Container carriers experience another difficult year with soft demand, excess capacity.
2013 was another tough year for the liner shipping industry, with the container operations of 15 public companies examined by American Shipper losing an aggregate $530 million.
While some companies—most notably, the world’s largest container carrier Maersk Line, with an operating profit of $1.6 billion—did well, it seems likely that many carriers will have difficulty sailing out of their sea of red ink in 2014 as capacity continues to outpace demand for transportation and freight rates remain depressed and highly volatile.
CMA CGM, the third largest container carrier, is not a public company, but also reports financial results, and said it had a good year with core earnings before interest, taxes, disposals and impairment of $756 million and consolidated net profit of $408 million. Hapag-Lloyd and OOCL also had modest operating profits, but most carriers reported operating losses.
“With respect to containerships, we assume that an improvement in the supply and demand environment will remain elusive due to continued deliveries of large containerships,” wrote Koichi Muto, president of Mitsui O.S.K. Lines, as the company reported its fiscal 2013 results in April. “In the containerships business, we plan to secure a certain level of profit by strengthening its cost competitiveness through such means as up-scaling the size of containerships, improving operational efficiency and expanding alliances.”
Slow growth ahead? “The great recession of 2008 and 2009 has had a tremendous impact on world trade,” said Jim Denton Brown, manager of planning at Bechtel, in a review of the shipping industry he presented at the 33rd World Congress of the World Association for Waterborne Transport Infrastructure (PIANC). “Trade has only begun to recover and is recovering very slowly, much more slowly I think than any of us might have thought four or five years ago. That has led to very weak demand for container shipping, in particular.”
Michael Behrendt, chairman of the executive board at Hapag-Lloyd, said in the company’s annual report the International Monetary Fund “anticipates a return to much stronger economic growth in 2014 and 2015, with this having a tangible effect on global transportation volumes.” IMF forecasted growth will rise from 3 percent last year to 3.7 in 2014 and 3.9 in 2015.
AlixPartners, a New York-based consulting firm, said ocean trade is forecast to grow 4-6 percent this year.
C.C. Tung, chief executive officer of OOCL, noted “looking forward, the industry faces two challenges. On the demand side, the likelihood of global trade growth repeating its high growth performance during the last decade is low.
“In addition, much of the outsourcing processes of the major developed nations have been completed. The result is that global world trade growth and the multiplier effect on container demand will be under pressure,” he said.
Traditionally container volumes have grown at a multiple of world GDP, but Tung said “economists forecast that GDP-to-container multiple for the half decade starting from 2013 may be half of that during the 2002–2007 period.”
“Up until 2008 you were basically looking at an industry that grew at almost a 10 percent clip every year since its inception in the 60s,” said Esben Christensen, director of the maritime practice at AlixPartners. “Everyone had gone through bad years, but they had never gone through a real downturn and what you’re seeing is an industry that hasn’t been able to get out of the downturn and has been in this for a five-, six-, seven-year period. So it is really in unprecedented waters.”
However, some carriers predict a boost in cargo volumes during the second half of this year and, in June, governments in Europe and China said they would take steps to stimulate economic growth.
The European Central Bank lowered rates further and started charging banks to hold funds overnight, so-called “negative interest rates.” The New York Times reported the bank’s president, Mario Draghi, left the door open to employ bond-buying used to restart growth in the United States by the Federal Reserve. China also said its central bank would encourage banks to lend more to exporters and announced an ambitious plan to develop infrastructure—waterways, roads, railways, and airports—along the Yangtze River.
Source: Research by American Shipper, carrier reports.Rates Playing Catchup. On the largest U.S. trade—imports from Asia, “carriers continue to play catch-up on rates, which have been effectively stagnant since 2011,” said Brian Conrad, executive administrator for the Transpacific Stabilization Agreement, at the end of April.
“Modest revenue gains from recent GRIs (general rate increases) will not be adequate to pay for upgraded services to meet likely demand surges in the coming months” he said, as TSA announced plans for a general rate increase of $150-200 per TEU in mid-May and a $200-per-TEU peak season surcharge in mid-June, though these were postponed by some carriers. There were reports that many shippers were able to renew their contracts from last year at similar rates as the prior year.
In the Asia-Europe trade, which has been flooded with large, new, highly efficient megaships like the Maersk Triple E and the CMA CGM Explorer-class ships, carriers are seeking to implement much larger GRIs—Hapag-Lloyd, for example, said it would implement a $1,000-per-TEU GRI on the Asia-Europe trade on July 9.
The London-based consultants Drewry said “peak season demand should ensure that average vessel utilization from Asia to Northern Europe remains high through to the end of the third quarter, thereby eliminating the need for sailing cancellations, and improving the chances of success with GRIs.”
However, Ben Hackett, founder of research and consulting firm Hackett Associates, which produces the widely followed PortTracker, reports, said few ports can effectively work some of the new large ships that have been put into the Asia-Europe trade during the past year, so carriers are not getting optimal use of them.
Tung noted “on the supply side, high bunker costs have led to available technological improvements and the focus on economies of scale of larger vessels. Together with the immense capacity of the shipyards, it is perhaps unavoidable that the industry will and can continue to place newbuilding orders in an effort to gain unit cost competitiveness.”
As larger ships have been put into the Asia-Europe trade, ships formerly used there have cascaded into other trade lanes.
For example, carriers are deploying bigger ships to bring cargo from Asia to the U.S. East Coast to take advantage of their economy of scale. Because those ships are too large to transit the Panama Canal, carriers are using Suez routings more commonly. Bigger ships are also being used on routes between Asia and the South American east coast and have driven down rates on that route.
“In my opinion, where the battle is going to be fought is in the secondary trade that is receiving all this capacity that has been cascaded from the East-West trades,” Christensen said. “I just don’t see how the other trades will be able to soak up all that capacity and that is something we will have to watch very, very closely in the years to come.”
Drewry said surplus Panamax containerships with capacities of 4,000-4,900 TEUs cascading into the North-South trades is still contributing to overcapacity. And it said the problem is likely to get worse when the Panama Canal’s widened locks open in early 2016. It predicts many of these vessels will eventually be scrapped regardless of age.
Ship scrapping could help bring supply of the container vessels more in line with demand, and the average age of these ships being scrapped is getting younger.
But Tung said “it is typical for the industry to see enhanced scrapping only when the operating results become unsustainable. If the situation remains unchanged, the net effect of such supply-and-demand dynamics is that the overcapacity will become a multi-year challenge for the industry.”
Lay-ups could also reduce supply, but Hackett said carriers have been loath to do so and laid-up capacity is at its lowest level in years.
While shippers should take advantage of low rates while they can, Hackett thinks carriers are making a mistake by not cutting capacity, adding “it’s sort of a basic Economics 101—your supply is too high and demand is not there to meet that increased supply. So, there is only one way prices will go… but then you lose market share and nobody in the industry likes losing market. So, there is sort of a lemming-type approach to the business.”
Source: Research by American Shipper, carrier reports. Although Hackett is skeptical, some analysts believe carriers have little ability to increase rates.
“You are at a stage in the market, and have been for a number of years, and the carriers recognized this, that they have absolutely no control over pricing,” said Lars Jensen, chief executive officer and a partner at SeaIntel Maritime Analysis, based in Copenhagen. “Pricing is becoming increasingly transparent and customers are becoming more and more willing to change to a different supplier. That is also why we have all that volatility in the rates out there.
“So, carriers have come to the understanding that when you can’t control pricing there are only two things you can control: First and foremost, you can control your own costs,” Jensen said. If a carrier can lower costs more than its competitors, it is “hurting less than everybody else.”
Carriers have reduced the energy costs of their fleets, both eliminating inefficient vessels; ordering larger, more efficient ships; and including new engines and hull designs to burn less fuel.
Yasumi Kudo, president of Japan’s NYK, has stated “cost reduction will depend on uncompromising efforts to eliminate wastefulness, irregularity, and unreasonableness.”
Jensen said the second thing liner companies can do is “try to control your volume, and you’re seeing carriers less and less just focus on volume and their focus is becoming increasingly on capacity utilization,” he said. “Problem is, when you’ve got an overcapacity like you do, a focus on capacity utilization de facto becomes a focus on volume because how on earth are you going to fill your ship if there are too many ships out there.”
The information service Alphaliner estimated that based on the order book as of May 1, even with delays in deliveries, 201 ships with 1.46 million TEUs of capacity will be added, bringing the world container fleet to 18.2 million TEUs by year end. Another 229 ships will bump the world fleet’s volume to 19.8 million TEUs by the end of 2015. With scrapping and those delays accounted, it expects the world fleet to grow 5.6 percent to 18.2 million TEUs this year and 8.4 percent to 19.8 million TEUs in 2015.
Most of the capacity being added is through large ships, and there are predictions more orders could come later this year from the G6 alliance carrier members (APL, Hapag-Lloyd, Hyundai, MOL, NYK, and OOCL) as they seek to bring their costs more in line with those of the planned P3 Network of Maersk, Mediterranean Shipping Co. and CMA CGM, expected to begin operation this fall.
H. J. Tan, executive consultant at Alphaliner, said “I do not expect to see any significant changes this year compared to 2013. The earnings gap between Maersk and most of the other carriers will remain.”
Tan predicted “none of the major carriers will exit the market and alliances appear to be the main strategic option that carriers are pursuing although it has failed to raise the carriers’ margins.”
Christensen of AlixPartners said fundamentally the shipping industry’s problem is a matter of too much capacity and too little cargo. “Carriers have realized—and Maersk is not alone in this—that one way to get better economics is to lower your slot costs. Bunker fuel is the biggest expense these carriers have and, if you can put more boxes on a ship, you can leverage that cost across more units and lower your costs.”
Source: AlixPartners analysis of publically traded company financials using the Altman Z-Score formula.Haves And Have-Nots. The industry is divided into “the haves and the have-nots,” with the “haves” being companies that have the capital and investment profile that allows them “stomach the short term pain of deploying big vessels and really contributing to the supply demand imbalance, with the expectation that in the longer run when the market stabilizes they will find themselves with a competitive advantage over the other players,” Christensen said.
Companies that don’t have the capital or scale to do that “have some tough choices in front of them because they’re not going to be able to compete most likely on cost in the main trades which are really cost driven and they’re going to have to think about what are the other trades and niches they can play in where they can get above average returns,” he added.
The entry of larger ships has resulted in the creation of new or enlarged alliances as carriers work together to obtain enough cargo to fill larger numbers of slots. These include the P3 Network, the G6 formed through the merger of the Grand Alliance and New World Alliance, and CKYHE formed when Evergreen decided to team up with the CKYH carriers—COSCO, “K” Line Yang Ming and Hanjin.
Are those alliances set in stone?
“I think if history is any indicator of what’s going to happen in the future, then it would suggest these alliances might change over time,” Christensen said. “Carriers have different priorities and if one carrier’s investment appetite changes and their fleet profile changes then it may or may not make sense for them to be in a P3 or a G6 alliance any longer, and there might be other players that are better suited. So, I think we’re going to continue to see players enter alliances, exit alliances over time.”
But the alliances have not led to actual mergers. Other than the merger of CSAV and Hapag-Lloyd currently underway, there have been no actual combinations of carriers in recent years.
Looking at the industry’s performance since 2008, “there has not been this wave of bankruptcies and defaults that the numbers would suggest that there could have been,” Christensen said.
“My personal perspective is I don’t feel there’s a huge consolidation play here,” he said. “You get some synergies on the cost-side, but I think with the alliances already in place, you really don’t get a lot of synergies on the network…. And so it’s hard to get the economics to work out and I think that’s going to have companies be more hesitant to do a big acquisition unless there are excellent opportunities. I just don’t see that being a huge trend, an accelerating trend.”
“The CSAV/Hapag-Lloyd consolidation remains the only merger play, but I expect the results to be underwhelming and I don’t see it as a catalyst for further industry consolidation,” Alphaliner’s Tan said.
Container companies have been able to avoid default or mergers in some cases because of government involvement or being part of more diversified companies that haven’t had liquidity issues, Christensen said.
“They’ve had losses, but they have had fairly deep coffers to be able to sustain those losses. That said though, if this trend continues for another period of time eventually some of those stakeholders and the shareholders in some of these businesses are going to make some tough decisions and decide whether they want to continue to pump equity and cash into these businesses or find other places to put money,” he said.
“What is happening right now is just not sustainable, and either it has to change or there is going to have to be another wave of consolidation, some companies or players leaving,” he added.
Diversification’s Twist. For several years, AlixPartners has monitored the financial condition of the liner industry using a well-known tool called the Altman Z-Score. (See Table 4). It shows the liner industry has been in the “distress zone” for four of the past five years.
Of course, liner companies are often part of larger shipping groups that operate everything from car carriers to dry bulk vessels and tankers, as well as related businesses such as logistics and terminal operations.
In the past, that diversification strategy may have served companies well, because “that’s given them an opportunity to ride the wave on one segment when it’s been high and to help offset losses in another segment when that’s been low,” Christensen said.
But in the past several years, nearly every segment of the shipping industry has been down, Esben said, noting diversification into other shipping segments has hurt lines rather than helped them in the current cycle, so far.
Container shipping tends to be less volatile than bulk transport, Christensen said, and part of the reason is because of the increased operational complexity of running a container line. “If you have a supertanker, a VLCC (very large crude carrier), it’s really a real estate play and if the real estate market is low you have very limited options to change your profile,” he explained.
Christensen believes one of the advantages of a liner company is that a carrier can do more through its management to affect performance.
Jensen sees Maersk’s standout performance as the story of the year in 2013, which he said was “very cleanly confirmed if you just look into Q1 this year” when Danish carrier reported a profit of $454 million, or $366 million excluding one-offs.
A former Maersk employee himself, Jensen recently published the book, Culture Shock in Maersk Line, which discusses changes at the company in recent years.
Different League. Jensen said the emerging picture is that Maersk is “performing not just somewhat better, but they are performing in a completely different league compared to all the other carriers.”
However, all the container shipping companies are in a “horrible” market, he said. For example, in the first quarter bunker fuel prices were about 7 percent lower than they were a year earlier, and most carriers cut unit costs by about 5 percent, “which tells me that a large part of that unit cost reduction was simply due to the oil price decline,” Jensen said.
On the other hand, he said, Maersk reduced unit costs by 9 percent, adding the carrier has done this not just because it’s a better negotiators, but through the “journey Maersk has been on for the last 10 years in transforming the way it operates the company.
“What we are seeing now is the result of driving a carrier not as you usually operate a shipping company, but the way you would operate any production company set up according to a lean philosophy,” he said.
He said the big ships that Maersk has ordered for its fleet are part of the reason for its success, but the company has also adopted a “process approach” that allows it not just to reduce the cost of buying, but address systematic costs. “It’s not a matter of buying things cheaper, but a matter of tying the decision-making process together in a different way to optimize the use of your ships,” Jensen said.
“The reason this has taken a very, very long time to do is because it has required a drastic change in power structures, basically who is allowed to make decisions,” he said.“If you want to run basically a cookie cutter you cannot have a lot of people with a lot of decision-making authority. They have decision-making authority over a very tiny part of the process and it has to be extremely well defined. Then you can get these savings.”
Cookie Cutter. Jensen said 10-15 years ago, Maersk had a lot of “strong shipping personalities, a lot of them extremely entrepreneurial, which was fantastic in the old ways of doing shipping. But when you’re running a cookie cutter the last thing you want is for every Tom, Dick and Harry to be an entrepreneur who wants to change things to his own liking. Because then everything comes unhinged. And then you will just return to all the waste that you had.
“Other carriers are facing the very stark reality that over the next two to four years, they’re going to have to play catch-up” and improve the utilization of assets, he said.
As an example, Jensen pointed to the decisions that a liner company must make when it experiences a booking shortfall, when a container does not show up for loading. Does the capacity manager release the slot at the next port in the rotation or several ports later? When does the capacity manager refuse a booking in favor of repositioning an empty container?
These are not new challenges, but he said Maersk has been good at getting such processes under control.
In addressing their challenges, Jensen thinks it’s important for companies to realize that information technology “doesn’t come first. IT has to be developed second once you find out what the processes are actually going to be. Because until you get to that point, you don’t actually know what your IT system is supposed to support. For most carriers this is not easy because they have huge, very old legacy systems. And it takes years to make any material changes in those systems. So, for a lot of the carriers, the challenge is how can we at least improve the processes given the systems landscape that we do have.
“But the next challenge, which I actually see a large number of carriers underestimating… is how hard it is to get the organization to actually adhere to these processes,” he said.
“The ‘easy’ part is to design the processes, to come up with a huge number of blueprints saying this is how the machine should operate. But once you put that into the hands of 2,000-5,000 people—people who are not used to be operating according to rigid processes, who are not used to how to improve processes—the first thing that will happen is a lot of them will revert to doing their decision making the way they used to,” he added.
“And the second they start to do that you get no value out of the processes. You are just reintroducing all of the pain points you already have, actually adding pain points because you will end up with some people who wanted to do things according to the processes but now it doesn’t work because someone else is doing something different because that is what he is used to doing.
“So what a lot of these companies have not even begun, in my opinion, to scratch the surface on, is how to change the mindset of the company to make sure you can even go to the point where you can improve the processes,” Jensen said.
Shipper Actions. While shippers are faring well in the current ocean freight environment, Christensen said they should monitor the financial health of liner carriers and may want to use a non-vessel-operating common carrier to move some cargo in case the market tightens unexpectedly. In late 2009 and early 2010, many shippers “got slammed” and had cargo leaving Asia rolled when carriers laid up many ships and volumes rebounded. A NVO can also be another way to get a view of what’s happening in the shipping market.
AlixPartners suggested benchmarking rates, considering index-linked or longer-term contracts, and have bunker charges well-defined, clear, and fair.
Bechtel’s Brown suggested the shipping alliances “may find that they want to extend their reach even further into the logistics chain and graft on other modes” and perhaps offer seamless logistics to inland points or even air cargo services.
That would be counter to the trend seen at many companies that Christensen said have “refocused, doubled down on the core business” and sold assets such as chassis, trucking affiliates and terminals. He said it is hard to tell if these moves have been forced on them by the poor state of the industry.
“Each situation is unique. But I think in general it’s fair to say that some of these businesses haven’t been sold because carriers all of a sudden woke up and thought that running terminals was no longer interesting, but rather found themselves needing cash or wanting to buy down debt and this is an asset class that was very attractive to investors,” Christensen said.
This article was published in the July 2014 issue of American Shipper.
