First Ship Lease Trust acquires second tanker for US $46m

Acquiring two product tankers for US$46m each. Following an earlier announcement of a product tanker acquisition on June 1st, FSL Trust today announced the acquisition of a second LR 2 (Long Range II) product tanker from Denmark-based TORM Tankers. The two 109,672 dwt tankers were each acquired for US$46m, as a sale and leaseback transaction.

Concurrently announces equity placement to fund acquisition. While the first tanker was acquired partly with the help of proceeds raised in the last round of placements (US$28m) done in late 2009, FSL Trust announced another round of placements to partly fund the acquisition of the second tanker. 

57m new shares (9.5% of existing share base) will be issued at a price range of S$0.347-S$0.354 – a discount of between 5-7% to the "Adjusted VWAP" (adjusted for estimated stub distribution of 0.87UScts for period from 1st April 2011 to 23rd June 2011, to which the new units are not entitled to).

The net proceeds of c. US$15m raised in the placement will be used, along with existing cash reserves, to fund about half of the acquisition cost of the second product tanker, while the other US$23m will be funded from draw down of existing revolving credit facility.

NAV dilutive, DPU accretive. As expected from a new equity issue at a discount to current market price, the placement will be dilutive at the NAV level, reducing FY11-end NAV by about 4.5%, on our estimate.

However, given that the vessels will be 50% debt-funded, and asset yield is higher than current portfolio yield, we expect DPU accretion in FY11/12F. On the topline, the deals will add about US$12m each year during the 7-year contract period to the current annual fixed lease revenues of US$86m. At the DPU level, we expect 2% increase in FY11 and about 9% increase in FY12.

While the distributable income accretion may be somewhat higher, we do not expect the Board to be too aggressive with respect to distribution policy. Hence, we expect DPU to increase from current level of 0.95UScts per quarter to 1.0USct level in 3Q and 4Q11 and possibly 1.15UScts per quarter in FY12.

Balance sheet still a worry. While we are positive on the renewed focus on growth, especially to offset the cash flow declines caused by the loss of long-term charters on the two smaller product tankers last year, we remain concerned about the Group's balance sheet strength.

Going by the track record, unitholders will have to bear the continuous risk of dilutive equity issues to finance growth even in the future, as further debt headroom may be limited. Once the current round of acquisitions are completed, net gearing could go up to 1.4x from current 1.2x and the Trust also has a pending refinancing target of close to US$200m debt by April 2012.

The Trust will be exiting the loan covenant waiver period at the end of June 2011, and we still have to wait and watch how comfortable lenders are with current loan-to-asset values. Our TP of S$0.43 and HOLD recommendation remains unchanged, pending further clarity on asset values and refinancing plans.