to align the interests of both short-term and long-term investors. As such, given the lack of near-term concerns, we believe there is better visibility to FSLT’s dividend payouts, despite trading at much higher yields of about 25%. Hence, we upgrade the stock to BUY, and our DDM-based TP is revised up to S$0.71.

Upgrade PST to HOLD. We are also upgrading our call on PST to HOLD with a revised TP of US$0.20, given that the worst that can happen now on its CSAV charters is a 35% rate cut. Elsewhere, we maintain our HOLD rating on RMT with a revised DDM-based TP of S$0.50.