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FSL Trust: An Asset Play with 80% discount to NAV?

Sunday, April 27, 2014

FSL Trust was an investment in my portfolio that I considered to be a mistake and I blogged about it a few times before. I collected quarterly dividends when I was vested and I also made some money by using technical analysis to trade the stock but, overall, the investment performed badly.

However, always bearing in mind what Peter Lynch said, I looked at FSL Trust again as its unit price plunged to about 6c a unit before recovering to about 10c recently after its trading suspension was lifted. All investments are good at the right prices. So, the question is whether FSL Trust is now at the right price.

Going through the latest annual report with numbers correct as of 31 Dec 2013, there seems to be plenty of optimism with a dose of caution on the part of the management. They took on more impairment to more accurately reflect the values of the assets held by FSL Trust and they also bought units in the open market as the price plunged, believing that the future of the Trust is now brighter.

Looking at the numbers, however, I believe that FSL Trust, at the moment, is attractive only as an Asset Play. With a NAV/unit of US$0.41 and a unit price of about S$0.10, it is trading at more than 80% discount to valuation. However, we have to bear in mind that ships are depreciating assets. So, their values have been and will continue reducing.

Click to enlarge.

When Peter Lynch invested in Asset Plays, he asked:

1. How much debt is there? This is important because creditors are first in line.

2. Is the company taking on new debt, making the assets less valuable?

3. Is there a raider in the wings to help shareholders reap the benefits of the assets?

To address the questions:

FSL Trust's NAV/unit of US$0.41 suggests that if the ships were to be sold at 20% discount to their book values now, after paying off all debts, we could see S$0.25/unit distributed to unit holders. This is a huge 150% premium to current unit price.

FSL Trust is not taking on new debt. In fact, it has been paying down its debt.

In recent months, we have seen some analyses on how the shipping cycle could be bottoming although conditions are still difficult. If these analyses are correct, then, could there be a corporate raider or two who might be eyeing a possible Asset Play like FSL Trust?

With revenue already in decline and with more charters expiring, possibly not to be renewed, FSL Trust is unattractive as an investment for income at the moment or even in the next 12 to 24 months.

Even if FSL Trust were to resume a quarterly distribution of US$0.001, at S$0.10 a unit, we will get a distribution yield of about 5% only. For an investment with assets depreciating at about 5% per annum and with useful life of 25 years when newly acquired, a distribution yield of 5% per annum is sorely inadequate.

Without any improvement or deterioration in revenue, FSL Trust will take about 16 years to pay off the bank loans. 16 years is a long time and given the relatively short useful life of ships, as income generating assets, they would be more or less spent by then.

Of course, one could argue that it is unrealistic to assume zero improvement in economic conditions in that same period. Indeed, FSL Trust could become a compelling investment for income again if its revenue were to improve significantly.

To continue, at the end of the hypothetical 16 years, taking into consideration depreciation and if we are somewhat conservative, FSL Trust's portfolio of assets could still give us a NAV/unit of US$0.20. So, if no corporate raider came along, for someone who decided to invest in FSL Trust at 10c a unit today, he could possibly see a capital gain of 150%, all else remaining equal, if the ships were to be sold away at book value then. Is this realistic?

This leads us to another question we have to answer and that is how realistic are the valuations of the assets? FSL Trust has already taken on more impairment but will there be more to come? More impairment could happen if shipping rates were to decline again. Experts are of the view that this is unlikely to happen as the global economy improves ever so slowly.

For investors for income, FSL Trust is a rather poor choice now and in the near future. As an Asset Play, however, it could be rewarding. However, we wouldn't know whether the unit price will reflect more closely the value of the underlying assets and, if it should happen, when.

Remember that the assets are depreciating in nature. So, the longer we hold, the lower their values. As I would like to be compensated adequately while I wait, I will need a much higher distribution yield than 5% from FSL Trust before considering re-initiating a long position, all else remaining equal. What about 10% which was what Rickmers Maritime Trust offered a year ago during its 1 for 1 rights issue, all else remaining equal?

Bearing in mind that all else will not remain equal and that things could get worse with expiring charters, investors attracted to FSL Trust as an Asset Play should demand an even higher distribution yield. Therefore, without any chance of revenue improving in the near future, as an Asset Play, FSL Trust will become attractive only at a unit price that is much lower than what it is today.

Suggested reading:
"One Up On Wall Street"
by Peter Lynch.
The last I checked, they have 7 pre-owned copies left at US$6.98 each. Free shipping worldwide.

Related posts:
1. Rickmers Maritime Trust: 1 for 1 Rights Issue.
2. FSL Trust: Sold some at 48c.
3. FSL Trust: Reduced DPU to US 0.10c.


seefei said...

thanks AK for the detail analysis. I dont invest in shipping trust but like your analysis of this counter as an asset play. open up my view of this sector as an asset play...

AK71 said...

Hi seefei,

I try to keep an open mind although having lost money in FSL Trust before, I am somewhat more cautious now.

What Peter Lynch says is correct most of the time and that is all investments are good at the right price. There are investments which we should not touch with a 5 feet pole, of course, and these are the con jobs.

FSL Trust is not a con job but the result of a cocktail of negativities which gives us what we see today.

The Trust will only get Mr. Market's attention again if its income distributions should improve. Even so, we have to make sure that the higher income distribution is the result of higher income from operations and not something else.

All things remaining equal, if the unit price should fall by 50%, I could grab some. ;p

seefei said...

the difficult things in handling mr market is keeping a clear and objective mind. especially when we are faced with negativities and herd instinct.

nothing beats doing our own base research and got it right... on hindsight. again, you are the beacon we lesser mortal look up to...

AK71 said...

Hi seefei,

Oh, don't say that. I am as mortal as anyone here. Otherwise, I would not have lost money before.

There is much that I still do not know and, over time, this fact is reinforced!

However, I am happy to share what little I know. I can only hope that my facts and thought processes are right. :)

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