Sunday, 7 May 2017

Valuation of First Ship Lease Trust

A reader recently alerted me to the undervaluation of First Ship Lease Trust (FSL). It is a stock that lost a lot of money for me, having bought it at $1.27 in Oct 2007, averaged down at $0.42 in May 2009, before finally throwing in the towel at $0.225 in Jan 2012. Together with Rickmers Maritime, the shipping trusts were the worst investments in the 19 years that I had invested in the stock market.

However, despite the heavy losses, I am prepared to relook at it 5 years after I sold it. FSL is in the business of financing/ leasing ships. The shipping industry has been in the doldrums for many years, and this has resulted in poor financial performance for shipping companies and trusts. Rickmers recently decided to wind itself up, with no residual value for its shareholders, despite reporting a net asset value of USD0.21 as at Dec 2016. Its ships, listed in the balance sheet at USD499.6M, fetched only USD113M in a fire sale.

FSL is facing similar business conditions. In my opinion, there are 2 key challenges facing FSL. The first is an immediate one. There is a term loan currently valued at USD192.5M which is due to be repaid in Dec 2017. If refinancing is not successful, FSL will face liquidation and potential fire sale like Rickmers. However, if refinancing is successful, the next challenge is sustainability of its cashflows. A lot of its existing ship charters will expire in 2017 and the next few years. These charters were entered into many years ago when charter rates were still high, but have fallen significantly in the past few years. When the charters expire, the ships will earn much lower rates, posing questions over whether it could generate sufficient cashflow to meet its annual debt repayment obligations. Finally, if supposed there is still sufficient cashflow left after meeting its debt obligations, there would be opportunities to restart distributions to shareholders, which have been stopped since May 2012.

What is my estimated current valuation of FSL? A lot would depend on the value of the ships. If, like Rickmers, its ships could only fetch 23% of their book value, there would be nothing left for shareholders. Thankfully, due to the structure of its loan, we can get some indication of the market value of FSL's ships, which are listed at USD418.4M as at 1Q2017. 

The interest margin that FSL has to pay on its loan is dependent on the Value-to-Loan (VTL) ratio, as shown below.

VTL Ratio Loan Margin
100% to 140% 3.0%
140% to 180% 2.8%
Above 180% 2.6%

In 4Q2016, it reported a loan margin of 2.8%, which means that the VTL ratio is in the region of 140% to 180%. In 1Q2017, it reported a loan margin of 3.0%, which means that the VTL ratio has dropped to between 100% to 140% due to the decline in market value of the ships. In the Annual General Meeting presentation on 28 Apr 2017, FSL also mentioned that the VTL ratio is above 125% despite vessel valuations declining considerably during 2016 and 2017 to date. Based on the above information, we can work out a high and low estimate of the current valuation of FSL. The high estimate is based on VTL ratio of 140% reported in 4Q2016 while the low estimate is based on VTL ratio of 125% reported in 1Q2017.

4Q2016 1Q2017
Loan 223.2M 192.5M
Loan margin 2.80% 3.00%
VTL Ratio 140% 125%
Ship Value (Secured by Loan) 312.4M 240.6M
Ship Value (Unsecured by Loan) 15.0M 15.0M
Trade Receivables 3.9M 5.3M
Cash 42.9M 25.1M
Total Assets 374.2M 286.1M
Total Liabilities 227.0M 198.2M
Net Asset 147.3M 87.9M
No. of Shares 637.5M 637.5M
Net Asset Value (USD) 0.23 0.14
Net Asset Value (SGD) 0.32 0.19

Thus, my estimated current valuation of FSL ranges from SGD0.19 to SGD0.32. As shown above, the valuation varies significantly with the market value of the ships. Based on the above calculation, the loan is fully covered by the market value of the ships. In addition, in its 1Q2017 results presentation, FSL reported that the remaining charters will generate USD90M in revenue. Thus, I believe that the probability of successful refinancing is high. Hence, I have added a short-term speculative position in FSL at $0.11 after a 5-year hiatus. This is solely a bet on successful refinancing. If and after refinancing is successful, I will likely reduce the position considering the uncertainty in sustainability of future cashflows.

Although refinancing is likely in my opinion, a rights issue to raise some money to partially pay down the debt cannot be discounted. At the current price of $0.097, a rights issue is going to be very dilutive. Hence, when I bought into FSL, I was also prepared to subscribe fully to the rights issue so as not to dilute my shareholdings.

This is still not the end of the valuation estimation. Like all distressed asset plays, there will be other players who want to bargain hunt. On 28 Apr 2017, it was announced that the major shareholder planned to sell all its shares to Navios Maritime Holdings. In addition, Navios would provide a convertible loan of USD20M to FSL, which is convertible to such number of shares that, together with the shares bought from the major shareholder, will result in it owning 50.1% of the enlarged share capital. This translates to an additional 330.5M shares to be issued if the USD20M loan is converted, or SGD0.0847 per share, which is a 13% discount to the current price of SGD0.097. The exact terms of this proposed transaction have not be confirmed. After this transaction, the estimated valuation of FSL would reduce from SGD0.19 - SGD0.32 to SGD0.16 - SGD0.24.

This will be my third time buying into FSL. Will I lose money again on it? Let's wait and see. This is definitely not for the faint hearted and certainly not recommended for anybody.

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  1. Thanks for the post. :) thinking of taking a small punt on this.

    1. You're welcome.

      Be prepared for the rough ride in the coming few months.