First Ship Lease Trust - AGM Highlights

I attended FSL Trust's first AGM for unitholders held at Marina Mandarin Capricorn Ballroom today at 2:30 p.m. There were about 30 or so shareholders and quite a few proxies appointed to vote on behalf of shareholders as well, and the atmosphere was relaxed. The Board of Directors consisted of 5 people, of mention were the CEO Mr. Philip Clausius and the CFO Mr. Cheong Chee Tham whom I had the chance to speak to. From what I gathered, the general mood of the Management was that of optimism and confidence as they knew what they wanted, and were going to go about executing their strategy to ensure yield-accretion for shareholders.

Below are the highlights and snippets from the AGM which I managed to gather (some from memory). Please note that this is NOT a comprehensive list of all that was discussed as there was more than one "camp" of people and many topics and issues were thrown back and forth. I am just summarizing what I can remember and what I feel is more crucial to understanding Management's philosophy for growing the trust and the DPU:-

1) The true underlying economic return on assets acquired is around 7-7.5% (i.e. IRR). This pertains to the higher depreciation charges for FSL's assets as compared to say, a ship owner. FSL uses a more aggressive depreciation policy compared to normal shipping companies and so the depreciation charge will be higher in the initial phase of the ship's lease. However, in time to come, assuming debt amortization takes place, the amount of finance costs will correspondingly decrease and profits will improve as a result. (Note: A shareholder was voicing his concern that net profit after tax was only about 1% of net asset value as at Dec 31, 2007).

2) A question was asked of PT Berlian Laju Tanker (BLT). Apparently BLT had a technical default on one of their debt covenents (unrelated to FSL Trust) and the shareholder was concerned about possible default risk of BLT with regards to the long-term leases signed with FSL Trust. Mr. Clausius replied that BLT was working on a de-leveraging plan and that it is true that there was a technical default; but they had done their due dilligence and BLT were fine before the lease agreement was signed. When asked if there was any recourse for FSL Trust should BLT default on their lease payments, the CEO mentioned that since FSL Trust had legal title to their vessels, they would proceed to re-possess the vessels according to the lease agreement. He also assured that the market value of the vessels is currently higher than its book value, which limits FSL Trust's risk exposure.

3) The BOD was also quizzed on FSL's target capital structure of 1:1 debt/equity. The CEO 's mentioned that it was not attractive to raise equity at 12% yield (FSL Trust's current yield) at the market price of S$1.12. Thus, the trust would have to rely exclusively on debt to acquire ships from ship operators and this debt was "cheap" at 3-month LIBOR + 120 bps. They could essentially borrow more as their Debt/Equity ratio is only 34% currently. There was a US$290 facility ready to be deployed for accretive acquisitions and this would bring the ratio to the eventual 1:1. Of course, the CEO admitted that the aim was to eventually rely on equity to raise funds in future for further acquisitions, and that he believed this could happen when yield compression occurred till yield adjusted to about 7-8%.

4) A point was brought up about the possibility of the market not recognizing the value of FSL Trust, thus all it could do was to just borrow more in order to acquire, which would bring its debt/equity ratio up much higher than the targeted 1:1. The CEO laughed and asked if the market would still accord the same unit price to the trust and let it trade at 16% yield ? He feels it will be a little ridiculous should that happen as the upcoming planned acquisition will increase the DPU per unit hence increase yield. Later on, he did mention other shipping trusts listed in the USA which were trading at yields of about 6-8% on average.

5) The CEO mentioned that shipping was cyclical and that certain classes of vessels were "popular" for certain periods of time; FSL Trust took on different types of vessels in order to diversify their risk and to ensure that they were not at risk of a protracted downturn in for example the dry bulk shipping sector. This is unlike other shipping trusts (e.g. Rickmers) which concentrates on specific types of vessels.

6) When asked about their payout ratio and whether it would still be 100%, Mr. Cheong chipped in and mentioned that the minimum payout ratio was 90%; but the question asked was whether any cash needed to be retained in the trust in order to pay off finance costs (interest on loans) as well as to prepare for the bullet repayment of 2014 when the current loan facility was due for full repayment. Mr. Clausius said that the Trust does not intend to actually pay down that loan in full as he believed in raising more funds along the way through more loans and even through equity. As a result, they would be able to re-finance the loan such that it could be paid down gradually in stages rather than the current arrangement of one bullet repayment. I assumed he meant that negotiations would take place to restructure the loan since it was only 2008 now (there are 6 more years till repayment).

7) Another shareholder asked how the Trust mitigated the risks of default and credit risk when selecting a potential lessee. Mr. Cheong categorically stated that FSL Trust was the only Trust which employed a full time risk assessment officer to assess the credit-worthiness of potential lessees on an ongoing basis. Most of the customers which FSL Trust transacts with need to have a relatively good credit record and also be prominent enough to be considered. FSL focuses more on small to medium sized shipping companies as the giants are all in the container shipping industry. This risk assessment can help to mitigate the risk of default. The worst case scenario (as mentioned earlier) was that the lessee went bankrupt or insolvent and FLS Trust would have to re-possess and re-deploy their vessel(s).

8) When asked about the prospects of the Trust getting good acquisitive deals, Mr. Clausius mentioned that the sub-prime crisis in the USA has tightened credit around the world, and that ship operators are increasingly turning to alternative forms of financing in order to lighten their Balance Sheet. Lease terms negotiated with FSL Trust offer flexibility with early buy-out options on some of the leases, and under lease accounting rules, the lessee can take their vessels off balance-sheet while raising the cash to fund future acquisitions (this is akin to what Swiber and Ezra have done which I have detailed in my earlier posts). But he did caution that there could also be a global recession which could also affect the ship operators and increase the default risk. Thus, the current crisis can be seen as a double-edged sword.

9) A question was also raised on whether there was competition which FSL Trust was up against in terms of getting good deals (i.e. against other shipping trusts or ship financiers) and how they would be able to distinguish themselves. The CEO said that competition was stiff in the time charter industry; but for bareboat chartering the competition was few and fragmented, thus he does not see a problem in competition. He also feels that increasing investor awareness through extensive marketing efforts by FSL Trust has also allowed corporate investors to better appreciate the way a shipping trust functions and how it can add value.

10) The CEO is all of 39 years old and he started the company (FSL Trust Management Pte Ltd) back in 2003. FSL was relocated from New York to Singapore and he said it was not even his initial intention to list the Trust on SGX. When quizzed on why he decided to list in Singapore and not New York where shipping trusts are more recognized, he said that in NYSE it was a case of "here today, forgotten tomorrow" when the next hot thing comes about (he is referring to rotational interest in different asset classes). In Singapore, he feels that shipping trusts are relatively new and that it can command attention due to its business model; and by being mid-cap (market cap of about US$500 million) it could also attract fund attention. I feel that his point was that by listing over here, he could capture and retain more focused attention on the Trust as Singapore had a smaller market, rather than listing on NYSE where the action was frantic and fast-paced (personal opinion).

11) He also mentioned that the older ships get higher leases but the problem was that older assets had the chance of going "out of fashion". If the tide should turn against older assets in the shipping industry, then the market value of those assets could plummet suddenly. He thus emphasized that it was important for a shipping company to have a very new and modern fleet so that even if the industry went into a slump, the company could still rely on their new vessels to generate some form of income. I was relating this statement to Ezra and Swiber; both companies are constantly ensuring that their fleet is new and up-to-date, unlike some companies such as CH Offshore (which is selling off older vessels to replace them with newer ones; albeit slowly) and Taiwan-based Courage Marine (which owns a fleet of old dry bulk carrier vessels).

12) A shareholder also brought up the point about the lessee not taking care of the vessel as it did not technically belong to them; thus in the last 2 years they would cut corners and cause the vessel to be poorly maintained. Mr. Clausius assured that there was a 5-year technical inspection (Mr. Cheong added that this was compulsory) for all vessels and that the lessee would have to pass this inspection before they could return the vessel to FSL Trust at the end of the lease period. Thus, this minimized any physical wear and tear or under-maintenance of the vessels (recall that under bareboat chartering, the lessee is responsible for the maintenance of the vessel at their own expense).

13) Mr. Clausius did not, however, assure that yield compression would SURELY take place; after all he emphasized that the market would determine the yield of FSL Trust and that he HOPED that yield compression would eventually benefit all shareholders, including the IPO shareholders who were "below-water" now. But he did reiterate that the 3 cornerstone shareholders had NOT sold out their stake. One had increased their stake a little, another had sold a little while the third had maintained his stake. Together with FSL Trust Management, they owned a total of 54% (30%+24%) of FSL Trust and the major shareholders were happy with the DPU thus far and see more potential ahead for DPU accretion.

14) Mr. Clausius had a possible explanation for the unattractiveness of FSL Trust at the present moment. The DPU is given out in USD currency and the USD is currently at its weakest against the SGD; this means that Singapore shareholders would receive a correspondingly lower SGD DPU as compared to their USA counterparts who were not affected as they received their DPU in USD. However, he said that even if the USD should weaken further, the current yield was still very attractive by any standard and the absolute DPU would increase further should the Trust make more acquisitions.

Candour and Disposition

The general mood that I could detect from the CEO was that he was candid and willing to take questions from all shareholders; he was also not evasive and did not deflect questions away. But he was cautious about being too optimistic about the Trust's prospects, as the unit price has thus far not done well. He was confident about the Trust's business model and also in his Management Team which had extensive experience and knowledge in structuring operating leases to maximise value for shareholders. This confidence shone through when he spoke to many of the unit-holders. He was also jovial and relaxed and was willing to stay for 45 minutes after the official business ended to take questions from unit-holders. Mr. Cheong was also very chatty and was explaining the business model of the Trust and various technical aspects to another group of unit-holders, but I did not stay to listen.

Please note that the FSL Trust website has mentioned that the forecast DPU for FY 2008 is expected to be 10.432 US Cents per unit. This translates to about 2.61 US cents per share, or about 3.57 Singapore cents using a rate of 1.37 to the USD. This would mean a potential DPU of 14.30 Singapore cents for FY 2008; implying a forecast dividend yield of 12.4% at today's closing price of S$1.15 per unit.

Overall, it was a very good experience to attend the AGM and to speak to Management about various aspects of FSL Trust. It remains to be seen if Management can successfully execute their long-term growth strategy for the Trust but thus far they have done better than the forecast DPU for FY 2007; so this could be an early indication of their ability to deliver.

I will be providing more updates of FSL Trust as they come around, but please feel free to contribute comments on the AGM and share information too.