Asian Container Liner Finances Under Microscope

By MarEx 2013-06-21 10:21:00

Drewry Maritime Equity Research initiates coverage on the global container liners’ sector with three major Asian container lines: Orient Overseas (OOIL), Neptune Orient Lines (NOL) and China Shipping Container Lines (CSCL).

It is a challenge to find an investable container shipping stock in the current environment. Most companies have seen their cash balances wither and total industry debt has more than doubled in the past five years to USD 100bn. Drewry’s analysis of the financial health of the industry paints a grim scenario for the global container liners with financial health under severe strain and shareholder value eroded. Most financial indicators point towards a greater need for the industry and in particular the listed carriers to get their house in order before it gets too late. If there is any positive aspect for the wider industry, the current financial pain will limit carriers’ ability to fight purely for market share. Drewry expects to see intermittent market-share campaigns but no single carrier can do it on a sustained basis.

Rahul Kapoor, senior analyst at Drewry Maritime Equity Research stated, “Even as the market awaits the fate of 1st July Asia-Europe GRIs, the sheer collapse in Asia-Europe freight rates in the past two months shows how fickle the industry's demand supply balance remains.  Short term, industry profitability has become highly volatile, driven not only by underlying supply demand dynamics but increasingly by carriers’ actions with respect to short-term capacity management. Accurate forecasts on a recovery in 2014 are especially difficult since the industry dynamics are highly fluid. Longer term, we expect the industry to be plagued by over capacity and the global supply/demand balance will not reach equilibrium until 2016.”

Kapoor continued “Lastly, peak season is a make or break for 2013 profitability. Freight rates have crashed on the key Transpacific and Asia-Europe trade lanes and there are few indications of a favourable demand environment. Carriers have a narrow window of opportunity to get their act together or risk severe losses as they are losing a lot of money at current rate levels. With no likelihood of an imminent demand surge, the only way to minimize losses is to address effective capacity immediately, or else any hope of full-year profitability can be written off after a very weak second quarter. Having said that, carriers can still expect to achieve GRI success outside of supply/demand fundamentals, if they were to take a hard-line and aim for profitability.” 

Drewry Maritime Equity Research’s top stock currently, with an attractive valuation and positive outlook, is Orient Overseas Int Ltd (316 HK). Whilst also taking a cautious view on both Neptune Orient Lines (NOL SP) and China Shipping Container Lines (2866 HK).

OOIL ticks all the boxes of a quality company which should be investors’ preferred play in what still is a challenging industry environment. Drewry likes OOIL as the company remains amongst the few profitable carriers in the industry. Driven by a strong management focus on achieving higher yields and cost optimisation, OOIL has delivered sustained profitability and has been consistent in generating higher ROE than its sector peers. OOIL’s financial soundness also negates any balance sheet concerns and liquidity risk in what is expected to be a volatile period for sector profitability. OOIL’s valuations are seen as attractive and sustained profitability deserves a premium. Despite the weakness in freight markets and minimal expectations of any upcoming surge, OOIL provides investors with a prudent play on recovery in the container shipping market with lower risk of losses. Drewry’s fair value for OOIL is HKD 58 implying 20% upside.

For NOL, even as it addresses its cost structure, the turnaround is unlikely before 2014. Drewry expects NOL to remain loss making at core levels in FY13 and its weakened balance sheet and high net gearing remain a key concern. The current valuations for NOL are deemed fair in Drewry’s view and they note that the market is not yet ready to assign a premium multiple to NOL, awaiting sustained profitability to emerge. However, with global port operators’ investing landscape recently buzzing with heightened investor interests, Drewry have identified APL Terminals as a hidden gem in the company’s asset portfolio. An opportune divestment of terminal assets even while retaining control will potentially unlock and add tremendous value for shareholders. Drewry accord fair value in its base case for APL Terminals of USD 720m with a high case valuation reaching as much as USD 1bn. Drewry’s fair value for NOL is SGD 1.22 implying a 14% upside.

CSCL shares carry an undemanding valuation and are currently trading near the bottom of their recent trading range. They are also now trading at a wide discount to their historical range. However, Drewry sees CSCL as a risky play. They expect the company’s core business to remain unprofitable in FY13, despite building in a modest 2H13 recovery in freight rates. Drewry believe that CSCL’s higher-than-industry-average exposure to spot markets in key long haul trades is the real nemesis for the company. In an environment of weak freight markets currently and expected to be volatile over the near term at least, CSCL will underperform most of its peers and thus warrants a cautious view. Drewry’s fair value for CSCL is HKD 2.24 implying a 23% upside.

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