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These Risks Can Potentially Sink First Ship Lease Trust

Last week, my colleague David Kuo and I were invited for an exclusive meeting with FSL Trust Management, the trustee-manager of First Ship Lease Trust (SGX: D8DU) .

I walked away from the meeting with a feeling that First Ship Lease Trust’s turnaround story painted by Mr. Alan Hatton, the trustee-manager’s Chief Executive Officer, was indeed possible. You can read more about my takeaways from the meeting in here.

That being said, the journey forward for First Ship Lease Trust is not without its risks. In fact, there are some key issues with First Ship Lease Trust that remains very worrying even now. Here are just a few of them and what it means for the business trust.

Market risk

Shipping is an inherently volatile business. Charter rates, like stock market prices, fluctuates constantly.

Now that First Ship Lease Trust is changing its business model to become more of a traditional ship-owner rather than a ship-financing company, the trust will generally be more exposed to the movement of charter rates.

In the fourth quarter of 2014, roughly 19% of First Ship Lease Trust’s charter revenue is coming from pool or spot charters.

Interest rate risk

First Ship Lease Trust does not have a very strong balance sheet; at end-2014, the trust’s debt to equity ratio is 119%. Meanwhile, the trust’s bank loans have floating interest rates that are based on the LIBOR (London Interbank Offered Rate).

This means that if and when the general interest rate environment would rise, First Ship Lease Trust’s interest payments will increase alongside. Although this might not be a very significant risk if the trust has sufficient cash flows to meet the interest payments, it is still a risk nonetheless.

Credit risk

This risk is key and it involves the credit-worthiness of First Ship Lease Trust’s clients.

The trust is in the process of transforming its business into a ship-owner model, but more than half of its revenue is still coming from legacy bareboat charters that were agreed upon by the previous management team (First Ship Lease Trust’s trustee-manager had undergone a restructuring in recent years).

Moreover, most of First Ship Lease Trust’s customers that are on the bareboat charters – such as Yang Ming, TORM and James Fisher – are suffering from weak financials. With the current highly-geared balance sheet of First Ship Lease Trust, it will most likely find itself in a very difficult financial position if any of its bareboat charter customers default on their charters again.

Foolish Summary

First Ship Lease Trust seems to be turning around its fortunes. But, investors should know that the turnaround is not without risks.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim does not own any companies mentioned above.