FSL Trust posted a 11.5% YoY and a 3.1% QoQ increase in net cash generated from operations to US$17.6m. DPU of 1.5 US cents was down 50.8% YoY and 38.8% QoQ because of the lower payout policy as well as the first effects of dilution from the recent placement. Over the past few months, FSLT has 1) reduced distributable payout; 2) secured loan-to-market value covenant waivers on its credit facility; and 3) raised net proceeds of US$28.3m in fresh equity. These actions, in our view, have stitched up some of the last remaining gaps in the balance sheet. 4Q DPU guidance of 1.5 US cents was higher than we expected, as we believe FSLT may fill any shortfall using surplus cash retained in previous quarters. Now that the immediate balance sheet overhang has been addressed, we believe our FY10F yield estimate of 14% is fairly defensible. Maintain BUY with S$0.72 fair value.

Results in line. FSL Trust (FSLT) posted US$24.6m in revenue, up 4% YoY but marginally down 0.9% QoQ. Net cash generated from operations of US$17.6m rose 11.5% YoY and 3.1% QoQ. DPU, however, fell 50.8% YoY and 38.8% QoQ to 1.5 US cents. This was primarily because of the lower payout policy as well as the first effects of dilution stemming from the recent placement. Cash retained for the quarter has been used to prepay loans. Note that 1.27 US cents of the DPU amount has already been declared for the pre-placement units in September. All units will enjoy the outstanding 0.23 US cents amount.

Stitching up the balance sheet. FSLT has had a busy 3Q09. First, it secured loan-to-value covenant waivers from creditors that lower the required market-value-to-loan coverage from 145% to 100% for a two year period. In return, FSLT shifts away from a bullet repayment structure and begins repaying US$8m in loans per quarter. Its cost of debt is also higher. Second, FSLT raised US$28.3m (net) through a placement of new units. The proceeds are earmarked towards acquisitions. These steps coupled with the already enforced lower payout policy coalesce into a strategy of “defensive to be offensive”, marking an important turning point in FSLT’s business model. Moreover, the planned asset buys will give the manager a chance to demonstrate the 1) quality of counterparty; 2) asset yield; and 3) lease structure available to FSLT.

Guidance surprises for 4Q DPU. FSLT has guided for a 4Q DPU of 1.5 US cents or flat QoQ. This is almost 5% higher than our estimate of 1.43 US cents, which was driven by the time lag between the dilution from the placement and the utilization of the proceeds. While we believe this time lag still exists, FSLT’s guidance suggests it has enough surplus cash that was retained in previous quarters to fill any shortfall. In addition, our estimates assume that any acquisition is not completed until 1Q10. If FSLT is able to move faster, early contributions from new vessels could also support the gap.

Still our top pick. Now that the immediate balance sheet overhang has been addressed, we believe our FY10F yield estimate of 14% is fairly defensible. Key risk remains counterparty health in a weak shipping environment. Nevertheless, FSLT is our top pick in the shipping trust sector for its diversified vessel portfolio as well as its newly restructured business model. Maintain BUY with S$0.72 fair value.

3Q results season is around the corner. For the Singapore-listed shipping trusts, we will be tracking: 1) charter performance; 2) balance sheet strength; and 3) how this translates to forward strategy and DPU guidance. FSL Trust is the only trust to have given clear guidance for 3Q09 payout, which we expect it to achieve. Pacific Shipping Trust is reviewing its payout strategy and has only said that 3Q09 payout will be no less than 70% of distributable income. This may be a significant quarter as its Board spells out its forward payout and growth strategy. For Rickmers Maritime, we do not see any scope for DPU increase until its various issues are resolved and in fact believe it more prudent to not price in any payout. Maintain UNDERWEIGHT on the sector. FSL Trust [BUY, S$0.72 fair value] is our preferred pick for its diversified vessel portfolio.