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Container market podcast for April 28 from Coracle and GFI

By • Apr 28th, 2011 • Category: Containers

The Coracle Container market podcast for April 28, 2011 in association with GFI

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The following comments are quoted directly from Macquarie Bank by their transport analyst, Mr. Robert Joynson. Whilst this report is focused primarily on the company A.P. Moller Maesrk, some of the analysis is valid to the wider container market.

Below is a brief summary:

Container pressures likely to intensify in 2011

Our analysis of volume drivers and supply-demand dynamics suggests a protracted period of weak freight rates on the east-west trade lanes which account for 61% of Maersk’s volumes. The outsourcing of manufacturing from
Europe/North America to Asia has now matured, suggesting a softening of the container volume ‘GDP multiplier’ seen during the past decade. We have little faith that capacity management will lead to a freight rate rebound in 2011, with our analysis suggesting less potential for ‘cascading’ on Asia-Europe than many believe, and benefits from slow steaming having played out.

To cite the parts that caught our eye…

Trade lane analysis suggests weak volume outlook

Our analysis of volume trends on the key east-west trade lanes to which Maersk is exposed – Asia-Europe and the Transpacific – suggests that growth rates could disappoint investors. In particular, our analysis suggests the outsourcing of manufacturing from Europe/North America to Asia matured in 2007, leading us to believe that the ‘GDP multiplier’ on these trade lanes – i.e. the extent to which growth in container volumes exceeds GDP growth – will weaken significantly throughout our 2011-15E forecast period. We believe the maturity of outsourcing is a trend that has largely gone unnoticed by most investors to-date – partly because the volatility in container traffic during this period (caused primarily by inventory fluctuations) has obscured underlying growth dynamics. This dynamic will become more evident as 2011 progresses, in our view. Given that Asia-Europe and the Transpacific account for around 51% of Maersk’s container traffic, a higher share than the majority of its container shipping peers, our analysis is of particular concern for Maersk.

Orderbook profile is particularly concerning for Maersk

The container fleet orderbook currently stands at around 26% of the existing fleet according to Clarksons, significantly lower than the peak of up to 60% seen during 2005-2008. While this may appear positive, one should bear in mind that the current outlook for volume growth is less positive than it was during the period of strong volume growth seen during 2002 to early-2008 that was stimulated by China‟s December 2001 accession to the WTO. From a Maersk-specific perspective, the profile of the orderbook is of particular concern given that it is dominated by ultra-large container vessels (ULCCs) with a capacity of 10,000+ TEUs. The current orderbook suggests the number of these vessels in service will increase from 71 at the end of 2010 to 177 by the end of 2012. At present, all vessels of 10,000+ TEUs are deployed on Asia-Europe, with no sign that this dynamic will change until the expansion of the Panama Canal is completed in 2014 (enabling it to handle vessels up to 13,000 TEUs vs. just 5,000 TEUs at present – increasing the cost effectiveness of all-water services from Asia to the US East Coast). For this reason, as a proportion of the existing capacity deployed on this trade lane, the newbuildings set to be deployed onto Asia-Europe in 2011 are likely to be materially greater than the overall orderbook-to-fleet ratio of 26%.

Cascade effect is unlikely to save the day…

With newbuild ULCCs likely to be deployed entirely on Asia-Europe, the key question mark concerns the extent to which these capacity increases can be offset by the ‘cascading’ of smaller vessels onto other trade lanes. While some believe (or maybe hope) that the capacity impact of newbuildings will be offset by the cascading of smaller vessels onto other trade lanes, this scenario appears unlikely, in our view. Our proprietary analysis of the current fleet structure employed on Asia-Europe, together with the profile of the orderbook, suggests the net impact on Asia-Europe capacity will be dampened by the cascading of vessels onto other trade lanes but not offset fully. Our analysis suggests that, while 6,000 TEU vessels are often described as the ‘workhorse’ of Asia-Europe, this is no longer the case. Although vessels up to this size account for 32% of the vessels employed, they accounted for just 19% of capacity in 1Q 2011 (down from 37% in 1Q 2008) – an observation which challenges the perception that significant potential remains for smaller vessels to be cascaded off Asia-Europe onto smaller trade lanes.

…while capacity lay-ups should not be relied on

The idling of capacity that followed the recent volume slowdown has been well documented, resulting in up to 11% of the global cellular fleet being idled. Nevertheless, given that our key concern for freight rates at present is driven not so much by the size of the orderbook per se, but by the size profile of the vessels on order, it is important to note that the size profile of the idled vessels was firmly skewed towards the smaller sizes. The vast majority of vessels laid up were <3,000 TEUs, with a maximum of just 20-30 vessels >7,500 TEUs laid up at any one time, suggesting the idling of capacity had a greater impact on smaller north-south trade lanes and feeder vessels than the key east-west routes to which Maersk is most exposed.
To assess the likelihood that shipping lines will lay up capacity on Asia-Europe and the Transpacific should the current weakness in freight rates continue, we have analysed the capacity management actions taken during 2009, the worstyear in the history of the container shipping industry. Given the sharp rebound in freight rates seen throughout thesecond half of this year, we were somewhat surprised to find that the largest operators on both of these trade lanes (including Maersk Line, which is the largest operator on both) stubbornly refused to lose share in much the same way that had been the case during previous downturns. In contrast to the widely held perception that the bounce back in freight rates seen from mid- 2009 to mid-2010 heralded a new era of rationality in the container shipping industry, our analysis suggests this rebound came about as much from luck as design. Quite simply, if the industry had been able to model the inventory cycle and thereby forecast
the upswing in volumes that followed the completion of de-stocking with any degree of accuracy, we believe
significantly less allocated capacity would have been removed from the key east-west lanes than actually proved to be the case. If this had been the case, it is almost certain that the rebound in freight rates would have been more muted than that which actually transpired.

The slow steaming lever can’t be pulled twice

A key driver of the recovery in freight rates seen during mid-2009 to mid-2010 was the introduction of „slow
steaming‟, in which excess fleet capacity (the total capacity that container lines deploy on a trade lane) was absorbed by the slowing down of vessel speeds without significantly increasing effective capacity (the space available to shippers). We estimate that the introduction of slow steaming reduced effective global capacity by around 4-5%. While this is significantly less than the capacity reduction of up to 11% provided by the idling of capacity, the impact on capacity on both Asia-Europe and the Transpacific meant that the reduction in capacity on these lanes specifically was significantly greater than the 4-5% global average.
For 2011 onwards, however, our analysis suggests that the benefits of slow steaming have largely played out, with the average number of vessels per string on Asia-Europe and the Transpacific having stabilised during mid-2010. As such, further reductions in steaming speeds appear unlikely to provide a meaningful capacity management tool in 2011 in the same way that was the case during 2010.

Impending contract negotiations unlikely to be favourable

We believe around 40% of Maersk’s business is tied to contracts arranged directly with the shipper (e.g. WalMart,
Tesco, etc) which typically have a duration of 12 months, while another 30% of volume is accounted for by freight
forwarders (the majority of which is tied to contracts typically lasting 3-6 months). Because of this relatively high
contract exposure, the full impact on Maersk’s earnings of declining spot rates (such as that seen during the period since 3Q 2010) is delayed until contracts roll off and are re-priced at levels closer to the spot rate.
The immediate catalyst in this respect is the impending Transpacific negotiations, for which around 90% of eastbound Transpacific volumes are based on 12-month contracts which usually run from May to April (with annual negotiations typically taking place in April). It appears highly likely that the average rate Maersk earns on this lane will decline significantly when the new contracts come into effect in May. We estimate the average Transpacific contract rate negotiated by shipping lines for the May 2010-April 2011 contract year was around US$2,700 per FEU, with the current spot rate of US$1,630 being around 40% below this level.
In the mid-term the outlook appears favourable.
Our analysis of the profitability of the container shipping industry, comprised of 20 container lines that account for
around 70% of cellular fleet capacity, illustrates the extent to which Maersk’s competitiveness has been transformed in recent years. After consistently producing lower container shipping margins than competitors during 2004-2008 (on a rolling 12-month basis), Maersk‟s relative profitability versus peers has improved dramatically during the past three years, increasing to the extent where its EBIT margin has been around six percentage points greater than the rest of the industry in recent quarters.
The correlation between size and profitability has switched from negative to positive in recent years, with the positive correlation seen since 2007/2008 progressively strengthening. Importantly, this trend holds true irrespective of whether Maersk is included in the sample of container lines or not, illustrating that this trend is representative of the industry as a whole rather than being driven by improvements at Maersk specifically. Given its status as the world‟s largest container shipping line, it is likely that the continuation of this trend would disproportionately benefit Maersk Line during the years ahead. This would be particularly true if Maersk can achieve (or get close to) its internal target of reaching 95% on-time performance, a feat which would represent a major improvement compared with recent performance of around 75% for Maersk and 56% for the overall industry.