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Wednesday, 21 January 2009

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:

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.”


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.


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.


Monday, 5 January 2009

Digging a hole to fill another

It is said that the current financial crisis is the worse the world have seen since the last depression in the 1930. So it is not surprising that big problems requires big effort to deal with them. The problem then becomes even bigger in itself when the effort turns too drastic.

The world greatest printing machine

A special report was published on cnn website sometime in early December 2008 that summarised the amount of bailout money US allocated and spent. The table does not include the recent auto industry bailout. At the time the report was published, 2.6 trillion USD was spent, out of 7.2 trillion allocated. On top of this, the coming US president, Barack Obama, is currently putting together an economic recovery package, possibly amounting to just under another trillion USD. United State's current account deficit is now about 700 billion USD, or 4.5% GDP, according to the latest issue of The economist, dated January 3rd-9th 2009. And the US government budget for 2009 is projected to be a deficit of USD 1.2 trillion, or 8.3% of GDP!!

One of the reason US can continue to borrow and spend is because they borrow in USD, and pay back in USD. Unless the creditor countries such as China and Japan stop lending to US, there is virtually no disincentive for US to print their way out of this crisis. The lending will not stop, China and Japan (and other export oriented economies) lend to US, so that US can continue to consume their exports, a 'win-win' situation?

This is like running a business, and keep selling to clients on credit. The business keep recording rising profit (foreign exchange reserves) year after year, and the credit (receivables) snowballs. The only difference is the client do repay one day, by printing money.

Thus, its either everyone will be millionaires or billionaires in USD one day, or the lending stops, and plunge the world into deep recession. Either way, printing the USD solves the problem now, by creating a bigger problem later, hopefully a few Presidential elections away.

Worldwide Easycash

With the onslaught of credit crunch, threatening a world wide recession, global interbank rate cuts are announced one after another, chasing each another to near zero (FED and BOJ), short of borrowing for free.

The following links shows the global interbank rates changes for 2008 and 2009:

FED at 0-0.25%, Bank of Japan (BOJ) at 0.1%, Bank of England 1.5%. Sooner of later, European Central Bank (ECB) will cut rates too. While there are warning of potential global recession leading to a wide spread deflation, the aggressive rate cuts is just setting the ground for hyper inflation many years later.

The current credit crunch, due to the over paranoid banks unwilling to lend for fear of losing a single cent more than losing business, will not see cheap money flooding pockets any time soon. But once most of the market excesses have been cut back, restructuring completed, scaling back done, business projections brought back to earthly expectations, really cheap money will start to flow. People will start to borrow to spend. Business will start to borrow again to expand to meet demand. The problem will be back, with greater vengeance.

Cheap oil

What goes up must come down. It is a nice surprise to see this principle applies to oil as well (at least for now). For crude oil future contract to crash from almost USD $150 to below USD $40 in about 6 months is really spectacular.

Expensive crude oil spur the aggressive hunt of alternatives and escalating conservation to cut the reliance. Many of these efforts make sense with crude staying above some emotionally expensive value, e.g USD $100 or economically viable value for alternatives (USD $80 to extract tar sand or produce biofuel).

Thus the problem of cheap oil could just slow current efforts to boost exploration for more oil, find alternatives or improve efficiency and cut wastage. To make matter worse, those efforts that are financed by debt might terminate prematurely in the current credit crunch. The future isn't bright either.

Cheap food

Food crop prices (crude palm oil, soya bean, rice etc) have corrected quite significantly. When real demand and speculative demand (anticipated rising demand) chase prices to unsustainable high, the high price itself (like oil) provided incentive for greater effort to produce and research to increase supply.

With the plunge in prices, the incentive disappears. Whether or not the unprecedented demand in 2008 is real or speculative, it does serve as a warning. Unless sustained effort is made to ensure that there is ample food supply to feed the growing (and also more affluent) world population (especially in emerging economies), a real food crisis could really occur not so long into the future.


It is always easier fill a hole by digging up another. But the problem neither goes away nor get any better. Going forward, investment might be easy, survival may not.