First Ship Lease Trust 4Q 2008 results - Desperate measures in drastic times

4Q results at a glance

First Ship Lease Trust posted its 4Q results today, 21st January 2009. DPU for 4Q will be USD 3.08 cents but will be cut to about USD 2.45 cents from 1Q 2009 onwards. i.e. Using last done price of 46.5 SGD cents and assuming 1.5 SGD to 1 USD, the yield will be cut from current annualised 39.7% to 31.6%.

Rationale behind distribution cut

It is mentioned in the press release that the distribution cut resulted from a change in distribution policy, from a target distribution of 100% distributable cash flow to 75- 80%. The reason stated was to conserve cash to reduce debt and take advantage of any potential opportunities arising from this crisis. The following is quoted directly from the press release:

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Beginning 1Q FY09, FSLTM will provide DPU guidance on a quarterly basis until longer term visibility returns. For 1Q FY09, FSLTM is targeting a DPU of US2.45¢, which represents about 75 to 80% of expected distributable cash flow. The retained cash will be applied to reduction in financial gearing and potentially to funding growth opportunities when they become available.


Mr Cheong Chee Tham, Chief Financial Officer of FSLTM, said: “Given FSL Trust’s secure long-term cash flows and lack of near-term refinancing needs, we believe that we are extremely well-positioned to take advantage of attractive opportunities which we expect will present themselves in the next 24 months. Our revised payout strategy will give us the needed financial flexibility to take advantage of these opportunities and will result in a more balanced yield / growth equity story for the capital markets.”
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Rationale analysis

Reduction in financial gearing

A DPU cut from 3.08 to 2.45 cents meant a savings of 0.63 cents per quarter, or annualised 2.52 cents. With 501.27m units in the market, this implies a savings of 12.63m per year. Against, its current debt of about 515m, the 12.63m will seem quite insignificant. So it is quite difficult to see how this will actually help in "reduction in financial gearing".

Funding growth opportunities when they become they become available

As for "funding growth opportunities when they become they become available", what can 12.63m buy? The following summarised the recent acquisitions by FSLT:

1. 12th May 2008: 3x Containerships for USD 210m from Yang Ming
2. 21st April 2008: 2x Crude Oil Tankers for USD 140m from Geden Lines
3. 7th November 2007: 2x Product Tankers for USD 113m from Groda Shipping
4. 1st June 2007: 3x Product Tankers for USD 45m from James Fisher
   

With the exception of the 3 product tankers from James Fisher, the other vessels are acquired at an average price of about USD 70m. With the collapse in shipping rates, BDI from more than 10k to around 800 and container shipping rates for free, prices of ships should be under pressure (more on FSLT's loan covenant later). A check on current ship prices shows that ships are still going from a few million to tens of millions, but not many around 70m.

So if there is a fire sale, there is still a chance FSLT can acquire for a bargain.

Drastic times call for desperate measures

However, I see things differently. The change in distribution policy is just a signal for more changes in the horizon.


Loan-to-market value (LTV) covenant

FSLT had on its books vessels totalling 905.6m against about 515m of debt or 175%. The required level before a technical default is effected is 145%, implying a remaining margin of 30% or 154.5m. Its ships are under pressure for further devaluation and breaching the convenant is a real possibility. Each USD 12.63m FSLT manage to save will give it an extra margin of about 2.45%. A further cut in distribution payout ratio will not be surprising.

Equity raising via rights issue

Exceptional times call for exceptional measures. The only threat against debt-based securities like business trust such as FSLT is debt itself. There is no sign the storm will ease up in the coming quarters (or even years as many feared) and there will definitely be further consolidation as weaker players exit the market. Drastic times call for desperate measures. Each player, including FSLT, will take desperate steps to survive. If it is cash they need, they will get it somehow, anyhow. If equity raising is punitively diluting, the medicine will be swallowed, no matter how bitter. Thus I will not be surprised if FSLT go down the road of rights issue in coming quarters, to reduce debt or even fund further asset acquisitions at bargain prices.

Conclusion

The current economic crisis offers both pitfalls and opportunities. No matter what FSLT does to survive, if it survive, it should emerge much stronger and see DPU (and yield at current price) recover spectcularly.

The risk is high (to balance the returns) and seems like the only way for FSLT (and other business trusts as well) to survive is to borrow there way out of this crisis, be it loan or equity. If United States can do it, so can FSLT.

This might seems crazy, but if one look at the number of vessels being taken out of the market, either due to ship building order cancellation or shipping firms going bust, one will know that the shipping market will be in for drastic drop in ship vessel supply years down the road. But can FSLT last that long? Only time will tell.