My new year resolution, at least initially, was to simply be kind in my treatment of all transport and logistics providers – this 2017 preview would, I mused, offer me a chance to test my diminished appetite for troubles in the new year.
2016 was difficult in virtually every sense. Freight forwarders had little option but to stick to the same old rhetoric (click here, here and here), while carriers appeared collectively in denial – until they collectively weren’t – and shippers barely managed to adapt to slowly growing economies.
How these interwoven industries manage the next 12 months while dealing with the hangover of 2016’s economic and political shocks is a question I continue to grapple with.
As consolidation on the information technology side of things continues, what will become the new supply chain dynamics remain unknown, although they could hinge on unpredictable macroeconomic trends – and may well require new leadership skills in an industry that is traditionally slow to learn, let alone act.
The star performers in supply chain management activities – the freight forwarders – are under the spotlight, of course.
Act of God
Barring few exceptions, I doubt forwarders will manage to exploit their full potential this year, at least on the stock markets, unless some seriously disruptive event takes place – a jumbo merger, for instance.
We almost reached that point in 2016, according to our sources – but then, somewhat sadly, all the parties involved dismissed the news as rumour and nothing came of it.
Deal-making makes a lot of sense in a business cycle where asset-light businesses like freight forwarders would do well to bulk up, getting stronger at the negotiating table with customers and suppliers whose activities are significantly more capital-intensive than their own.
After all, operational hurdles have become more apparent at some of the major forwarders, while equity valuations broadly close to record highs do not bode well with sluggish prospects for consolidation. Furthermore, rising oil prices and uncertainty in China could complicate expansion plans – “at risk of capital flight, China marked the new year with extra requirements for citizens converting yuan into foreign currencies”, Bloomberg reported on Tuesday.
Accuracy risk & paper losses
Forwarders ought to be careful when it comes to trusting accuracy models based solely on organic growth prospects. I have learned in the past 15 years that inaction and stellar equity valuations seldom make good bedfellows.
Meanwhile, the real gauge of fear – the price of oil – remains more likely to bring bad than good, in terms of inflation, through to 2018, which means those companies whose shares are not listed on public markets ought to draft alternative plans, simply because diminished earnings power will hurt them the most.
The obvious downside here is that mergers and acquisitions might end up being explored as plausible, value-accretive options only when their own equity valuations are worth much less than currently. And that is an additional risk for the industry, which could be poised for value destruction and more bankruptcies among companies that have revenues below $500m, particularly if other major carriers go belly up.
If recent trends are anything to go by, shareholders of major freight forwarders could be faced with significant paper losses – on a like-for-like basis, it is highly likely that deflationary effects on top lines will only marginally offset inflationary cost structures, determining lower earnings and cash flows per share based on constant share counts, in my opinion.
Kuehne + Nagel, Panalpina, Expeditors, DSV and the like all continued to perform relatively well in 2016, despite difficult market conditions, but quarterly figures will become more and more difficult to beat in 2017, as the most recent quarterly numbers for virtually all public companies I have covered indicate.
While bulls argue that the sector remains a strong long-term play for value investors, due to its high level of fragmentation, among other things, its adjusted risk premium is less attractive, particularly considering short-term strains stemming from freight rates risk and counterparty risk, which make this the most difficult supply chain segment to call in terms of effective capital deployment. (Incidentally, it is also the only part of the supply chain that has many options in that regard)
My advice to investors is to carefully monitor any announcement concerning dividend hikes and buybacks by major players, including diversified logistics providers such as DP-DHL, UPS and FedEx, whose prospects have been boosted by e-commerce trends rather than underlying strength and truly encouraging dynamics in their diverse portfolios of assets.
For the time being, winners also include Atlas Air and ATSG, while contract logistics is similarly in a sweet spot.
Carriers & shippers
Carriers and shippers, and their relationships deserve a word. Clearly, while both are at the mercy of the business cycle, the big difference is that the latter often have resources the former lack.
Take Lufthansa Cargo and Air France-KLM Cargo, for instance. They are in a limbo (brilliantly articulated in The Loadstar’s recent podcast by our contributor Niall van de Wouw), catching up with their American competitors, but I still don’t expect any major consolidation events in the coming year. Rather, it is the container shipping industry where things should get really exciting.
My extensive coverage of container shipping makes me think that nobody there is gauging risk efficiently, but the lead provided by AP Møller Mærsk on corporate strategy should not be overlooked.
Although execution, timing and the appointment of certain family members in critical posts all remains questionable, the Danish group has shown a willingness to address its corporate tree, “forcing many of its competitors to prepare appropriate corporate strategies for 2017”, a senior transport executive based in New York pointed out this week.
In this context, it will also be a delicate balancing act for non-operating vessels owners, with Seaspan – the world’s largest – needing to come up with some creative solutions in terms of refinancing, if volatile trading conditions persist.
More broadly, in a world where the stock of a bellwether company such as Hong Kong-based sourcing specialist Li & Fung still trades at paltry multiples based on earnings and cash flows – it is worryingly close to a 52-week low and some 34% below its 52-week high – where China’s capital is deployed is possibly the most critical element in any corporate decision across the supply chain.
This goes down to capital control in a disguised form, which ultimately will determine capital allocation strategies on the corporate side, as well as also how swiftly and openly China adapts to the new reality facing it. There might be great activity in deal-making, but that’s not translating to more debt activity – quite the reverse, in fact.
“It is not just about the oft-vaunted switch from exports to domestic consumption, but also its ascent up the value chain in terms of manufacturing,” we argued around mid-October, adding that Chinese companies “are building higher-tech stuff that is mostly physically smaller and generally far less polluting, and that is how the government in Beijing wants it”.
The fact that the fortunes of the US stock market hinge on the speed of the devaluation of the Chinese yuan is distinctly uncomfortable.
As a reminder, soon after the US elections, Beijing started to dump US government bonds to prop up its own currency, which clearly was responsible for a steepening of the yield curve ahead of the Federal Reserve’s decision to hike interest rates last month.
I now find myself closely watching how yield curves behave around the globe, so what the hell happened to my new year’s resolution?
It turned out to be as tough as quitting smoking – then I gave up completely when I discovered the price of bitcoin had breached the $1,000 mark, surpassing a three-year high this week.
Reading the 2017 outlook for the US stock market didn’t make things any easier.
Some things about the world today appear to defy the laws of gravity; the art of making predictions is not one of them.