Differences Between First Ship Lease Trust and Rickmers Maritime

For investors in First Ship Lease Trust (FSL), the question at the top of investors' minds is: will FSL go the way of Rickmers Maritime and be wounded up? This is my third time investing in FSL and the previous 2 attempts have ended in major losses. I certainly do not wish to lose money on it a third time, which explains this series of blog posts on shipping trusts.

Rickmers is currently in the process of winding-up, after their failure to secure re-financing of their loans. Although this is the triggering point for winding-up, it is not the only challenge facing Rickmers. Would FSL face the same challenges and end up being wounded up as well?

One of the differences between FSL and Rickmers is their business models, which is discussed in detail in A Comparison of Shipping Trusts' Business Models. Essentially, FSL started off with a ship financing business model (but progressively took on a ship rental business model for reasons beyond their control) while Rickmers had a ship rental business model. In good times when demand for ships is high, Rickmers' ship rental model would provide better returns than FSL's ship financing model. However, in bad times when demand for ships is low, FSL's ship financing model allows a faster return of capital than Rickmers' ship rental model. 

Another difference between the 2 shipping trusts is the diversity of ships. Rickmers specialises in container ships, especially Panamax container ships of 3,450 and 4,250 twenty-foot equivalent units (TEUs). Panamax ships refer to the largest ships that can pass through the Panama Canal, which is an important route for ships sailing between Asia and US east coast. In Jun 2016, the Panamax Canal was expanded to accommodate larger container ships of above 10,000 TEUs. Classic Panamax container ships became less useful now that bigger container ships can pass through the expanded Panama Canal. Daily charter rates for classic Panamax container ships fell as a result. Rickmers provided a discussion of the challenges facing the classic Panamax container ships in its Annual Report for FY2016. The figure below, taken from Rickmers' Annual Report, shows the fall in charter rates for classic Panamax container ships.

Fig. 1: Average Daily Charter Rates of Classic Panamax Container Ships

FSL also has 4,250 TEU classic Panamax container ships. Like Rickmers, its charter rates for these ships would fall drastically when the charters expire in 2020. However, FSL has a more diversified fleet of ships. Besides Panamax container ships, it also has feeder containers of 1,200 TEUs, product tankers of various ranges, chemical tankers and Aframax crude oil tankers. The diversity in ships allows FSL to better manage the low demand in any one segment of the shipping industry.

Like Rickmers, FSL has a lot of ships whose charters have expired or are expiring. In 2017, 9 out of its 22 ships will be completing their charters and be redelivered to FSL. When the ships are redelivered, new employment needs to be found for them, likely at lower charter rates. However, this is not the first time ships have been redelivered to FSL. FSL had in the past encountered unexpected customer defaults on the charters and had to redeploy the ships at low charter rates. Fig. 2 below shows the historical charter rates that FSL had. Figures in red mean a decline in charter terms/rates whereas figures in blue mean an improvement in charter terms/rates. "BBC" refers to bare boat charters while "TC" refers to time charters. For time charters, the bare boat charter equivalent (BBCE) revenue is about 60% to 65% of time charter revenue.

Fig. 2: FSL's Historical Charter Rates

As shown in the figure above, it is not a one-way decline when ships are redelivered to FSL. While most ships experienced a decline in charter terms/rates after redelivery, the Medium Range (MR) tankers and Aframax crude oil tankers saw improvements in charter terms/rates in recent years after redelivery.

In its Annual General Meeting presentation in Apr 2017, FSL disclosed the current and average time charter rates in the past 5 years for its ships (see columns in blue in Fig. 2 above). Except for the Panamax container ships, the charter rates that FSL currently have are not too far off the current and 5-year historical average charter rates. Thus, there is a chance that the redelivered ships will not suffer too large a decline in charter rates after redelivery. My estimates for FSL's BBCE revenue for FY2017 is USD62M, which is a 15% decline from FY2016 after redelivery of the 9 ships (see Sustainability of First Ship Lease Trust's Cashflows for more info).

There is, however, 1 key risk that FSL has which Rickmers does not have, which is customer credit risks. Rickmers' customers are all major shipping companies such as Mitsui OSK Lines, CMA CGM, Maersk Line, etc. which could survive the industry downturn better than others. They did not default on the charters with Rickmers. On the other hand, FSL's customers are smaller players. FSL had encountered a no. of defaults in the past, resulting in loss of attractive charter rates. In fact, a major risk facing FSL currently is whether Yang Ming Marine Transport Corp, which chartered the 3 Panamax container ships at high rates, would default or fail. If it does, it would have a large impact on the viability of FSL.

Finally, FSL has only 1 group of creditors while Rickmers has 4 groups. It is easier to negotiate with 1 group of creditors instead of 4 groups.

In summary, there are differences between FSL and Rickmers. FSL might not go the way of Rickmers and be wounded up. The major caveat is Yang Ming does not default or fail. If it does, all bets are off.

See related blog posts:

• A Comparison of Shipping Trusts' Business Models
• Sustainability of First Ship Lease Trust's Cashflows
• Valuation of First Ship Lease Trust

A Comparison of Shipping Trusts' Business Models

You might be wondering why I am still writing about shipping trusts' business models when there is only 1 shipping trust left. This is because for investors in First Ship Lease Trust (FSL), it is useful to understand the differences between the business models of FSL and Rickmers Maritime to assess whether FSL would go the way of Rickmers Maritime and be wounded up. 

On the surface, both FSL and Rickmers are shipping trusts, however, their business models (at least in the initial stages) are quite different. As an analogy, supposed you wish to become a Uber driver but do not own a car. There are 2 ways to obtain a car, either rent a car from a car rental company, or buy a car by taking out a loan from a finance company. From this perspective, a car rental company is very different from a finance company. Rickmers is in the rental business, whereas FSL started off as a finance business (however, over time, FSL became more and more like a rental business for reasons discussed later).

The business model and risks between a car rental and a finance company are very different. A car rental company would want rental of its vehicles (return on capital) for as long as possible, while a finance company would want return of its loan (return of capital) as quickly as possible. Supposed a car has an economic lifespan of 10 years, a car rental company would hope to rent out the car for the full 10 years, whereas a finance company would hope to recover all its loan by no later than the 7th year.

Going back to FSL and Rickmers, both of them bought 4,250 TEU Panamax container ships in 2008 and leased them out. The structure of the deals shows the differences between a rental and a finance business. FSL assumed the ships have economic lifespan of 25 years and leased them out on a bare boat charter for 12 years. At the end of 12 years, the lessee has an option to buy out the ships. Rickmers assumed the ships have economic lifespan of 30 years and leased them out on a time charter for 10 years. Assuming that the bare boat charter equivalent (BBCE) revenue of a time charter is 65% of the time charter revenue, the cashflows for both shipping trusts work out as follows.

	FSL	Rickmers
Purchase Price	$70.0M	$72.0M
Daily Charter Rate (Time Charter)	NA	$26,850
Daily Charter Rate (BBCE)	$18,315	$17,453
Annual BBCE Revenue	$6.68M	$6.37M
Charter Duration (Years)	12	10
Buyout Option Price	$30.0M	NA
IRR @ End of Charter	2.16%	-2.17%
IRR @ End of Charter with Buyout	6.20%	NA

From the table above, the annual BBCE revenue generated by Rickmers in a rental transaction is less than that by FSL in a financing transaction. This is because a financing lessee has to make principal repayments whereas a rental lessee does not. Thus, at the end of their respective charter periods, FSL would be able to recover all its capital and generate a positive annualised return of 2.16% without considering the buyout option. If the lessee chooses to exercise the buyout option, the annualised return would increase to 6.20%. On the other hand, Rickmers would not have recovered all its capital at the end of the 10-year charter period. It would only do so in Year 12. This is not to say that Rickmers' rental model is entirely bad. If it could find shipping companies to rent its ships for the entire 30-year economic lifespan, its annualised return would be 7.96%, much higher than FSL's 6.20%. Unfortunately, in a market downturn where there is little demand for ships, a ship finance business like FSL would be able to recover its capital faster than a ship rental business like Rickmers.

As you can see, the return for FSL is higher if the lessee exercises the buyout option. In fact, the buyout option is probably designed to entice the lessee to exercise it. Based on the purchase price of $70.0M and straight-line depreciation of 25 years, the annual depreciation charge would be $2.8M. At the end of the 12-year charter period, the accumulative depreciation would be $33.6M, leaving the ship with a book value of $36.4M. Assuming that the market value approximates the book value had there been no market downturn, the buyout option price of $30.0M would represent a discount of $6.4M to the lessee. It is actually in FSL's favour if the lessee takes up this option, as it would get back another $30.0M by Year 12, which could be used to initiate a new financing transaction.

From the above example, it also shows that the risks of a rental business and a finance business are different. The main risks of a rental business are market risks, i.e whether it can find shipping companies to rent its ships at good rates. On the other hand, the main risks of a finance business are credit risks, i.e. whether the lessee has the ability and willingness to make principal and interest payments on the loan as scheduled. Going back to FSL, the 3 Panamax container ships that FSL has are leased to Yang Ming Marine Transport Corp. They generate an annual BBCE revenue of $20.0M even though the annual BBCE revenue at current market rates is estimated to be only about $1.6M, assuming 50% utilisation rate (see Sustainability of First Ship Lease Trust's Cashflows for the estimate). If Yang Ming were to default or fail, those lucrative charters would be lost and the viability of FSL would be in question. Thus, FSL's main risks are the credit risks of its lessees.

There is still one more difference between FSL's and Rickmers' business models. FSL's preference is for bare boat charters while Rickmers specialises in time charters. In a bare boat charter, the lessee has to bear vessel maintenance costs, whereas in a time charter, the lessor has to bear these costs. Like a car financing transaction, the lessee (or car "owner") has to pay repair cost or mandatory vehicle inspection cost for the car. The finance company is not responsible for these costs. Whereas in a car rental transaction, the lessee can ask the rental company for a replacement car or deduct rental charges for the period the car is not available for use. In times of market downturn, every cent counts, and FSL's bare boat charters reduce the operating costs needed to run the business compared to time charters.

Having said the above, I mentioned that FSL started off as a ship finance business but gradually became more of a ship rental business like Rickmers. As mentioned earlier, the key risks that a finance business faces are credit risks of its lessees. If the lessee were to default, the ships would be returned to the trust and the trust would have to find new charterers at charter rates that are likely to be lower than the previous charter rates. That is when a finance business becomes like a rental business and faces the same risks. FSL had encountered lessees defaulting previously. In addition, many of its existing charters will be expiring in the next few years. Given the current low market price of ships, none of its lessees are likely to exercise the buyout options. As the charters expire, FSL would progressively become a ship rental business.

Since we are at this topic of shipping trusts' business models, there used to be another shipping trust called Pacific Shipping Trust, which was delisted from SGX in 2012. At inception, its business model was also different from that of FSL or Rickmers. It was set up by Pacific International Lines to monetise its fleet of container ships. Going by the earlier analogy of the Uber driver, this would be a case in which the Uber driver owns a car, but decides to do a sale-and-leaseback. It too became more of a rental business after it expanded its business to lease ships to other companies besides its parent company.

It is probably a moot point now that FSL is progressively becoming a ship rental business, but starting off with the ship finance business model during its initial stages helps to manage the downturn in the shipping industry.

P.S. I am vested in FSL. Also, I will be overseas next week and will not be able to respond to your comments until I return.


See related blog posts:

• Differences Between First Ship Lease Trust and Rickmers Maritime
• Sustainability of First Ship Lease Trust's Cashflows
• Valuation of First Ship Lease Trust

Sustainability of First Ship Lease Trust's Cashflows

Last week, I blogged about the estimated current valuation of First Ship Lease Trust (FSL) and mentioned that since the current market value of the ships exceeds the loan amount, the probability of successful refinancing is quite high. However, the more important factor in determining successful refinancing is whether future cashflows are sufficient to meet the loan obligations. In this post, I will estimate the future cashflows of FSL and determine whether it is a viable business going forward.

For FSL to be viable, its cash inflows must be sufficient to cover its cash outflows. On a Bare Boat Charter Equivalent (BBCE) basis, the annual cash inflow must be able to cover the trust's operating expenses, loan principal repayment and interest expenses. For FY2016, the trust operating expenses (comprising management fees, trustee fees and other trust expenses) amount to USD4.8M, loan principal repayment is USD42.7M (excluding early repayment) and interest expense is USD9.6M. The total non-discretionary cash outflow is USD57.1M. Assuming that loan principal repayment remains the same after refinancing, the only item that will change much from year to year is interest expense. Thus, FSL must be able to generate cash inflows of between USD50M to USD57M annually, otherwise, there is a risk that it might run out of cash and be liquidated in a fire sale like Rickmers Maritime.

On the cash inflow side, FSL generates revenue from 3 types of charters, namely, voyage charter, time charter and bareboat charter. In a voyage charter, FSL acts as a shipping company like NOL to provide a service to ship goods between places. It bears all the costs necessary to provide the service. Among the 3 types of charters, on a comparable basis, voyage charters generate the highest revenue and costs. In addition, it also has to bear the risks of finding sufficient goods to ship at good freight rates. The consolidation of container shipping lines last year shows the high risks that shipping companies have to bear for providing voyage charters. As far as possible, FSL avoids having voyage charters.

At the other end of the spectrum, in a bareboat charter, FSL only provides the ship. All other expenses are borne by the charterer. Thus, bareboat charters generate the lowest revenue and costs among the 3 types of charters. This is the preferred type of charters for FSL, as the cashflow is the most steady.

In the middle of the spectrum are time charters, in which FSL bears the cost of the ship, crew, dry-docking, ship insurance, etc. while the charterer bears the cost of the bunkers, port charges, etc. Based on the financial results for FY2016, the BBCE revenue of a time charter is about 60% of the time charter revenue.

Besides the 3 types of charters, FSL also entered into a pool or Revenue Sharing Agreement (RSA) for some of its ships. Due to an oversupply of ships, FSL might not be able to find a charterer for some of the ships. Thus, it entered the ships in a pool to share revenue among similar ships. As an example, supposed there are 10 ships in a pool, but only 8 ships are hired on average. The 10 ships will share the revenue generated from the 8 ships. Thus, each ship will get only 80% of the revenue the ship would have in a time charter. Hence, for ships in a pool or RSA, there is a potential discount factor to consider in estimating the BBCE revenue based on the utilisation of the ships in the pool.

After discussing the various types of charters and pool arrangement, can FSL generate sufficient cash inflows of between USD50M to USD57M every year to meet its operating expenses and loan obligations? While I cannot predict what charter rates FSL can obtain in the future, we can at least assess whether FSL can generate sufficient cashflows based on historical charter rates. In its AGM presentation, FSL disclosed the current and average time charter rates in the past 5 years for its ships. Fig. 1 below compares FSL's charter rates against the 5-year average and current time charter rates in the market, as well as FSL's BBCE revenue in FY2016 against the BBCE revenue implied by the 5-year average and current time charter rates. As shown in the figure, some of the charter rates have fallen significantly. The last column provides a rough estimate of the sustainable BBCE revenue assuming that the existing charters are reset to the lower of the 5-year average or current charter rates. This figure also takes into consideration the possible utilisation rate for ships currently or likely to enter into a pool when their existing charters expire.

Fig. 1: Charter Rates and Estimated Sustainable BBCE Revenue

Based on the assumptions in the figure, the estimated sustainable BBCE revenue is USD43M, which is below the non-discretionary cash outflow of between USD50M to USD57M mentioned earlier. Thankfully, the BBCE revenue will not fall immediately from USD72.9M in FY2016 to USD43M as some of the more lucrative charters will not expire until mid 2020. Fig. 2 below shows the estimated annual BBCE revenue for each type of ships from FY2017 till FY2022.

Fig. 2: Estimated Annual BBCE Revenue

From FY2017 till FY2019, FSL is still able to generate BBCE revenue of USD63M, before falling to USD53M in FY2020 and USD43M in FY2021 and beyond. Based on the above estimated annual BBCE revenue and annual cash outflows, the year-by-year cashflows are estimated below.

Fig. 3: Estimated Annual Cashflows

Thankfully for FSL, just as the BBCE revenue begins to fall from FY2019 to FY2021, the loan principal repayment also ends around the same period, resulting in positive cashflows every year. By FY2021, FSL would have repaid its entire loan of USD192.5M and the remaining cashflow could be used to resume distributions to shareholders or buy new ships. The estimated balance sheet, excluding the value of ships which is subject to variable impairment losses, is shown in Fig. 4 below.

Fig. 4: Estimated Balance Sheet

By FY2020, the current assets (CA) would have exceeded the total liabilities. The value of FSL would be CA - Total Liabilities + Market Value of Ships.

Hence, based on the estimated future cashflows of FSL, it is likely to meet the loan obligations, providing another reason for believing why refinancing will likely to be successful.

Having said the above, the viability of FSL will depend very much on the Panamax containers, which are very lucrative when compared against the current charter rates in the market. They are currently leased to Yang Ming Marine Transport Corp. If Yang Ming were to default or fail, FSL will run out of cash unless the banks allow it a longer period to pay down the loan. This is definitely a high-risk game.

P.S. I am vested in FSL.


See related blog posts:

• Valuation of First Ship Lease Trust
• A Comparison of Shipping Trusts' Business Models
• Differences Between First Ship Lease Trust and Rickmers Maritime

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.

See related blog posts:

• Sustainability of First Ship Lease Trust's Cashflows
• A Comparison of Shipping Trusts' Business Models
• Differences Between First Ship Lease Trust and Rickmers Maritime