Refer to important disclaimers at the end of this report DBS Group Research Asian Insights Office 26 July 2016 Overall Outlook Industry alliances shaken up as consolidation trend gains momentum The recent consolidation trend in the industry, firstly with CMA CGM set to acquire and privatise Singapore-listed liner company NOL (APL) and, secondly, consolidation of the container operations of Chinese state-owned enterprises COSCO Container Lines and China Shipping Container Lines under one entity (China COSCO), will lead to big changes in the liner alliance networks While the 2M network (Maersk and MSC) remains unaffected, the existing G6 (APL, Hapag-Lloyd, Hyundai Merchant Marine, MOL, NYK Line and Orient Overseas Container Line) and CKYHE (Cosco Container Lines, "K" Line, Yang Ming Line, Hanjin Shipping, and Evergreen Line) vessel-sharing alliances will be reorganised by April 2017 CMA CGM (including APL), China COSCO (including China Shipping Container Lines), Evergreen and Orient Overseas Container Line first teamed up to form the Ocean Alliance, while six other liners teamed up to form THE Alliance UASC, which is currently undergoing a merger with Hapag-Lloyd, will be part of the latter while Hyundai Merchant Marine (HMM), which is undergoing debt restructuring in a bid to avoid going bust, has recently agreed to join the 2M Alliance While these alliances should hopefully contribute toward a more rational container shipping market in future, if the three big alliances are on a more equal footing with regard to market shares, we believe the market would be better served by more mergers and acquisitions (M&A) activity and liner exits through bankruptcies or otherwise The demand-supply outlook is still unfavourable in the near-term Since 2010, the demand-supply gap has been almost consistently unfavourable for industry players, as structural changes in demand coincided with a glut of ultra large containership orders Last year was an exceptionally bad year for the industry as trade growth slowed to only around 2%, while containership capacity increased by more than 8% during the year, in what was a record year for new containership deliveries With global GDP growth coming under pressure owing to the slowdown in emerging economies, the rebalancing of the Chinese economy, lower commodity prices and the gradual exit from accommodative monetary policy in the US, the gap between container trade growth and containership supply is expected to remain negative over the next two years Freight rates remain under serious pressure as market share wars continue The 2016 first half saw severe day rate declines across trade lanes, with average freight rates from China 30% lower on-year, as the market struggled to absorb the excess capacity additions Average operating margins of 12 carriers who reported first quarter results fell to minus 52%, with only four liners managing to stay in the black Even industry leader Maersk reported only a 02% operating margin in the first quarter, even though it carried 7% higher volumes on-year, indicating it continues to pursue market share gains through a decline in freight rates Page 1
APM-Maersk Mediterranean CMA CGM + APL COSCO Evergreen Line Hapag-Lloyd Hamburg Süd Hanjin Shipping OOCL Yang Ming MOL UASC NYK Line Hyundai MM K Line Zim PIL Wan Hai Lines X-Press Feeders KMTC Top 20 container liner league table million TEUs Existing capacity On order 40 35 30 25 20 15 10 05 00 1 Top 20 list assumes recent M&A deals are completed 2 CMA CGM will consolidate third position after APL acquisition 3 Merger of China COSCO and CSCL operations has pushed the entity to fourth place 4 The proposed Hapag- Lloyd UASC merger could push it to fifth Source: Alphaliner, DBS Bank Key Industry Trends GDP multiplier for container shipping had shrunk to new lows Container shipping volumes grew at close to doubledigit levels in the two decades leading into 2008, before the financial crisis happened Since 2011, however, container demand growth has slowed, owing to the slowdown in global growth patterns, especially in the developed countries of Europe and the US as well as flattening out of trends like containerisation and outsourced manufacturing The new normal in container demand growth is considered to be closer to 3-5% per year, with intra-regional trade driving most of the growth However, 2015 container volume growth came in at just 24% on-year and represented a watershed event the first time that container volume growth was lower than global GDP growth (31% in 2015) In other words, the GDP multiplier effect of 2-3 times that container shipping has enjoyed for the last 30 years is no longer applicable as the industry reaches a new level of maturity Huge gap between supply and demand set to remain Since 2011, the demand-supply gap has been almost consistently unfavourable as structural changes in demand coincided with a glut of ultra large containership orders The gap between containership supply growth (a whopping 81%) and demand growth (24%) in 2015 was second only to 2008 when the global financial crisis had happened This implies a lot of surplus capacity will need to be absorbed by the market even before any additional supply Looking forward, the International Monetary Fund recently cut 2016/17 GDP growth projections to 32% and 35% respectively, as the pick-up in economic activity is expected to be more gradual in emerging economies and developing markets Based on this, we are looking at container trade growth of around 25% per annum in both 2016 and 2017 Given that the fleet is expected to grow by at least 4-5% each year in 2016/17, the gap between supply and demand will continue to exert pressure on freight rates and asset values over the next two years Page 2
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016F 2017F 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016F 2017F Container trade growth and supply-demand gap 200% 150% 100% 50% 00% 1 Container trade growth trend has fallen from the pre-global financial crisis highs of around 10% per annum to around 2-3% currently -50% -100% -150% Trade Growth Fleet Growth 2 Fleet growth has mostly exceeded demand in recent years and this trend is expected to continue New orders have slowed year-to-date in 2016 Some sanity seems to be returning to the market as far as new orders are concerned After a reasonably boom year in 2015, with close to 22 million twenty-foot equivalent units (TEU) in new orders, we have seen a lull in newbuilding contracts since the start of 2016 As market share wars continue, though, it remains to be seen whether the trend of alternate boom and bust years of newbuilding cycles will continue, with new orders again picking up in 2018 if market trends improve While good news for the shipyards, this additional supply in future can only imply extended periods of intense competition and pain for the liner industry, in our opinion Significant increases in fuel costs during the past decade drove global carriers into a race to build and operate the largest, most fuel-efficient vessels in order to drive down slot costs Fleet growth was at its fastest in five years in 2015, at 81% The skew toward ultra-large container ships above 13,000 TEU size, and in particular, vessels above 18,000 TEU which can only find gainful employment on the Asia-Europe route is a worrisome one Firstly, the Asia-Europe route is probably the weakest in terms of demand fundamentals in the near- to medium-term Secondly, more liners jumping onto the bandwagon means rates will be subject to more pressure and liners that don t have the advantage of these mega vessels will struggle to remain in the black when these ships are delivered between 2015 and 2018 Indeed, the investment costs for these ships have fallen significantly over the last two years (with 18,000 TEU vessels now costing between US$135 million and US$150 million, down from the US$170 million Maersk paid when it pioneered the trend back in 2011) Deliveries of new containerships: Trend and forecast m T EUs 18 16 14 1 Deliveries of new containerships reached a record level in 2015 12 10 08 06 2 Deliveries will slow down in 2016/17 but it won t be a sharp fall off 04 02 00 Source: Clarkson Research, Alphaliner, DBS Bank Page 3
Jan/10 May/10 Sep/10 Jan/11 May/11 Sep/11 Jan/12 May/12 Sep/12 Jan/13 May/13 Sep/13 Jan/14 May/14 Sep/14 Jan/15 May/15 Sep/15 Jan/16 May/16 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 New containership orders trend m TEUs 35 30 25 20 15 10 05 1 New orders crossed 20 million TEU mark in 2015 2 74% of new orders by TEU is for ships over 12,000 TEU in size 3 Zero new orders yearto-date in 2016 00 No respite for freight rates though Industry freight rates for main Asia-Europe and Asia-US lanes continue to see high volatility since the last highs in 2012, as the supply-demand situation is still not favourable General rate increases (GRIs) have become more frequent and the quantums higher, but these rate increases have not stuck beyond a few weeks owing to the influx of capacity and pricing wars to retain market share Last year turned out to be one of the worst years for freight rates, owing to lower oil prices, which have been more than passed on to customers through the removal of surcharges In 2016 year-to-date, the situation is no better The spot container freight rate index the Shanghai Containerised Freight Index (SCFI) reached 400 in March 2016, the lowest level since its launch Asia-Europe rates led the decline of course, with rates down close to 60% on-year in the first quarter, but the cascading of vessels down to other routes like Asia-US and Asia-South America had a sharp negative impact on these routes as well We are unlikely to get a respite from freight rate volatility in 2016 As can be seen in the following charts, imposition of a GRI in January 2016 and July 2016 led to a spike in rates, but they have fallen off again toward unprofitable levels amid a quest for market share SCFI spot freight rate index has touched new bottoms recently 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 S hanghai Containerized Freight Index 1 SCFI index reached an all time low of 400 in March 2016 2 SCFI was down on average by 36% in the first half 3 Declines of 30% onyear on average in Asia-Europe and about 50% on average in Asia-US routes in first half Page 4
Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15 Apr-16 Oct/09 Feb/10 Jun/10 Oct/10 Feb/11 Jun/11 Oct/11 Feb/12 Jun/12 Oct/12 Feb/13 Jun/13 Oct/13 Feb/14 Jun/14 Oct/14 Feb/15 Jun/15 Oct/15 Feb/16 Asia-Europe spot rates are the key reason for volatility 2,500 2,000 S CFI - Europe/ Med 1 Europe/Mediterranean routes continue to see very high volatility 1,500 1,000 2 Rate increases not sticking 500 0 Europe Med 3 Asia-Europe spot rates were down by 30% on-year on average in first half Lower oil prices are being passed on to customers amid market share wars Crude oil prices have fallen by more than 50% from June 2014 levels and, in turn, bunker fuel prices are currently hovering around US$300 per metric ton, down from US$600 per metric ton in June 2014 Overall in the 2016 first half, the average bunker fuel price was down 34% on-year This decline has not resulted in any meaningful margin boost for the liners, as liners have swiftly given back all the gains in the form of lower freight rates to shippers as part of price competition Thus, the sharp fall in the oil price only resulted in a lower normal for freight rates and, contrary to earlier expectations, has not resulted in any long-term benefits for shipowners and operators amid the highly competitive scenario Bunker fuel price trend US $/ ton 800 600 400 200 1 Bunker fuel prices declined from levels of US$600 per ton in mid- 2014 to around US$200 per ton in January 2016 before rebounding to current levels of around US$300 per ton 0 2 Overall down 34% onyear on average in 2016 first half Source: Bloomberg Finance LP, DBS Bank 3 This partly contributes to the decline in freight rates as fuel surcharges were lowered Asset owners will continue to have a hard time deploying assets profitably After a few years in the doldrums since 2011, containership charters rates staged a fairly animated recovery toward the middle of 2015, before the rally fizzled out shortly thereafter The rally was driven by an increase in Panamax earnings, but the fall in ship demand in the 2015 second half, owing to the dip in global demand during peak season, not only saw charter rates giving up all the gains but also led to a significant increase in idle fleet The expanded Panama Canal, opened at the end of June 2016, is expected to deal another big blow to the classic Panamax market 4,000 to 5,300 TEU vessels with the influx of 6,000 to 10,000 TEU vessels into the trade Charter rates for 4,200 TEU class units have already fallen below daily operating expenses and we should be seeing more idling and scrapping of these vessels in coming months Page 5
Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-07 Jun-07 Nov-07 Apr-08 Sep-08 Feb-09 Jul-09 Dec-09 May-10 Oct-10 Mar-11 Aug-11 Jan-12 Jun-12 Nov-12 Apr-13 Sep-13 Feb-14 Jul-14 Dec-14 May-15 Oct-15 Mar-16 Containership charter market trends 140 120 100 80 60 40 20 0 Containership Timecharter Rate Index 1 Index rose 34% from 47 at beginning of 2015 to reach 63 by May 2015, but fell back to 43 by end of 2015 Currently at 42 2 Panamax average charter rates rose from US$9,125 per day to US$14,675 per day in May 2015 before falling all the way back to US$5,350 currently Lower oil prices are helping support asset prices to an extent though Containership second-hand prices have recovered to an extent from the lows seen earlier in 2015, owing to the longer term boost possible from lower oil prices for some of the older tonnage, which were earlier deemed fuel-inefficient Newbuilding prices have stayed largely flat though, as has the order book-to-fleet ratio, as the industry still struggles to absorb the excess capacity on the water Containership newbuild price and second-hand price trends 180 160 140 120 100 80 60 40 20 0 Containership newbuild price index vs secondhand price index 10 year-old secondhand price index Newbuild price index 1 Newbuild prices have held largely firm, though there was some softening toward the end of 2015 2 Second-hand prices recovered after a dip in early-2015 as the charter market staged a brief rally, but have been weakening again since October 2015 Page 6
1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Containership order book-to-fleet ratio 120% 100% 80% 60% 40% 20% 0% Post Panamax Panamax Sub Panamax Handysize Total 1 Containership order book-to-fleet ratio has dropped to 18% as new orders have dropped to zero yearto-date in 2016 2 64% of all containerships on order above 12,000 TEU capacity, another 22% between 8,000 and 12,000 TEU Risks and Regulations Liner operating performance goes from bad to worse As a result of the volatile and weak freight rates, and wide differences in slot costs between the more efficient players and the less efficient ones, industry profitability has been scarce since 2010 The average operating margin for 15 of the main liner companies have been negative in more than half of the last 16 quarters From the 2015 second half onward though, the margin story has taken a dismal turn, and the average operating margin has been around minus 5% over the last two quarters, as record low freight rates take a toll Even in periods where margins have been positive, it has been nothing to write home about, and returns on capital don t make for good reading In such a scenario, we believe scale and cost efficiencies through consolidation may be the only way out for the industry Average operating margin of 15 main liners by quarter (2009-2014) 200% 150% 100% 50% 00% -50% -100% -150% -200% -250% -11% -120% -179% -181% -196% 107% 160% 74% 13% 47% -02% -55% -70% -105% -121% 05% -11% -10% -32% -18% -43% 34% 52% 10% 04% 24% -18% -46% -52% Average of APL, CMA CGM (from 2010), COSCON, CSCL, Evergreen, Hanjin, Hapag-Lloyd (incl CSAV to 2014), HMM, KLines, Maersk, MOL, NYK, OOCL, Wan Hai, Yang Ming, Zim 1 Industry performance worsening since 2015 third quarter 2 Maersk, CMA CGM, Wan Hai among consistently profitable liners 3 HMM, APL, Yang Ming under more margin pressure than others Source: Alphaliner, DBS Bank Idle capacity not enough to tackle the problems Based on Alphaliner s numbers, the idle containership fleet has soared to a record high of 157 million TEU as of March 2016, surpassing the previous peak recorded at the end of 2009 in the aftermath of the global financial crisis This represents close to 8% of the existing fleet But idling alone does not seem to the solution for the supply-demand crisis, as demolitions have not kept pace with the sharp rise in ship supply While 2016 could see around 400,000 TEU of ships being broken up, this is well below the 12 million TEU of capacity Page 7
expected to be delivered in 2016 Another factor that has led to excess capacity build-up is the gradual removal of slow steaming and extra-slow steaming owing to the low fuel price environment, which has prompted liners to increase average sailing speeds again Risk of bond defaults loom Multiple years of losses owing to volatile industry conditions have stretched the balance sheets of most of the liner companies Among the worst affected are Korean liners HMM and Hanjin Shipping HMM has been undergoing financial restructuring efforts as it had upcoming debt repayments of 120 billion Korean won (US$105 million) in April 2016 and 240 billion won (US$210 million) in July 2016 to bondholders After bondholders rejected the carrier s debt rescheduling plan, and negotiations with ship-owners to reduce charter rates didn t go too well either, HMM defaulted on the April notes, triggering a downgrade of its corporate bond ratings to the extremely speculative C grade While it has recently secured approval for a debt-for-equity swap plan from bondholders, which paves the way for a capital restructuring plan, the bankruptcy of HMM, if it happens, would make it the largest ever container shipping bankruptcy The rapid deterioration of HMM s financial situation has put the spotlight on other carriers balance sheets as well, and even the credit ratings of industry leader Maersk have not been spared Our In-House Expert Suvro Sarkar suvro@dbscom +65 6682 3720 Please note that DBS Bank Ltd may have research coverage in the companies mentioned in this industry report, that have been produced prior to or subsequent to its publication Please refer to the links below for the latest specific equity research reports published on below-mentioned companies and the accompanying disclaimer/disclosure of DBS interest in the companies mentioned in the respective reports Page 8
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