First Ship Leasing Trust is a shipping trust listed on the Singapore Stock Exchange. It was listed in Mar 2007.
Investors have a hate relationship with this business trust. I think this trust is shaping up interestingly.
Share Price: SG$0.168
Outstanding Shares: 639 mil
Market Cap: SG$107 mil equivalent to Us$80 mil ( 1.40 USD to SGD)
In this article, I will give a brief history of FSL Trust’s challenges in the past, the outlook for the shipping segments they operate in and how I see their valuation and future free cash flow.
Caught at the wrong part of the shipping cycle
The hate relationship was mainly due to how FSL Trust have turned out as an investment. If FSL have been properties instead of ships, they would not be so hated.
The shipping cycle went on a good run from 2000 to 2008 as the emerging market was the center of a huge commodity boom. More ships was built and due to the demand for transporting various items, charter rates reached an all time high during 2007 to 2008.
Since then rates at which ships were chartered at have plunged, and the market became oversupplied with ships. 7 years later, and the supply and demand situation is still challenging.
Not much new ships were built, but the situation did not alleviate as commodities demand is very low relative to the hey days.
There are three shipping trusts in Singapore and they were caught with their pants down.
The most challenging was FSL Trust. In the above illustration at various times, they faced one risk that investors not familiar with the industry would omit, that is the company that they charter the ships to decides to default on their charter.
When the people chartering the ships default, your cash flow or EBITDA gets severely impacted, the value of your ships nosedive and your loans, which have covenants tied to loan to value ratio, gets impacted.
FSL Trust, hit my so many negative events, traded lower till less than $0.10.
How things have
At times when we see what happened at FSL, it lets us reflect on the importance of management when it comes to business trust, REITs.
The assets are easily understandable, but if you have a good manager, they know when to buy, when to sell, manage risk well, connects with good charterers or tenants, how to structure their debts to lower cost and spread out maturity duration.
The management of FSL Trust did not manage to do well in this area.
In the depths of despair, there was a change in management. In came the current management team led by Chairman Tim Reid and CEO Alan Hatton.
Management change might not always bring the positive change investors expect. Unless you are well acquainted with the situation in the company, or that you are acquainted with the calibre of the new management, you wouldn’t bet your house that they will improve the situation.
Credit to the management, they steadied the ship. They sold off ships to pay down loans, they negotiated with new charterers to improve the cash flow. They brought the company to compliance with the 2011 loan agreement, which have stopped FSL Trust from pay a dividend to shareholders.
The share price recovered to $0.193.
What caught my eye was the management’s quality but also the potential of the business going forward.
The Business Model
The model for a trust is straight forward. You list a trust to realized part of your capital to deploy in some areas and to earned management fees.
Investors are attracted to a trust due to the dividend payout from the cash flow generated. The advantage is that leverage through debt can be use to purchase more ships.
As the number of ships increases so does the cash flow. As the cash flow gets more meaningful, and return on investment of each new ship is higher than cost of capital, it adds value to the trust.
As the size grows, value of the stock goes up, placement against the share price can be carried out to purchase more ships.
The 2007 bust cycle, exposes the trusts and investors alike to the risk that credit becomes scarce, expensive and that when asset value falls, leverage can be a double edge sword.
The shipping trust changed their business model: They don’t roll over their interest only debt. They use part of their cash flow to pay down debt. Smaller dividend but more sustainable.
All 3 shipping trust in Singapore eventually did that, while you will see the international cousins still adopting the roll over model.
The difference here is the international cousins have strong backers, these 3 local shipping trust do not have.
FSL Trust Fleet of Ships
FSL currently own 23 ships all chartered out.
7 of the ships are container ships and 16 are tankers.
Majority of the 23 ships are young to mid age. Most of the ships are on bare boat charter while less are on time charter. Majority of the ships are product tankers and chemical tankers. 7 of the 23 ships are container ships.
Once chartered at a particular rate, the cash flow do not change, but the charterer can DEFAULT and choose not to pay.
Most of the ships chartered out then is on long duration charters. That was a good thing in that it makes cash flow predictable.
If you reference Rickmers Maritime Trust’s case study, the trust also showed that there are 2 results, either the counterparty chartering the ships continues to pay the high charter rates, or that they default upon the charter. The counter party for Rickmers continue to pay the high rates (more than 100% of the current rate).
Container Ship Market
The container ship market is not in a good shape. Specifically, compared to 2007, the rates are much lower than it was then. The implication is that once the charter expires for the ships, the EBITDA cash flows would be cut severely.
As seen from our recent Rickmers analysis, if you do not factor in this fall in EBITDA in your analysis, could see you purchasing an asset that is only half its intrinsic value.
This slide is taken from Rickmers and it shows the current 4,400 TEU rate to be US$6,700. FSL Trusts container ships were chartered at US$ 18,000.
Suffice to say, the container ships, if you value them according to their potential future cash flows, are worth much less than the value when they were bought.
In contrast, the tanker market is improving.
Crude oil prices have dropped and for refining companies it means cheaper raw materials. This means more demand for product tankers
In terms of the supply situation, the order book as a percentage of existing fleet remains low, which bodes well for the rates since more supply suppresses the rates.
Going forward, the improving rates is one of the reasons to be optimistic about FSL Trust
Overall outlook for FSL Fleet of Ships going forward
There are some bad points and some good points.
2 of the container ships are going to be expire next year. As they are 20 years old, they are likely to be scraped.
Had the container market remain good, they would be able to chartered out for 5 more years on short spot rates.
They are estimated to be scraped for US$12 mil at the end of their charter. I remained optimistic that they can achieve a 50% and higher rate revision.
In terms of contribution, the loss in revenue of the 2 container ships outweigh that of the 2 product tanker.
New Ship Purchase
On 26th Oct 2015, FSL Trust announced that they intend to purchase a 2007 built 46,000 DWT MR at a cost of $21.8 mil. This will be fully funded by their cash reserve of $41.8 mil.
They expected this ship to deliver a cash on cash yield of 14.5% based on a conservative TCE of $16,500 per day.
Purchasing this ship will offset some of the loss in revenue of the 2 lucrative container ships when they expire next year. It will be massive if they can lock in a $20,000 – $25,000 per day charter rates.
The management looks to do what business trust set out to do, which is grow and grow.
They purchase this ship without a charter so they must have real confidence on the demand and rate side to do such a bold move.
I hope I get the right signal here.
We will have to take a look at the cash flow analysis.
I thought looking at the profile of the ships in FSL, the management have kept a portfolio of ships with good future upside.
Cash Flow Analysis
What is important for us as investors is to take a look at the historical cash flow, understand their quality in the past, but concerned ourselves with the cash flow going forward.
Shipping is cyclical, and we try not to project too far forward.
FSL Trust EBITDA will have to factor in:
- Dry Docking
- Paying down its $252 mil debt principal, US$44 mil per year for now
- Pay interest expense currently US$13 mil per year. Interest expense will go down as debt principal is paid down
The current EBITDA per year is US$20/qtr US$80/yr
With the loss of 2 big EBITDA generators in the scraping of the container ships, this would reduce the EBITDA. Recent upward revision of expiring tankers, not to mention the new ship purchase with unannounced charter may reduce the impact of the EBITDA revenue loss.
I anticipate a net loss of US$ 7 mil in EBITDA per year.
This will bring full year EBITDA to an anticipated: $73 mil /yr
Factoring the $44 mil/yr principal repayment and $13 mil /yr interest payment, the free cash flow left would be US$16 mil /yr or SG$ 22 mil /yr
This free cash flow can be used to
- purchase ships with leverage
- buy back shares
- pay out as dividends
The free cash flow yield is therefore 22/107 = 21%
That is an astounding yield at this current share price.
The assumption here is that the product tanker market continues to improve, which may not always be the case.
In investing, if the cash flow is certain and visible to all, the share price most likely would not trade at SG $0.17
The prospect of future dividends
Judging by the free cash flow potential and that they have complied to the loan covenant, what shareholders are anticipating is a resumption of dividend payout.
From the indication of the management, they would like to do that as well.
However, as the 2 containerships’ EBITDA was loss, they want a clearer earnings visibility before doing that.
Based on the cash flow, even if they were to pay out SG$0.017, that would amount to a 10% dividend yield. This would cost them US$7.8 mil in free cash flow.
They could do that and still seed a new ship for US$8 mil.
The share buy back
Even if they do not pay out a dividend soon, buying back shares might yield a better return, then going out to buy a new ship.
That is, if the management deem the company shares to be undervalued.
Management have been buying back shares consistently, which is a good thing.
With SG$22 mil/yr, at current price of SG$0.17, they could buy back 129 mil shares per year. In 2 years, this would reduce the outstanding share float from 640 mil to 380 mil.
The FCF per share will explode from SG$0.034 to SG$0.057. That will be a 33% FCF Yield!
The FCF would only matter if the share price revalues higher, or that a dividend payout occurs.
I would encourage the management to buy back more if they deemed the company to be undervalued.
With the purchase of the new tanker, the current balance sheet looks somewhat like this:
Short Term Debt: US$ 44 mil
Long Term Debt: US$ 252 mil
Cash: US$ 20 mil
Vessel Cost: US$ 531 mil
Forward Enterprise Value: US$ 383 mil
Forward EBITDA: US$73/yr
Forward EV/EBITDA: 5.24 times
Net Debt to EBITDA: 3.78 times
5.24 times EV/EBITDA does not look expensive. Not dirt cheap but when its below 6 times, I take notice. My reservation here is that when it comes to ships they have a limited life span, and thus perhaps my usual metric of EV/EBITDA cheap needs to be reduced further.
Then again to purchase a ship with cheap money might not be so difficult to replenish.
The most conservative valuation metric is to use FCF/EV. The base is factoring equity and debt and the top removes much maintenance capex, debt repayment and interest payment. Essentially, it is unfair to the company to value it this way since, why do you factor in debt at the denominator when you are taking out debt in the numerator?
FSL Trust forward looking FCF/EV is 4.1%. If we put back interest expense it is closer to 8%. That is not too shabby.
We have already seen the FCF yield and what happens if there is a buy back. Provided the cash flow assumptions don’t get too wrong, it doesn’t look too expensive.
TORM recent financial performance
FSL Trust have 2 product tanker ships on sale and lease back with TORM. They are chartered on index linked rates, which means spot rates.
In May 2915, TORM achieve its first positive profit in a long time.
In November 2015, TORM announced their operational platform have delivered the strongest freight rates since 2008. The average spot rates was $24,600 per day.
They are also mulling listing on the NYSE.
They are also embarking on fleet expansion, which will deliver 8 product tanker in fourth quarter 2015.
It looks to me that FSL isn’t the only shipping company benefiting from this improving climate.
New ships chartering out at Spot Rates
One interesting note is that the recent renewal of charter is on rather short term time charter or spot rates. This was brought to the attention of the management by analyst.
Analyst were clamoring when will they lock in longer charter terms.
Alan Hutton the CEO reveal that they are comfortable with the spot rates now. This looks to be an indication that rates will rise further based on their competency in assessing the market.
Locking in to a longer term now, with that view, would not be beneficial to the shareholders. A few years later, we would know whether the management is right, or that they would fall flat on their face on this decision.
Alan also explain that the charter rates is not as volatile when in operation as what we have seen in the freight rate charts. Essentially their average monthly charter rates is still higher than the prevailing charter rates.
FSL Trust have snooked many investors thinking it was a value purchase around the price of $0.50 cents. Even basing the valuation on how the average shipping cycle reacts in the past can be a problem considering the recent shipping cycle have been rather prolong.
We have an outlier then.
Therefore a purchase today is a contrarian decision that people are over playing the risk, and not seeing things will eventually be related to the supply and demand fundamentals of shipping.
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