We switch valuation methodology for the three Singapore-listed shipping trusts, namely, First Ship Lease Trust (FSLT), Pacific Shipping Trust (PST) and Rickmers Maritime (RMT), from discounted cash flow (DCF) to P/B, which is the common method for valuing shipping stocks.

The share price volatility of the shipping trusts since mid-08 leads us to acknowledge that investors do not perceive shipping trusts as defensive stocks, despite their relatively resilient earnings from long-term charter contracts. The shipping trusts’ share prices have mirrored those of traditional shipping companies. Share prices of FSLT, PST and RMT have rebounded 20%, 72% and 58% ytd respectively after slumping 50-60% in 2H08.

We believe the P/B method will be more reflective and responsive to the changing risk profile of the shipping trusts, as financing risks are reduced when the shipping trusts overcome their balance sheet hurdles on the back of easing of credit and a recovery in ship prices. The shipping sector (as proxied by container shipping stocks) typically trades at 0.5x P/B at a cyclical trough and 2.5-3.0x at a cyclical peak.

Despite the recent share price rallies, the same risks remain.

a) In view of the collapse in ship values, we do not rule out a breach in the loan-to-value (LTV) covenants of 69% and 90% for FSLT and RMT respectively. PST has no LTV covenants its loan documents. Should asset prices continue to fall, the bankers may require FSLT and RMT to reduce dividend payout in order to partially pay down its loans or a higher cost of borrowings may be levied.

b) FSLT’s Distribution Reinvestment Scheme (DRS) has a dilutive effect on DPU and yields as it offers existing shareholders new shares in lieu of dividends. This was implemented for the first time for 1Q09 dividends. Against a share price rebound in a strong market rally, its dilutive effect on share price did not materialise.

c) Re-negotiation of charter rates by their charterers.

We are guided by the P/B valuations of the container shipping sector because most of the ships owned by the shipping trusts are containerships. In view of a change in our valuation methodology, we raise our fair prices, but maintain our recommendations.

FSLT. We raise fair price from S$0.50 to S$0.64 based on the container shipping sector’s 0.8x 2010F P/B because FSLT’s net gearing of 138% is quite comparable with the sector’s gearing of 143%. FSLT remains a HOLD. RMT. We increase fair price from S$0.44 to S$0.76 based on a lower 2010F P/B of 0.4x, a shade below US peer, Danaos’ P/B of 0.5x because RMT would have a similarly very high net gearing of 4.0x assuming debt financing for the US$700m capex due in 2010 relating to the purchase of four containerships to be chartered to Maersk. While our fair price for RMT is 24% above its current share price, we maintain our HOLD in view of its unfunded US$700m capex due in 2010. We see a re-rating in RMT should it manage to resolve this financing hurdle.