Majestic Maersk at Felixstowe
Majestic Maersk at Felixstowe

“Net interest-bearing debt increased to $10.7bn ($7.8bn), mainly due to share buy­back of $475m, dividends of $1bn, new finance leases of $947m and net interest­-bearing debt of $0.4bn acquired through the Grup Marítim TCB transaction, partly offset by proceeds from sale of Danske Bank shares of $482m.” – Maersk, annual results 2016 (emphasis on the amount of debt is mine)

It is relatively easy to forget how big certain numbers can become, spiralling out control when cyclical hurdles become harder to predict – and in this battered container shipping market, the amount of net indebtedness that AP Møller Mærsk accumulated last year deserves a mention.

Consider that some $10bn of debt equates in absolute terms to the primary surplus of a developed country whose operating income ranks well below Italy, but above France.

(Primary surplus is calculated as tax receipts, or country revenues, minus expenditure, before interests paid on the debts; this a good proxy for operating income in the corporate world.)

That net liability on Maersk’s books should not raise eyebrows based on historic trends, debt profile, and a few other factors.

Maersk debt & others

Source: Maersk 2016 annual report

Maersk debt profile

Maersk debt profile – source: Morningstar

However, a 37% rise year-on-year in net debts is meaningful because a recovery in its underlying profitability doesn’t seem to be around the corner, regardless of what certain analysts have to say on the matter.

Debt

As far as its core container shipping unit, the main revenue-driver, is concerned, “compared with 2015, cash flow from operating activities decreased by $2.2bn, to $1.1bn”, while “cash flow used for capital expenditure was $1.6bn lower, at $586m, as there were no deliveries of newbuild vessels. Maersk Line delivered a positive free cash flow of $474m,” it noted, down from $1.1bn one year earlier.

Maersk 2016 revenues

Maersk revenues (source: Maersk 2016 annual report)

While shipping experts point to a solid balance sheet, and a gross cash pile that surely gives it time to cope with the downturn while gauging appropriate corporate options, Maersk could have a headache, if recent cash-flow trends persist. Despite a recent rise in freight rates, time could run out faster than expected if certain asset sales in other parts of its vast portfolio are not executed at a decent price, although it is fair to say that in isolation, Maersk Line is holding up relatively well despite the storm battering the industry.

Still, it is noticeable that 2013 was the last time its net interest-bearing debt hit current levels – although in contrast, its operating income at that point was $7.3bn, compared with operating losses of $226m in 2016, as shown in the first chart above.

Once certain non-cash items that impacted economic profits in 2016 – such as net depreciation, amortisation and impairment losses – are added to its operating profit line to measure underlying cash flows, it derived a good proxy of adjusted operating cash flows (AOCF) before working capital adjustments (mainly changes in trade receivables and trade payables).

In most businesses, this usually represents the amount of cash used to finance heavy investment, or capex – given roughly $7bn of non-cash items, which almost equated to capex requirements in 2016, the group looks safe, based on trailing figures.

However, Maersk’s net leverage (net debt/AOCF) was just less than one in 2013, but now it is over 1.4 times, and it is easy to speculate it could end up being close to 2 times, given its recent deal-making – partly funded by new debt, I gather – for which the financing structure had not been disclosed.

Equity

Underlying profits have fallen dramatically since 2013, and inevitably the book value of its equity took a hit due to impairments and diminished profits that more cyclical assets would bring in future.

Maersk underlying results

Source: Maersk 2016 annual repoort

Maersk has not buried its head in the sand, rather it has adapted, which is remarkable for a family-owned business. While managing expectations, however, it is hiding critical financial information at a time when not only its real net leverage figures are unknown, but also synergy benefits from its re-organisation and the integration of Hamburg Süd look reassuring only on paper.

Recent disagreement about price with DONG Energy proved that the successful divestment and/or spin-off of certain assets that are a drag on group performance could be more problematic than initially envisaged.

As a reminder, in the fourth quarter of 2016, Maersk reported a loss of $2.7bn, negatively impacted by impairments of $1.5bn in Maersk Drilling and $1.1bn in Maersk Supply Service. The corresponding result for 2015 was impacted by post-tax impairments of $2.5bn on oil assets.”

While the value of its total assets between 2012 and 2016 dropped 16.4%, its equity fell more rapidly, by 18.5%, but the latter’s plunge was more pronounced over the past four years, at -25% versus -17.5% for its total assets.

So, in a worst-case scenario, will Maersk have to raise new equity? Just how likely is a cash call, say, by early 2018?

Debt

Judging from price movements for its outstanding debts in the secondary market, a rights issue is a highly unlikely outcome over the short term. Bond investors seem to be fairly relaxed about financial soundness – and rightly so for the time being, in my view.

Its gross cash position at the end of 2016 was unchanged year-on-year at $4bn, and although the balance of its current and non-current assets makes me wonder as to whether the rise in receivables has gone a step too far, there is room to accommodate additional debt to the tune of $2bn (this could be related to the purchase of Hamburg Süd) on the balance sheet, although that move might displease the rating agencies, pushing it closer to junk territory.

“AP Møller­ Maersk remains investment grade rated; however, the credit rating agencies Moody’s and Standard & Poor’s downgraded APMM’s rating from Baa1 and BBB+ to Baa2 and BBB, respectively, both with negative outlook,” the company reveals in its 10k form.

Several companies with global operations rushed to refinance their outstanding debts in recent weeks as yields kept rising, while there remains dividend risk at Maersk if divestments do not go according to plan by early 2018.

More broadly, though, rising debts on the books of the market leader heighten systemic risk in a container shipping industry where corporate transformation is one part of the story; the other being that of a sector where prompt access to liquidity along the supply chain is becoming a much bigger problem, and not only for many smaller operators.

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