Hapag-Lloyd Outlook Revised To Stable From Negative On Improved Financial Performance; Affirmed At 'B+'

Transcription

1 Research Update: Hapag-Lloyd Outlook Revised To Stable From Negative On Improved Financial Performance; Affirmed At 'B+' Primary Credit Analyst: Francisco Serra, London (44) ; Secondary Contact: Izabela Listowska, Frankfurt (49) ; Table Of Contents Overview Rating Action Rationale Outlook Ratings Score Snapshot Issue Ratings Related Criteria Ratings List DECEMBER 12,

2 Research Update: Hapag-Lloyd Outlook Revised To Stable From Negative On Improved Financial Performance; Overview Hapag-Lloyd's debt prepayments and cost synergies--combined with improved shipping freight rates and stable near-term industry prospects--will support rating-commensurate financial measures and liquidity through We are therefore revising our outlook on Hapag-Lloyd to stable from negative and affirming our ratings on the company, including our 'B+' corporate credit rating. The stable outlook reflects our expectation that Hapag-Lloyd will maintain its adjusted funds from operations to debt above 12% in 2018, driven by moderate earnings growth and gradual debt reduction. Rating Action On Dec. 12, 2017, S&P Global Ratings revised its outlook on Germany-based container liner operator Hapag-Lloyd AG to stable from negative. We affirmed our 'B+' long-term corporate credit rating. At the same time, we affirmed our 'B-' issue rating on Hapag-Lloyd's senior unsecured notes. The recovery rating remains '6', reflecting our expectation of negligible recovery of 0%-10% (rounded estimate: 0%) in the event of payment default. Rationale The outlook revision reflects our expectation that Hapag-Lloyd's improved EBITDA performance and gradual debt reduction will contribute to rating commensurate credit metrics and adequate liquidity in Further underpinning our outlook revision is our expectation of stable average container shipping freight rates in 2018 (after they improved in 2017 from historical lows in 2016). Furthermore, and because Hapag-Lloyd has an efficient and young fleet with low-level investment needed in the medium term after the merger with United Arab Shipping Co. (UASC), we factor in its relatively low capital investments--to be funded with internally generated cash in In addition, Hapag-Lloyd's strict cost controls and effective integration of UASC five months after the transaction closed should improve its cost position (as measured by transportation expenses per 20-foot-equivalent units; TEU). In our view, Hapag-Lloyd will be able to DECEMBER 12,

3 unlock the bulk of the targeted US$435 million synergies in 2018, mainly coming from the fleet and route optimization, and slot cost advantages. As we anticipated, Hapag-Lloyd will significantly expand its reported EBITDA to 1.1 billion- 1.2 billion in 2017 and about 1.3 billion in 2018 (from about 600 million in 2016), pro forma for the merger with UASC on a 12-month basis (we acknowledge the company will include UASC for only seven months in 2017). We estimate Hapag-Lloyd to reach S&P Global Ratings' adjusted debt of about 7.5 billion in 2018 (from about 8.1 billion, which we forecast in 2017) incorporating the early prepayment of existing debt (with proceeds from the recent million capital increase) and additional debt reduction (from free cash flows). As a result, we expect S&P Global Ratings' adjusted funds from operations (FFO) to debt to improve to about 16%-18% from our forecast of 13%-14% in This compares with above 12% that we consider as commensurate for the current 'B+' rating and indicates some headroom if average freight rates perform below our base case. Average freight rates on major trade lanes have recalibrated to more sustainable levels for container liners this year. This resulted from decent trade dynamics, higher bunker fuel prices, and supply-side measures, such as vessel demolition or lay-up and rationalization of networks, thanks to dynamic consolidation between container liners. The most recent mergers and acquisitions, and the South Korean container liner Hanjin's insolvency, have resulted in the leading players expanding their marker shares so that the top five hold about 65% of the total sector. This normally should support future industry pricing. These positives, however, may be counterbalanced by rapid deliveries of ultra-large containerships during These vessels were ordered a few years ago when industry projections were much brighter, but the inflating fleet capacity now poses a downside risk to the current freight rates, which will ultimately depend on future supply discipline of the leading container liners. In our base case, we assume: Worldwide economic growth will remain vital to the shipping industry. Given the global nature of shipping sector demand, we consider the GDP growth of all major contributors to trade volumes. We forecast GDP growth in the eurozone of 2.2% in 2017 and 1.8% in 2018, compared with 1.8% in 2016; largely flat GDP of 5.6% in 2017 and 5.5% in 2018 in Asia-Pacific, compared with 5.5% in 2016; and 6.7% this year in China and 6.3% in 2018, after 6.7% in On continued job gains, wage inflation, and a relatively healthy economy, we expect U.S. GDP growth of 2.2% this year and 2.3% in 2018, compared with 1.6% in In 2017, Hapag-Lloyd will add about 3.1 million TEUs with the incorporation of UASC, to achieve a total of 10.7 million TEUs. On an organic basis, we forecast annual growth rates in Hapag-Lloyd's transported volumes of about 5% in 2017 and 3%-4% in 2018, based on global GDP growth trends. An increase in bunker prices (fuel to run ships and one of Hapag-Lloyd's major cost positions) flowing directly to bottom-line earnings in We estimate that Hapag-Lloyd will spend $310-$320 per metric ton in DECEMBER 12,

4 and 2018 compared with about $210 per metric ton in This largely follows our estimates for stable crude oil prices, which are typically a good indicator of bunker price performance (see "S&P Global Ratings Raises 2018 Brent Oil Price Assumptions To $55; WTI Unchanged At $50; Assigns 2020 Oil & Gas Prices," published Nov. 24, 2017). We forecast a 2% decrease in average freight for Hapag-Lloyd in 2017, compared to 2016, because UASC has structurally lower average freight rates based on its route network and different inland transportation costs (incorporated in the freight rate). On a stand-alone basis, Hapag-Lloyd achieved a higher year-on-year average freight rate, in line with the improved freight rates conditions in We believe that Hapag-Lloyd will achieve the targeted US$435 million synergies in 2018 and Increasing the average vessel size (as compared with Hapag-Lloyd stand-alone), optimizing the network, and keeping a tight grip on cost control will help the company lower its unit costs (excluding bunker). We expect a decrease in average cost per TEU to from about 765 in 2017 (all-in expenses per TEU excluding bunker). Total annual capital investments of about 350 million- 400 million in 2018 and These relate to payments for new containers and dry-docking/maintenance. Scheduled debt repayments of about 700 million and additional debt prepayments of about 450 million in No dividend payments in the next 12 months. Based on these assumptions, we arrive at the following credit measures: A ratio of adjusted FFO to debt of 13%-14% in 2017 and 16%-18% in 2018, compared with 15%-16% in 2016 for Hapag-Lloyd on a stand-alone basis. A ratio of adjusted debt to EBITDA of about 5.0x-5.5x in 2017 and 4.0x-4.5x in 2018, compared with about 4.7x in 2016 on a stand-alone basis. Our assessment of the business profile remains constrained by the high-risk shipping industry and Hapag-Lloyd's profitability, which is susceptible to the industry's cyclical swings, heavy exposure to fluctuations in bunker fuel prices and freight rates, and the company's limited short-term flexibility to adjust its operating cost base. We believe the company's operating margins and returns on capital will likely remain volatile. These weaknesses are partly mitigated by Hapag-Lloyd's leading market positions and coverage through a far-reaching and strategically located route network, broad customer base, and attractive fleet profile supported by a young, large, and fairly diverse fleet. Our business risk profile assessment incorporates the company's track record of achieving operational efficiencies and its proactive and successful measures to steadily reduce its cost base, which prop up earnings and which we consider to be a critical support to earnings. DECEMBER 12,

5 Liquidity The adequate liquidity assessment reflects our expectation that the company's sources of liquidity will cover its uses by at least 1.2x over the coming 12 months. Furthermore, we believe the company has sufficient headroom to maintain adequate liquidity, since we expect liquidity sources will exceed uses even if our forecast EBITDA declines by more than 30% (rather than the standard 15%) in the 12 months from Sept. 30, In addition, Hapag-Lloyd appears to have sound relationships with its lenders and a generally satisfactory standing in credit markets and we consider the company's financial risk management to be generally prudent. However, our adequate assessment is susceptible to the company performing below our base-case scenario in the context of the inherent industry volatility and pronounced swings in freight rates. We estimate its principal liquidity sources for the 12 months from Sept. 30, 2017, to include: On-balance-sheet surplus cash of about 911 million, after deducting about 310 million (US$350 million) minimum cash requirement under a bank covenant. Availability of about 389 million under undrawn revolving credit facilities, of which about 100 million matures in October 2018 and the remainder in Committed bank funding for new containers of about 165 million. Capital increase of million in cash completed in October 2017, with proceeds used to prepay debt. Operating cash flows (after interest paid and dividends received) of about 900 million as per our base-case forecast. We estimate that liquidity uses over the same period will include: Scheduled amortizations and short-term maturities of about 720 million. Early debt prepayments of about 900 million (of which million with proceeds from capital increase) and 203 million that were in escrow to enable early prepayment after the Sept. 30, 2017, balance sheet date. Capital spending on vessels/containers and maintenance of 400 million- 450 million. Intra-year seasonal working capital requirements of about 150 million. Maintenance financial covenants on Hapag-Lloyd's bank debt stipulate limits, such as a minimum ratio of fair-market vessel or container value to debt of 65%-90%. As of Sept. 30, 2017, through the refinancing of some of its bank debt and subsequent prepayment of existing financing facilities, the loan-to-value risk was mitigated. Given the current headroom and improvement in fair-market values for containerships, we expect the company to be compliant with its covenants during the next annual test on Dec. 31, 2017, and semi-annual test on June 30, Other maintenance financial covenants on the company's bank debt stipulate limits such as a minimum level of equity and minimum liquidity. The liquidity DECEMBER 12,

6 covenant stipulates minimum liquid funds of US$350 million--up from US$300 million before the merger. Under the minimum equity covenant, equity must be higher than 30% of total assets or higher than 2.75 billion. Hapag-Lloyd passed these covenant tests with sufficient headroom as of Sept. 30, 2017, and we expect it to pass the coming quarterly covenant tests in There are no leverage ratio or interest coverage covenants. Outlook The stable outlook reflects our expectation that the recovered average freight rates will largely hold over the next 12 months, resulting in Hapag-Lloyd's sustained adjusted FFO to debt of above 12%, further underpinned by the company's ability to gradually reduce debt and achieve the targeted synergies from the merger with UASC, while maintaining prudent capital investments. Downside scenario We could lower the rating if credit metrics appear to deteriorate, such that adjusted FFO to debt is less than 12% in the next 12 months because of weakened freight rate conditions without prospects for a short-term improvement, higher-than-anticipated bunker fuel prices and inability to recover cost inflation, or unexpected debt-funded investments preventing reduction in financial leverage. Furthermore, we might consider lowering the rating if we see clear signs that liquidity coverage will underperform our base case of above 1.2x coverage of uses by sources in the next 12 months on a rolling basis. Upside scenario Given the industry's inherent volatility, an upgrade would depend on Hapag-Lloyd's ability to further reduce debt and therefore achieve an ample cushion under the credit measures for potential fluctuations in EBITDA, combined with a stronger liquidity coverage. For example, we would raise the rating if Hapag-Lloyd were able to maintain its improved reported EBITDA at or above 1.4 billion, underpinned by the continued reduction in unit cost and the industry's supply discipline, and reduce its financial leverage, such that adjusted FFO to debt improves and remains at or above 20%. Ratings Score Snapshot Corporate credit rating: B+/Stable/-- Business risk: Weak Country risk: Intermediate Industry risk: High Competitive position: Weak Financial risk: Aggressive DECEMBER 12,

7 Cash flow/leverage: Aggressive Anchor: b+ Modifiers Diversification/portfolio effect: Neutral (no impact) Capital structure: Neutral (no impact) Liquidity: Adequate (no impact) Financial policy: Neutral (no impact) Management and governance: Satisfactory (no impact) Comparable rating analysis: Neutral (no impact) Issue Ratings Recovery Analysis Key analytical factors Our 'B-' issue and '6' recovery ratings on Hapag-Lloyd's senior unsecured notes reflect the notes' unsecured, unguaranteed, and structurally subordinated nature, which offers limited protection against additional debt issuance. The rating is further constrained by the strong security provided to virtually all the group's bank loans over the company's best assets and ahead of the notes, as well as the risk of multijurisdictional insolvency proceedings. As a result, recovery prospects are low, in the 0%-10% range, incorporating UASC debt and assets. In a distressed scenario, we anticipate that the remaining value from unencumbered assets would be absorbed by prior-ranking lenders, leaving no recovery upside for the unsecured noteholders. Our hypothetical default scenario assumes weakening economic conditions, transport volumes, and freight rates, which would lead to rapidly falling vessel values and a payment default. In our view, Hapag-Lloyd would still have a viable business model if it were to default, given its existing commercial customer base. Individual ships could be readily sold to other operators to generate liquidity. Consequently, we use a discrete asset valuation to evaluate the recovery prospects associated with the underlying assets. Simulated default assumptions Year of default: 2021 Jurisdiction: Germany Simplified waterfall Gross enterprise value at default: about 5,145 million Administrative costs: 514 million Net value available to creditors: 4,345 million Priority claims: 5,622 million Unsecured debt claims: 1,600 million --Recovery expectation: 0%-10% DECEMBER 12,

8 Related Criteria Criteria - Corporates - General: Recovery Rating Criteria For Speculative-Grade Corporate Issuers, Dec. 7, 2016 Criteria - Corporates - Recovery: Methodology: Jurisdiction Ranking Assessments, Jan. 20, 2016 Criteria - Corporates - General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014 Criteria - Corporates - Industrials: Key Credit Factors For The Transportation Cyclical Industry, Feb. 12, 2014 Criteria - Corporates - General: Corporate Methodology, Nov. 19, 2013 General Criteria: Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013 General Criteria: Methodology: Industry Risk, Nov. 19, 2013 Criteria - Corporates - General: Corporate Methodology: Ratios And Adjustments, Nov. 19, 2013 General Criteria: Group Rating Methodology, Nov. 19, 2013 General Criteria: Methodology: Management And Governance Credit Factors For Corporate Entities And Insurers, Nov. 13, 2012 General Criteria: Use Of CreditWatch And Outlooks, Sept. 14, 2009 Ratings List Ratings Affirmed; Outlook Action To From Hapag-Lloyd AG Corporate Credit Rating B+/Stable/-- B+/Negative/-- Senior Unsecured B- B- Recovery Rating 6(0%) 6(0%) Additional Contact: Industrial Ratings Europe; Corporate_Admin_London@spglobal.com Certain terms used in this report, particularly certain adjectives used to express our view on rating relevant factors, have specific meanings ascribed to them in our criteria, and should therefore be read in conjunction with such criteria. Please see Ratings Criteria at for further information. Complete ratings information is available to subscribers of RatingsDirect at All ratings affected by this rating action can be found on the S&P Global Ratings' public website at Use the Ratings search box located in the left column. Alternatively, call one of the following S&P Global Ratings numbers: Client Support Europe (44) ; London Press Office (44) ; Paris (33) ; Frankfurt (49) ; Stockholm (46) ; or Moscow 7 (495) DECEMBER 12,

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