In our recently published addendum to Financial Health Check, we have reassessed container industry prospects and profitability in view of changes in market dynamics. Amid falling spot freight rates, we have significantly reduced the industry profitability forecast for 2023. Container companies continue to prioritise building cash war chests instead of deleveraging. Also, vertical integration moves will make their business model resilient in the long term.
Low demand drives weak freight rates
While 2021 was the year of easy money, 2022 saw rapid monetary tightening by the central banks around the globe as they changed their stance dramatically to tame the heightened cost of living. Amid the worsening economic situation, container volume growth started to decline. This, coupled with the easing congestion in ports (which added to the effective container capacity), lowered freight rates. Accordingly, Drewry World Container Index declined by 77.5% in 2022. While we expected liners to be aggressive in capacity management, taking advantage of the higher coordination owing to the highly consolidated industry, it seems liners have prioritised maintaining their market share over arresting the free fall in freight rates.
Revenues to decline in 2023 after surging in 2022
Carrier companies posted phenomenal revenues in the first three quarters of 2022. However, we expect a significant decline in 4Q22 numbers on a YoY and QoQ basis. Results declared thus far for 4Q22 point in the similar direction. Hapag-Lloyd’s EBITDA and EBIT slumped by about 32% and 35% QoQ in 4Q22. Similarly, Maersk’s EBITDA and EBIT slumped by 39.8% and 46.0% QoQ in 4Q22. In line with dimming industry prospects, the company expects its EBIT to come in a range of USD 2 – 5bn (vs 2022: USD 30.9bn). We expect a similar trend in the results of other companies under our coverage. Accordingly, we have significantly downgraded our industrywide 2023 profitability estimate, as the effects of the deteriorating macroeconomic environment, improving supply chain logjams, record capacity additions and falling spot freight rates start to affect earnings.
The era of vertical integration
Liners are anxious to insulate their earnings against the mercurial freight market and as such are investing heavily in the businesses of ports and logistics. The race for providing end-to-end integrated solutions played a foundational role in the breakup of the 2M alliance, as the strategies of the two carrier giants Maersk and MSC became irreconcilable. On 25 January 2023, carrier giants Maersk and MSC decided to no longer renew the 2M alliance post its expiration in 2025. While MSC has been focused on aggressive liner fleet expansion via newbuild investments and the S&P market, Maersk has preoccupied itself with expanding its end-to-end logistics capabilities. To this extent, it acquired The Martin Bencher Group, Pilot Freight Services, LF Logistics Holdings Limited, and Senator International. While Maersk’s strategy focuses on the complete value chain, other players are also integrating their capabilities to enhance the value proposition of their offerings. Notably, Hapag-Lloyd acquired a 35% stake in India’s J M Baxi Ports & Logistics from Bain Capital after announcing a new transshipment terminal being built in Damietta, (Egypt), following the purchase of the ports and logistics business of SM SAAM, an acquisition of a 49% stake in Spinelli Group, as well as a 30% shareholding in Container Terminal Wilhelmshaven. HMM revealed a KRW trillion investment plan to diversify its business portfolio over the next five years (2022-26).
Lower multiple to attract value investors
Owing to the high correlation between freight rates and earnings of liner companies, the Drewry World Container Index and the Drewry Container Equity Index move in tandem under normal circumstances, but a divergence in the movement of these indices has been recorded. Despite the continuous fall in freight rates, stock prices of the major liners have started to consolidate at the historically low valuation level. At the current Price/Book (P/B), the industry is half its five-year historical average, marking the opportunity for equity investors. The ongoing consolidation at the current P/B level hints that the financial community has already accounted for the near-term weakness.
Source: Drewry Equity Research Services