The 2014 Container Shipping Outlook
The 2014 outlook for the container shipping industry appears bleak. According to AlixPartners’ 2014 Container Shipping Outlook,1 the industry as a whole remains buried under a growing mountain of debt amid continued market turbulence. And this is hardly breaking news. With few exceptions, the industry has struggled for the better part of the past decade. What is new is the impact that that widespread financial distress is finally having on carriers and other key stakeholders: we are now seeing a number of profound structural changes to the industry—changes that may result in broad-ranging impacts on the major market participants.
The race to build and deploy the largest, most-efficient vessels is both a cause and an effect of the persistent financial pressure. Unfortunately for carriers, the deployment of that new capacity has coincided with sluggish demand, which has in turn created the basis for unprecedented operational consolidation on major trade lanes as carriers scramble to find new ways to fill their ships. The alliances promise high levels of utilization, low slot costs, and greater potential market share. The larger lines that have pioneered the new alliances are separating from the pack of carriers unable to make the necessary capital investments. At the same time, carriers of all types are taking a laser focus on cost-cutting activities that are reshaping the very nature of their services.
In short, change appears to be close on the horizon for the container shipping industry and its stakeholders. Financial indicators suggest that the scenario for carriers continues to deteriorate, but the actions carriers are taking suggest a change of fortune may not be far off.
Container carriers’ financial performance points toward continued market turbulence. For the 15 publicly traded carriers included in the Outlook, the Altman Z-score, an indicator of financial distress, was lower—indicating a higher risk of financial distress—in 2013 than since the start of the financial crisis (figure 1).
That measure indicates that the market as a whole has suffered during the past year, falling deeper into the risk of the severedistress range. Only five of the carriers included in the study saw their scores improve from 2012, and those increases appear to be very modest.
Looking a little more deeply into the causes of the financial distress reveals that although the number of carriers reporting negative results in earnings before interest, taxes, depreciation, and amortization (EBITDA) fell in 2013 when compared with 2012, interest coverage fell to 4.9, the lowest level since 2007 (figure 2).
That onerous interest burden can be traced to the steady increase in leverage across the industry in the past decade, as carriers have invested in new tonnage (figure 3). In 2012, capital expenditure grew to $26 billion, a level not seen since 2008. In 2013, carriers reversed course by dialing capital expenditure back to $20 billion.
Although the container shipping industry has for decades been subject to a vicious cycle of mismatches in supply and demand, this time the cycle has been different: there has been no sustained period of recovery—no seller’s market—in which the carriers could rebuild their finances. The impacts of this prolonged financial stress appear to have been exacerbated by the extraordinary levels of investment required to keep pace with the largest carriers’ order books.
Global container-fleet capacity rose by less than 6% since 20122 but an increasing amount of that investment has been dedicated to megavessels. Larger vessels seek to deliver advances in fuel efficiency and other scale economies, theoretically driving slot costs down. Maersk Line launched the largest-yet container vessel—the Triple-E class3—and many other lines have acted quickly to follow suit, launching their own giants. However, slot cost benefits are contingent on high utilization, and some lines are simply precluded from such investment because they hold inadequate market share in the Asia-Europe trades that such megavessels will be constrained to—at least for now.
Liner shipping has exhibited stubborn resistance to consolidation; there have been no major marriages of shipping lines since a series of major deals were struck in 2005. However, in an effort to fill these megaships, operational consolidation is taking place through new alliances. The G6 alliance, formed at the end of 2011 to bring members of the New World Alliance and the Grand Alliance together in the Asia- Europe trades, secured 20% of the market.4 That alliance was recently extended to certain transpacific trades this year and provides 30% of capacity between the Far East and the US Gulf Coast.5 The P3 alliance—formed by Maersk Line, Mediterranean Shipping Company, and CMA CGM—unites the three largest lines across the three East-West trades: Asia- Europe, Transpacific, and Transatlantic. Capacity will be shared, and a stand-alone organization set up to operationally manage the tonnage contributed by the lines, which together currently capture 45% Asia-Europe and 19% transpacific market share.6 Those alliances, designed to reap further scale economies, may present additional challenges to lines left out in the cold. Recognizing the emerging threat, Hapag-Lloyd, a key member of the G6 Alliance, and Chilean-based CSAV announced their intention to merge, which would form the fourth-largest global container shipping line.
More capacity in fewer hands has led to the evolution of creative capacity-management techniques. Through slow steaming, vessels are trying to save bunker fuel, which is the largest component of a carrier’s operating cost structure; and lines are quick to skip sailings and pull services when presented with a savings opportunity. Larger vessels necessitate efficient terminal operations and are limited in the number of ports with the capacity to accommodate them, thereby reducing the total number of ports a given service can call on. This has ramifications for both port operators, faced with increased interport competition, and shippers, faced with fewer service options and reduced supply chain flexibility.
Trade routes are changing at the same time as new vessels are getting deployed. With cost increasingly trumping transit time, the Panama Canal—a critical gateway for US East Coast cargo— has lost out. The expanded Panama Canal will not be fully operational until 2015, which is prolonging the use of less-efficient and more-expensive Panamax vessels on services transiting the canal. Panama Canal dues have doubled since 2005, and the expansion cost is expected to be reflected in even higher dues, making Suez Canal routes more attractive prospects for serving the East Coast. Since 2010, the Panama Canal’s share of this trade fell to 54% from 68% as of August 2013.7
Sales, pricing, and customer service practices among carriers are also changing, with suggestions that non-vessel-operating common carriers (NVOCC) are being squeezed by carriers that offer more-competitive rates directly to shippers in an attempt to cut out the middlemen. There is also evidence that some carriers in particular are changing their traditional sales channels so as to marry better with their new alliance partners. This move from wholesale to retail—dealing directly with shippers— may have lasting ramifications on the industry.
Carriers of all financial fortunes are freeing up capital by divesting noncore activities. Lines have recently sold off terminal assets and peripheral businesses such as container manufacturing, but activities that more directly affect customers are now coming onto the firing line: (1) South Korea–based Hanjin Shipping went so far as to announce it plans to drop out of the transatlantic trade altogether as of May 2014 in an effort to trim unprofitable activities. (2) Chassis pools are being divested. (3) And carriers continue to limit unprofitable inland services, thereby reducing options for shippers. As lines continue their refocus on minimizing costs and as they face requirements to free up capital, further slimming down of ancillary, value-added activities may occur.
Strategies for Success for Carriers, for Carriers’ Customers, and for Investors
Carriers face a prolonged fight for survival—especially those facing heavy debt burdens. The emergence of strong operational alliances at the same time as the rolling out of larger tonnage has divided the sector into haves and have-nots, with smaller lines in particular left with tough choices. To survive, the have-nots will want to:
- Stem the bleeding Continued financial losses and heightened debt burdens are not sustainable. Unprofitable trades should be exited. Continued efforts must be made to draw down on debt unless investment is necessary to capitalize on clear and specific opportunities.
- Focus on costs The industry-wide gains to be made by reducing costs are evident, but to compete for costconscious customers, a continued and heightened focus on cost minimization is essential.
- Recognize value propositions Not all carriers will be able to compete effectively for volumes on the commoditized trades: lowest slot cost will win. Smaller carriers may have to accept downsizing in some trades, finding profitability instead by serving secondary ports or through specific industry or service niches.
- Find safety in numbers Carriers should look to consolidate with complementary partners either through outright mergers and acquisitions or through growing operations alliances.
- Divest noncore activities Many carriers continue holding peripheral assets ranging from container terminals to container manufacturing. With private equity exhibiting an appetite to invest in transportation assets, carriers may be able to realize favorable valuations, which may replenish cash reserves.
Shippers remain uneasy about market conditions. The whipsaw market that pinched many major shippers in 2010 is still top of mind. Increased operational consolidation reduces choice in service offerings in any given market and potentially reduces competition, leading to higher rates. Procurement strategies for 2014 will vary by market segment, but shippers should consider the following steps:
- Closely monitor the financial health of the carrier base.
- Keep a NVOCC in the mix to provide both a view to the market outside key carriers and a safety valve for excess capacity requirements should the market tighten unexpectedly.
- Avoid over-consolidating the carrier base. Key carrier programs have drawbacks as well as the well-publicized benefits.
- Benchmark rates and service levels via objective third-party resources.
- Consider index-linked or long-term contracting options if operating with high volumes on lanes with low volatility.
- Pay carriers for bunker fuel via a clearly defined—and fair— fuel surcharge program.
Financiers should approach the industry with caution. Carrier requirement for capital provides ready opportunity for investment, but such investment comes with high risk levels. To reap returns, investors should specifically bear in mind that:
- Carriers, particularly those lines with high debt burdens, will raise capital through bond issues. Hovering around investment grade, the debt brings return, but the widening chasm between the haves and have-nots raises questions of ongoing viability.
- Divestments of noncore assets are not being made at fire-sale prices; terminal transactions, for example, are at lower multiples than in 2007–08; they also show reduced growth prospects; and they suffer from a shrinking customer base due to operational consolidation.
Change appears clearly close on the horizon for carriers and other key stakeholders in the container shipping industry. The widespread financial distress that has long plagued the industry is driving a number of profound structural changes that may have broad-ranging impact on key market participants. In this environment, carriers, their customers, and investors can take a series of strategic steps to preserve value and position themselves for success.
1AlixPartners’ 2014 Container Shipping Outlook. The Outlook is an annual update on the state of the industry. All references, facts, and opinions contained in this article can be found in the Outlook.
2Alphaliner’s Cellular Fleet Forecast – February 2014
4Drewry Container Insight newsletter – December 16, 2013
5Drewry Container Insight newsletter – December 16, 2013
6BlueWater Reporting presentation provided at American Shipper’s Executive Summit – August 15, 2013
7BlueWater Reporting presentation provided at American Shipper’s Executive Summit – August 15, 2013
The information contained in this article is also subject to the terms, limitations and assumptions contained in the The 2014 Container Shipping Outlook, a copy of which can be provided upon request, including those assumptions, disclaimers, and other limitations contained in that survey.
This article regarding Change on the Horizon: The 2014 Container Shipping Outlook (“Article”) was prepared by AlixPartners, LLP (“AlixPartners”) for general information and distribution on a strictly confidential and non-reliance basis. No one in possession of this Article may rely on any portion of this Article. This Article may be based, in whole or in part, on projections or forecasts of future events. A forecast, by its nature, is speculative and includes estimates and assumptions which may prove to be wrong. Actual results may, and frequently do, differ from those projected or forecast. The information in this Article reflects conditions and our views as of this date, all of which are subject to change. We undertake no obligation to update or provide any revisions to the Article.