Monday, January 14, 2008

First Ship Lease Trust - Purchase and Analysis of Purchase

I purchased some FSL Trust today at a market price of S$1.17 to add to my portfolio. After doing some research on the Internet and on forums for high-yielding stocks, I chanced upon shipping trusts. There are 3 of them currently listed on SGX, namely Rickmers Maritime Trust, First Ship Lease Trust (FSL Trust) and Pacific Shipping Trust (PST). Since this was a relatively new asset class and promised high yield, I decided to do my research to see what I could sniff out in terms of yield and returns.

Apparently, of the 3 shipping trusts, only FSL Trust works on a bareboat charter basis, which means that they are not responsible for the costs of maintaining the vessels under their care. The business model for all 3 shipping trusts is similar: buy vessels and lease them back to the shipping operators on an operating lease (usually 7 to 9 years lock-in). The trust will then collect the lease revenue, pay off the trust's management and distribute the remainder as dividends to unit-holders. What differs is that FSL Trust does purely bareboat chartering, in which the cash flows are stable and certain as they are NOT exposed to operating costs and NOT exposed to technical/vessel downtime. As a result, they are able to more or less guarantee a specific dividend being paid out of their profits as profits are more certain and predictable. This qualifies it as a "safe" investment as I do not like surprises when it comes to high-yield instruments.

FSL Trust started off by launching its IPO at US$0.98 which began trading on March 27, 2007. Initially, the trust had a portfolio of 13 vessels, of which 4 are containerships, 4 are product tankers, 3 are chemical tankers and the remaining 2 are dry bulk carriers. The average age of the vessels are 5 years old and they are leased to international shipping operators such as Evergreen Marine, Berlian Laju Tanker (which is also listed on SGX), Schoeller Holdings, Siba Ships and James Fisher. There is flexibility with regards to structuring such lease arrangements for lessees which makes FSL Trust's business model attractive. In addition, to date, FSL Trust has only utilized US$50 million out of a potential US$250 million loan facility to acquire new vessels. This leaves more room for yield-accretive acquisitions which can increase DPU (distribution per unit).

A business update by the company dated November 9, 2007 shows that they had acquired 3 product tankers on June 1, 2007 from James Fisher for US$45 million, marking their first acquisition post-IPO. In addition, there is also an option given by James Fisher to sell and leaseback a fourth vessel by June 30, 2008. The lease term is 10 years and is accretive to DPU. Another 2 product tankers were acquired on November 7, 2007 for US$113 million from Groda Shipping and Transportation for a lease term of 7 years. This acquisition is immediately accretive and we will see the effects in the upcoming 4th quarter DPU announcement due on January 16, 2008 (Wednesday).

Now for the numbers: The previous DPU for the period July 1 to September 30 (paid on November 23, 2007) was US 2.23 cents per share, thus annualized DPU based on this payout would be US 8.92 cents, or about SGD 12.67 cents using a conservative exchange rate of 1 USD: 1.42 SGD. At my purchase price of S$1.17 per share, this would represent a dividend yield of 10.82%. This is obviously much better than any REIT and bank account, and beats inflation by almost double (inflation is expected to hit 5% for 2008). The additional positives are that the trust will be looking out for more yield-accretive acquisitions to add value to shareholders, while yield plays generally do quite well during market corrections.

There are always risks to any investment, and the risk in this case is that distributions are paid out in USD, and the USD is currently on a decline, hitting 1.428 as I write this post. There is also a risk of lease rates slowing down and moving lower, thus limiting FSL Trust's capacity to acquire vessels to increase yield for unitholdings. Of course, the ever present risk is of capital loss, as in any investment which is listed on a stock exchange, but hopefully the impact can be mitigated by a higher dividend yield.

Comments are welcome and I appreciate some healthy feedback on shipping trusts in general, as well as FSL Trust.

36 comments:

shuaka said...

Hi musicwhiz

Please share with me your thoughts.

Is the high yield dvd of >10% your prime reason for purchasing/parking your excess funds ?

What would be some of the business risk involved for FSL ? Oil price ?

It will be good if you could compare with the other 2 trust so that we know what is the worthwhile price to consider .

Thanks

p/s: there was a program recently on CNA on China malls and I wonder the REITs market here in SG is it trending up or maturing ??

Simon said...

musicwhiz,

you missed out on the MOST prevalent risk for FSL - credit risk of the charterer!

Shipping companies are very prone to economic cycles. FSL has to make sure its lessees are credit worthy and will not default on payment even if times are bad. I won't be so worried about capital loss for FSL. The rest of the risks that you mentioned also pale in comparison to the risk of default by the lessee.

Anyway, you made a good buy. =) a common misperception among ppl is that they assume FSL is a shipping company. It's not! it's a financing company for ships! If you look at it that way, the structure of this business trust is a beauty...

Shuaka, oil price has no effect on FSL. It's part of operating cost e.g. lubricating oil. Even port charges and insurance has to be borne by the lessees. =)

anyway, im a fan of this stock. anything you wanna ask, just shout it out. =)

musicwhiz said...

Hi shuaka,

Yes, the very high yield of 10% and above is the primary reason for me to park my funds here. Also, there are no companies which are attractive enough from a valuation and business model perspective with which I am considering to purchase.

The business risk for FSL Trust has been mentioned by Simon, which is the credit risk involved if the shipping operator should go bust. ALL costs are borne by the lessee for the bareboat charter model, which makes it attractive compared to the other 2 shipping trusts (I have a DBS report on Rickmers which compares the 3 shipping trust characteristics, and I used this for my background research as well).

I do not have much experience or knowledge about the REIT or property market, sorry. This is one area I am attempting to brush up on.

Regards, Musicwhiz

musicwhiz said...

Hi Simon,

Yes, good point you brought up which I did not include in my post - credit risk of the charterer ! As the companies mentioned in FSL Trust's presentation represent internationally established shipping companies, I felt that this risk was mitigated somewhat. As for shipping cycles, yes you have a point but I will bank on FSL Trust's Management conducting proper due dilligence on potential acquisitions before they even embark on the sale-and-leaseback.

FSL Trust is indeed NOT a shipping company; in fact I have some experience with sale and leaseback models as Ezra and Swiber had also gone through such methods to grow their fleet quickly.

Thanks for visiting and commenting !

Regards, Musicwhiz

gimz said...

Hi,

Must admit my heart was itching when i saw the yields for shipping trusts as well. But did not make the plunge due to the falling USD.

When the client (lessee) is solely responsible for the maintenance, it might not be a good idea as they simply would not bother to maintain it properly since they are just leasing it for a few years. I wonder if the other trusts charge rental while pricing in the maintenance. I believe this might make the ship to be better maintained in that case.

Another important factor could be the price of ships down the road. Currently given the shipping building boom, there might be a high chance of oversupply of ships where prices might drop. In the worst case scenario, ship financiers end up with low rentals, low resale value and a lousy old ship.

Just my 2 cents, i feel that the biz cycle and credit risk can be diversified through a portfolio of clients and is not much different from those that REITs face.

musicwhiz said...

Hello gimz,

Good points you brought up ! The falling USD is a concern due to the current sub-prime crisis, which I feel may blow over after several years. I did a quick calculation and even if the USD fell to 1.20 against the SGD, there would still be a decent 8-9% yield assuming dividend quantum can be maintained. Thus, that is the buffer I have in case the USD crashes further against the SGD.

You are right to say that under bareboat charter, lessees have less inclination to maintain the vessels and may leave them to "rot". This is definitely a risk but whatever the case, the trust still collects the lease income anyway. Since the operator needs to charter the vessel out to customers, I do not think they will let the vessel get too worn out, thus they will ensure minimal maintenance and replacement of parts to ensure it is sea-worthy.

Yes I to forsee an oversupply of ships in 2010 to 2012 period. In the worst case scenario, FSL will not have yield accretive acquisitions but will stick to their current portfolio of vessels, which still gives a very decent yield. Assuming an 11% yield, it will take about 9 years to recover my capital. Most of their leases are 7 to 9 years.

Thanks and regards,
Musicwhiz

java_guru said...

I would have tot Rickmers Maritime was the superior trust because:

1. Automatic feeder from its parent shipping line

2. distributes only 75% (unlike FSL's 100%) which implies the yield is much higher and there is cash for acquisitions.

Of course the down side is that they are into container ships only.

musicwhiz said...

Hi java_guru,

I guess each shipping trust has its pros and cons, and investors will buy based on their weighing the importance of each pro and con. For me, I prefer FSL Trust's diversified customer base of international shipping operators.

For the distribution part, I don't really understand why the yield is higher if it distributes 75% instead of 100% ? Perhaps you would care to elaborate ?

For Rickmers, their focus is too much on one type of vessel (container ships, as you mentioned), thus I still prefer FSL for they have 4 types of vessels. Another point is that costs are only fixed till 2009, after which it is anyone's guess if Rickmer's Trust has to bear higher costs which may eat into net profits for distribution.

Regards, Musicwhiz

Kit said...

Bro,

I bought FST before, impressed by the yield given the volatility of the current market.

After reviewing my investment objectives and considering some of the points raised by the forumers, I decided to give it a miss.

The main reason is opportunity cost. For my fund to be locked in a so called safer stock, I miss the opportunity to buy some other good stocks which have been badly battered down despite their strong fundamentals.

When market situation improves, these good companies will arguably recover faster. In that case, making 10% or 20% should not be too difficult and maybe within a much shorter period of time.

However, to each his own. If market continues to fall, then it would be a good investment in hindsight.

musicwhiz said...

Hello Kit,

First off, thanks for visiting and leaving your comments. :)

The reason for me to park my money in a high yielding shipping trust instead of investing it in a growth company is because after all my research, I still do not see value in the companies I am eyeing at current prices. Of course, there are 100's of companies out there and Mr. Market may have under-valued more than half of them, but I need to have all factors in my favour before investing (I do not compromise my criteria). Thus, I can say that through my research, I have yet to identify a good opportunity.

Thus, in order to maximise my money and make it work harder for me, I chose to invest it in FSL Trust.

Regards, Musicwhiz

Anonymous said...

There was a sharp jump in share price ar Dec 07 from $0.8+ to $1.2 (50%); Was it due to flight of safety to yield play?

Market entry at $1.00 will provide better margin of safety imo

regards,
Ryan'

Simon said...

i wrote a very long comment, but it seemed to have disappeared. sheesh.

anyway, to java guru.

1. when u say automatic feeder, you mean rickmers has a visible pipeline of ships to acquire? i think that's where the misunderstanding is. shipping trust are not REITS. you don't need a sponsor to supply you ships. the lessees are the very sponsors themselves! in fact, the more independent the shipping trust is, the better as it reduces conflict of interest with other competing shipping companies.

2. do you know why rickmers can only distribute 75%? it's because they have to save 25% for future capex requirements, not for acquisitions. you don't use distributable income for acquisitions, that's not allowed if im correct. anwyay, capex requirements are due to shipping regulations, hence rickmers has no fixed dividend policy. so don't be surprised if distributable drops to 50% if there is a drastic change in regulations. anyway, for FSL, additional capex to ships are borne by the lessees.

Simon said...

To kit,

yup. i agree FSL is not the best if you have a 3-4 bagger stock lying somewhere else. But with 12% yield, you can actually get back your capital in 8 years time (and the FSL's fixed leases are 9-12 years). Even if USD depreciates to 1:1 with SGD, the yield will still be a whopping 8%.

Simon said...

to gimz,

it is already indicated in the lease agreement that the lessee will have to return the ship to FSL in the same condition as they receive at the beginning of the lease. any breach will have to be compensated to FSL. Moreover, FSL conducts yearly inspection of the ship to make sure it's in proper order.

as for market downturn and oversupply of ships, I want to reiterate again, FSL is NOT a shipping company. It is a financing company, hence it is not susceptible to shipping cycles.

anyway, if u r not convinced, FSL already indicated there will be no force sale of the ships during market downturns. in fact, they will be chartered by a subsidiary of Schoeller holdings at a spot rate until it is attractive to enter into a long term lease again. in any case, if you do an NPV analysis of the ships, 80%-85% of the value of the ships that FSL bought at is already locked into the long term lease. since we know these ships are new, there is still a useful life of around 15-20 years after the first lease ends, meaning the ship can be leased out a few more times. I also want to add that, although it is quite irrelevant, a lease of 9-12 years long is good enough to ride out any shipping cycles, which itself is actually shortening

if is any comfort, if u r familiar with the shipping industry, no ships will be left to rot at the dock. i understand that for REITS, no tenants means the shop will be empty, but it just doesn't work that way for ships.

i know nobody raise this yet, but i'll talk abt depreciation. ships will be sold not on the depreciated value but on how much charter income it get bring in. so a ship of 20 years old can be sold at multiples of its buying price if its sold during the shipping upturn just because it can bring in high charter income during period.

Simon said...

to ryan,

i think that was when FSL started trading in SGD instead of USD. u might want to check the SGX announcements.

ryan said...

to simon,

noted my mistake, thanks.

The dividends could be USD or SGD.

My question: Can the dividend (USD) be channelled to a "USD-saving account" like HSBC multi-currency account, to wait for the future appreciation of USD dollar?

Can instruct cdp to deposit my dividend (in USD) to one account and other dividend (in SGD) to different account?

Simon said...

ryan, the dividends are in USD. maybe you will get a cheque in USD... I am really not sure how it works...I am not vested as there are some restrictions in my company, so i have no experience in this...anyone else care to enlighten us?

musicwhiz said...

Hi Simon,

Wow, I must really thank you for helping me to answer all the queries raised by other readers who had left their comments. I think you even answered some of them better than I could ! Thanks for the extra information too which will be helpful to me in enhancing my knowledge of shipping trusts (particularly FSL Trust).

As for Ryan, I think the change was done on Nov 30, 2007 to enable the traded currency for FSL Trust to be in SGD instead of USD, hence the sudden "jump" in the share price. I do not know of the rules regarding the USD and SGD dividend and how it will be dispense. Perhaps I can ask my broker about it.

Regards,
Musicwhiz

Anonymous said...

Hi, care to explain a little on biz trusts? and the specific model fsl is using? if fsl is a finance coy, then who owns the vessels, surely there are some major refits that will cost the owners to maintain? and since there are cycle for shipping biz, usa recession looming isn't a concern.. sorry but this seems too good to be true.

musicwhiz said...

Hi Anonymous,

FSL Trust is a shippinh trust, and you can download their investor presentation dated Nov 9, 2007 for more information on how it is structured. Basically, FSL Trust acts as a finance company and arranges for sale and leaseback of vessels which are owned by vessel operators.

As evident from the presentation, FSL Trust engages in bareboat chartering which means the cost of maintenance are borne by the lessee (i.e. the vessel operators). FSL Trust will own the vessels and they are leased out on long-term leases ranging from 7 to 9 years. Thus, these leases provide stable cash flows and are unaffected by shipping cycles and recessions.

One risk that was mentioned in earlier comments is the credit risk (default risk) in case the ship operators go bust. So you may like to keep that in mind.

Regards, Musicwhiz

Simon said...

heh. yeah. at 12% yield it is really too good to be true because ppl don't bother to talk to management and read every word in the prospectus to understand the complexity of the business. if u want to get a taste of the performance of a similar entity, u can check out ship finance international ltd listed on nyse. it was trading at 12% when it first got listed. now it's 8%.

major refits are borne by the lessees. recessions and shipping cycles will only affect the ship liners who charter the boats from FSL. Hence, as investors, we have to be very concerned about the credit worthiness of the shipping liners.

TheKen said...

heya, good luck with your investment in FSL.

musicwhiz said...

Hi Simon,

Thanks for a little history regarding shipping trusts in USA. Hope that the yield continues to remain high and maybe even increase as time goes by.

Regards, Musicwhiz

musicwhiz said...

Hello theken,

Thanks a lot !

Regards, Musicwhiz

Simon said...

hi musicwhiz, actually we should hope the yield to go down in the future. it means the price of the stock has gone up. we hope for the dpu to go up, yield to go down. =)

Anonymous said...

hi simon, if all borne by lessees, they would have to earn more than 12% given 100% payout by fsl? these are big names and surely they can own ships unless there are no ships or ships are still being build. if that's the case fsl will have limited gowth going forward?

Simon said...

hi anonymous,

i don't quite understand the 'earn more than 12%' part. Anyway, the ship operators will definitely charge higher than the bareboat charter fees they pay to FSL, or else they cannot make money!

Yes, these are big ship liners and they can own ships if they want. But as i said, FSL is a financing company. The big ship liners may want to go asset light, hence they seek financing from FSL. in layman's terms, ship operators buy the ship, sell it back to FSL and charter the ships back from FSL, so that instead of having all the capital locked up in the ships, the ship liners can free more capital up to expand their fleet of ships even more. Plus, this arrangement is treated as off-balance sheet i.e. no debt recognised in their BS. So it's not a matter of whether there are no ships or ships being built. It's a financing company. The question u should be asking is whether can FSL get credit worthy customers and whether FSL has the funding power to finance its customers.

As for growth, on the contrary, FSL has so much growth potential! If u looked at yesterday's announcement, FSL declared that instead of targeting US$200mil of acquisition per year, they have raised the target to US$300mil simply because there is so much demand for the financing service that it offers to the ship operators.

musicwhiz said...

Hi Simon,

Yield does not have to go down. In fact, DPU can increase along with share price, thus keeping yield constant. This would be a win-win situation in terms of getting better absolute dividend, as well as capital appreciation to boot.

I think what you mean is that you assume a fixed DPU, thus as the share price rises the dividend yield will correspondingly drop.

I am optimistic that there will be more acquisitions in time to come to boost DPU. All we need now is patience.

Cheers, Musicwhiz

Drizzt said...

you will need to worry if the real interest rates move above growth rates.

under that scenario it will be bad for yield stocks.

as for now, yield stocks with 7-10% div is a good mix for your portfolio.

im looking to add such to my portfolio as well.

TYL said...

Hi whiz,

Noticed that most of your holdings are in O&G and shipping industry. Just wondering are you working in that industry too? Your knowledge on these businesses are really in-depth. Very informative =)

http://tylequityresearch.blogspot.com/

musicwhiz said...

Hi Drizzt,

Yes, that would be a real cause for concern. But for now, enjoy the high yields ! :P

Regards, Musicwhiz

musicwhiz said...

Hello TYL,

No, I am not working in that industry. I gathered all my knowledge through intensive readings throughout 2 years+, starting from Ezra and then onto Swiber. I also read related O&G industry news and some E&P news too. In addition, I also speak to Management of Ezra and Swiber to understand how the business works so as to get a better feel of the company's prospects.

Thanks for visiting !

Regards, Musicwhiz

Simon said...

hi musicwhiz

any good websites for o&g and e&p news u can share with us?

musicwhiz said...

Hi Simon,

Some of the good sites for O&G related news are:-

1. www.rigzone.com (Rigzone)
2. http://www.oilpubs.com/oso/ (Offshore Shipping Online)
3. www.energycurrent.com (Energy Current)

In addition, you can also try competitors' web pages to see what they are up to, relative to what Ezra or Swiber are planning.

Some competitors I know of include Solstad, Tidewater, Bourbon S.A., Global Industries and Cal Dive, but there are more.

Regards, Musicwhiz

touzi said...

Did somebody say that ship's sealife is only 15-20 years? That is short compared to landlease. Does the 12% yield still look high compared to real estate trust?

musicwhiz said...

Hello Touzi,

Most of the ship's USEFUL life is about 30 years. This is merely the useful life used for depreciating the ships and is not an indication of the actual sea-worthiness of the ship(s). Of course, I agree it still cannot be compared to the actual lives of buildings and property which may extend more than 50 years.

Still, if you consider that you can make back your principle within 10 years, I do not think the issue of 20 or 50 years depreciation is that critical. It is more a case of whether the cash flows from the trust can be sustained.

Regards,
Musicwhiz