Shipping Trust - Comparing First Ship Lease Trust (FSL) and Pacific Shipping Trust (PST)

What is a shipping trust?

Shipping trust a company that make money by acquiring ships and leasing out to shipping operators. They stay in business by leasing ships at a higher rate of return than the interest rate on the debt they incur to purchase the ships. Most of the profit derived are distributed as dividend to the shareholders.

For more information, see the following overview on Shipping Trusts.

How does shipping trust stay in business?

Shipping trust have to make sure the rate of return on lease exceeds the interest rate on the loan incurred. Normally, shipping trust have access to credit facilities that offer competitive interest rates.

How dividend calcuated?

Distribution (DPU) to shareholders are paid out of operating cash flow instead of accounting profits (for typical companies). This means that are arrived at:

DPU = Revenue from lease - All Management, trust fees & other trust expenses + Depreciation.

Depreciation is an accounting item that accounts for the slow depreciation of ships over their useful life. However, this does not impact the cash flow.

Case Study 1 - First Ship Lease (FSL)

	2Q	3Q	4Q	Projected
Revenue	12.672	12.819	15.224	22.377
Depreciation	(9.161)	(9.052)	(10.360)	(15.735)
Mangement Fees	(0.507)	(0.513)	(0.609)	(0.895)
Trustee Fees	(0.025)	(0.024)	(0.028)	(0.042)
Other trust expenses	(0.276)	(0.327)	(0.443)	(0.938)
Finance Income	0.098	0.169	0.182	-
Finance Expense	(0.472)	(0.928)	(2.048)	12.614
NPBT	2.329	2.144	1.918	4.766
Income Tax	0.022	0.030	0.036	0.067
NPAT	2.307	2.114	1.882	1.882
Added non-cash items and other adjustments	9.220	9.036	10.218	15.94
Units	500	500	500	500
DPU (USD cents)	2.30	2.23	2.42	3.56
Total Assets	527.236	516.874	629.234	919.234
Total Liabilities	47.049	48.653	169.824	459.824
Equity	480.187	468.221	459.410	459.410
Liabilities to Equity Ratio	0.0980	0.1039	0.3697	1.0009
Implied Interest Rate on Lease (Quarterly), IRL	2.40%	2.48%	2.42%	2.43%
Implied Interest Rate on Debt (Quarterly), IRD	1.00%	1.91%	1.21%	1.37%
Net Interest Spread (IRL - IRD)	1.40%	0.57%	1.21%	1.06%
IRL on Assets less IRD on Debt	12.20	11.89	13.18	16.07
NTA (SGD)	1.35	1.32	1.30	1.30
Change in NTA over previous quarter		-2.49%	-1.88%
DPU (SGD cents)	3.25	3.14	3.41	5.02
DPU w.r.t. NTA	2.40%	2.38%	2.63%	3.88%

The above shows the past 3 quarters of FSL. FSL was debt free prior to listing on SGX and started to acquire ships solely from debt. Its policy is to acquire ships until its debt-to-equity ratio is 1.

As of last quarter, 3Q, its debt-to-equity ratio is 0.3697. It recently announced that it had secured another USD 200m credit facilities, bringing total undrawn financial capacity to 290m.

Once fully drawn down, FSL will have about 900m in shipping assets, giving it a projected DPU of about 5 SGD cents per quarter.

Sustainability of Distributions, DPUs

1. The implied interest rate on lease, IRL (revenue/assets) over the quarters are quite consistent; quite so for the implied interest rate on debt, IRD (finance expense/debt) too.
2. The difference between lease returns and cost of debt, (IRL x assets - IRD x debt) is comparable with revenue every quarter. Deducting trust fess & other expenses and adding back depreciation, the remainder is the distribution units for shareholders.
   

Taken together, this means that, so long as lease returns exceed cost of debt by sufficient margin (Net Interest Spread), about 1%, the DPU should be sustainable over several years at least. (Lease terms are normally about 10 years).

Major Risk Factors (to shareholders)

1. DPU are paid out in USD, whereas the trust units are in SGD. Numerically, there is no doubt the DPU can be sustained and grow as projected, but the actual yield in SGD may decline if USD continue to depreciate in short term.
   
2. Shipping vessels are depreciating assets, typically over 30 years. The existing ships will slowly depreciate from the assets in the balance sheet. Note the declining NTA (in red) above.
   

Case Study 2 - Pacific Shipping Trust, PST

	1Q	2Q	3Q	4Q
Revenue	8.514	8.609	8.703	8.703
Depreciation	3.219	3.219	3.219	2.421
Finance Expense	2.263	1.811	4.562	4.183
NPAT	2.700	5.523	0.589	1.649
Total Assets	267.747	266.595	262.224	259.722
Total Liabilities	120.915	116.745	115.357	114.880
Equity	146.832	149.850	146.867	144.842
Liabilities to Equity Ratio	0.823492	0.779079	0.785452	0.79314
Implied Interest Rate on Lease, IRL (Quarterly)	3.18%	3.23%	3.32%	3.35%
Implied Interest Rate on Debt , IRD (Quarterly)	1.87%	1.55%	3.95%	3.64%
Net Interest Spread (IRL - IRD)	1.31%	1.68%	-0.64%	-0.29%
Units	337	337	337	337
NTA (SGD)	0.614342	0.626969	0.614488	0.606015
Change in NTA over previous quarter		2.06%	-1.99%	-1.38%
DPU (SGD cents)	1.4664	1.4664	1.5087	1.5228
DPU w.r.t. NTA	2.39%	2.34%	2.46%	2.51%

PST is in a more mature state than FSL. Its debt-to-equity ratio are nearly 0.8, compared to FSL's 0.37. Similarly to FSL, PST's NTA are dropping nearly every quarter, although much slower.

One note of caution, though, its Net Interest Spread, IRL - IRD is negative in 3Q and 4Q. This means there might be a possibility PST is having difficulty getting debt at a cheaper rate than it can get from leasing ships. Not a good sign for distribution sustainability.


Conclusion

Another shipping trust, Rickmers Maritime, does not have sufficient reporting quarters to be compared here. But just by looking at FSL and PST, it shows up the inherent risk in shipping trust's business model:

They make money by leveraging between the returns on ship lease and the cost of borrowing. This is similar to banks giving lower rates on deposits and lending these out on higher interest rate. The margin, though meagre, is normally sufficient to support their profits.

However, for shipping trust, this business model built on leveraging can quickly collapse if the interest rate increase and lease rates fail to keep up. Though they normally go into hedging to minimize the risk, the danger still exists.

Comparing Super Coffeemix, Food Empire and Tsit Wing on 26th June 2007

My love for coffee spurred my interest in coffee counters. Hence I decided to compare and contrast the three listed in SGX. Though I buy into companies on individual merit, regardless of sectors they operate in, my portfolio coincidentally hold 2 out of the 3 counters.

Overview

1) Food Empire operates primarily in Russia, Ukraine, Central Asia and Eastern Europe. Its main brands are MacCoffee, Klassno, FesAroma, Bésame, OrienBites, MacCandy, Zinties and Kracks.

2) Super Coffeemix operates primarily in Singapore, other parts of Southeast Asia and China. Its main brands are Super, Owl and Nova.

3) Tsit Wing operates primarily in Hong Kong and a lesser extent in China and Canada. Its main business is actually distribution of coffee and tea products to restaurants and hotels.

Business comparison


Figure 1 - Revenue from 2003 to 2006

It is clear from 2003 that Tsit Wing was running far behind Super Coffeemix and Food Empire in terms of sale. Tsit Wing had closed to 80% of market share in Hong Kong and due to limited expansion success overseas (esp. China), their sale basically stagnated across the years. Super Coffeemix expanded well in Southeast Asia and to a limited extent, China. The growth in Southeast Asia (incl. Singapore) already improved sales by a large margin. Food Empire seemed to have even a better success in Russia, Ukraine, Central Asia and parts of Eastern Europe. It's sale was a little behind Super Coffeemix in 2003 but caught up quite significantly by 2006.

Profitability



Figure 2- Profit Margin from 2003 to 2006

Coffee distribution business is a very competitive business. Competitive business environment without perceivable barriers to entry will ultimately drive down profits to zero for all players. As can be seen from the chart above, Tsit Wing was enjoying high profit margin but competition erodes the margin significantly. Super Coffeemix, profit margin after is no better off after 2005. In stark contrast, Food Empire's profit margin, though showing signs of erosion, kept above 10%.



Figure 3- Earnings per share from 2003 to 2006

Comparing earnings per share, it is clear Food Empire is a runaway success.


Figure 4- Return on equity from 2004 to 2006

Comparing return on equity, unsurprisingly, Food Empire lead the pack. However, Tsit Wing earned better returns on equity than Super Coffeemix.

Comparing the numbers

	Food Empire	Super Coffeemix	Tsit Wing
Revenue (Sale)	234,124	210,690	64,341
Cost of goods sold	117,509	135,161	36,827
Selling & distribution expense	56,746	27,211	10,886
General & administrative expense	23,904	24,440	8,520
Other expense	5,041	898	205
Efficiency
Cost of goods sold to sales	50.19%	64.15%	57.24%
Selling & distribution expense to sales	24.24%	12.92%	16.92%
General & administrative expense to sales	20.34%	18.08%	23.14%
Other expense to sales	2.15%	0.43%	0.32%
Profitability
Net income (excl. non-operating income)	26,319	17,159	6,874
Profit Margin (after tax)	11.24%	8.14%	10.68%
Return on Assets, ROA	17.08%	6.34%	13.02%
Return on Equity, ROE (incl. minority interest)	21.70%	9.17%	15.25%
Earnings per share, EPS
Earnings per share (Cents)	6.42	3.48	3.56
Valuation (As at 26 June 2007)
Historical P/E	20.47	22.43	7.31
Intrinsic Value (SGD)	1.04	0.72	0.30

Table 1 - Business performance across the 3 companies

Comparing their price

From the above figures, it is without doubt that the better performer is Food Empire. The only company amongst the 3 that can maintain a high, double digit ROE, a relatively high, double digit profit margin and yet speculator sales growth is Food Empire. Hence it is not surprising to note that's share price is traded at $1.05, above $0.97 and $0.28 for Super Coffeemix and Tsit Wing respectively.

One interesting fact to note is that the market valued Food Empire and Super Coffeemix relatively the same (97 cents is not that far off $1.05). However, Tsit Wing's ROE, ROA, profit margin and EPS was so much better than Super Coffeemix, yet Tsit Wing traded at only less than 30% of Super Coffeemix's share price.

One possibility was that the market might have anticipated a speculator growth in profitability of Super Coffeemix to justify current price valution. Hence, assume that Super Coffeemix is fairly valued, is there a possibility that Tsit Wing is actually unvalued, given its strong performance indicator? That its trading at such price because it is largely ignored, under researched, compared to Super Coffeemix?

Valuation

I decided to investigate for myself. Taking into consideration their current business prospects and factoring anticipated future earnings, I estimated their intrinsic value using the Residual Income Model. Using a Expected Rate of Return of 10%, I found that Food Empire and Tsit Wing was actually trading at fair value while Super Coffeemix was trading above its intrinsic value. Maybe I underestimated the potential earnings growth of Super Coffeemix.

United Food vs People's Food - 15th June 2007

Shortage of live pigs and rising cost
The current shortage of live pigs in China, due to disease and supply control by farmers (rising cost of rearing without passing cost to customers resulted in margin erosion), seemingly bode well for Unifood. For news on the shortage of live pigs can be found online, one of them is given here.

People's Food vs United Food
People's Food's core business focuses and does very well in processing live pigs into fresh, frozen and processed meat products. United Food, on the other hand, struggles to stick a hand in everything (nicely labelled as "vertical integration"). They are involved in pig rearing, animal feed, meat processing, soya bean processing, health care products etc.

Possible recovery?
Due to the surge in price of the live pigs, People's Food is expected to be affected. They duly issued a business update. On the other hand, if the farmers does react in the way the report depicted, the first to benefit should be United Food's two business segments;

1. Pig rearing
2. Animal feed

Reservations
Will this result in better quarters ahead for United Food? I do hope so but I am still sceptical. Their Fresh, Chilled and Frozen Pork segment also faced the brunt from the escalating cost of live pigs. Their Q1 2007 results quoted 61.16% lower pre-tax profit compared to Q1 2006. Going forward, I wonder whether the above 2 segments can offset the expected plunge in this segment.

Inspired by a Chinese article at Zaobao and another article posted on Shareinvestor forum.