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While most observers focus on about half a billion dollars of aggregate net losses for the major ocean carriers in the first half of 2018, I am pleased to offer a rather different diagnosis on the health of the container shipping industry, based on cash flow management considerations.

I have not turned bullish yet, but the reminder of the year might be less complicated than many suggest, based on certain metrics.

Pivotal Q3

An alternative approach to gauging adjusted/unadjusted P&L losses is important when it comes to determining the fortunes of huge companies with poorly balanced corporate structures operating in cyclical industries, as is the case with container shipping lines.

Plenty of growth is kicking around, but unfortunately it is the kind of growth that deflates earnings, which are also under pressure from heavier interest expenses due to higher leverage, while reckless tariff threats from the US threaten global trades.

So, in this environment, how troubled are the major players as we approach the end of a pivotal third quarter?

Liquidity crunch?

Given the prevailing debt maturities, cash balances and cash flows disclosed by the top five carriers (obviously excluding non-listed MSC), none is set to suffer a liquidity crunch this year. However, biting off more than they can chew, in terms of net leverage, could come back to haunt them all, alongside other obvious operating hurdles such as the painful jumps in oil prices.

Since predicting a grim outlook for the liner industry in early January, two key financial metrics have been ever-present on my radar: free cash flow (FcF) and working capital management (WCM).

Let’s take the latter first. Changes in core working capital items – such as inventories, receivables and payables – determine daily cash inflows and outflows that affect how much short-term liquidity is available to meet short-term bills that typically fall within a year.

When borrowings surge (in recent memory, debts in the container shipping industry have never been as high), companies must quickly chase and cash outstanding credit while keeping creditors at bay in the knowledge that short-term liabilities can become a precious source of funding.

First-half trading updates from leading box liners indicate that some have WCM under control and some don’t, although they promise this quarter will see an improvement.

How it normally works for listed companies is that if WCM is not managed effectively, then operating cash flow declines and a company has less FcF to allocate to dividends and share buybacks, which is precisely a risk that some of the top freight forwarders are facing.

It’s a different ball game with ocean carriers. Dividends have either already been cut (Maersk) or just installed (Hapag-Lloyd), and in any case most of the largest forwarders have rock-solid balance sheets, which clearly doesn’t apply to the carriers.

Rising stars

France’s CMA CGM, with annual revenue of over $20bn, double that of Germany’s Hapag, is the carrier boasting the higher degree of flexibility in terms of capital deployment opportunities, although its tiny profit in the second quarter ($32.8m; first-half loss $34.4m) had little to do with it.

In light of WCM and FcF generation, its management is unsurprisingly looking at investment options including mergers and acquisitions, as well as adding new vessels to the fleet while cutting prices and compromising between incrementally higher cash flows and market share.

The first half of the year was challenging for most, for a variety of reasons, but look at the following two tables:

CMA cash flows (source: CMA CGM)

CMA CGM cash flows (source: CMA CGM)

CMA CGM cash flows 2017 (source: CMA CGM)

CMA CGM cash flows 2017 (source: CMA CGM)

CMA CGM is not a public company, but if its stock was traded it could well be the best performer of the lot, although Hapag-Lloyd’s FcF yield was very impressive on a trailing basis. Unsurprisingly for the bulls, Hapag – whose shares are priced to perfection – also enjoyed a very solid first half, based on FcF and WCM metrics.

The following tables testify to a situation that is nowhere close to being as bad as it was only two ago – and goes to show what a blessing the UASC deal turned out to be.

Hapag FcF 2018 vs 2017 (source: Hapag)

Hapag FcF 2018 vs 2017 (source: Hapag)

Hapag Fcf 2017 vs 2016 (source: Hapag)

Hapag Fcf 2017 vs 2016 (source: Hapag)

Hapag made a good job of managing receivables and payables in the first half.

Hapag cash flows and WCM (source: Hapag)

Hapag cash flows and WCM (source: Hapag)

Stock prices – Hapag shares trade close to record highs – often move one or two quarters ahead of news, so what its valuation implies now is that flawless execution is expected for the remainder of the year.

Hapag vs Maersk (source: Yahoo Finance)

Hapag vs Maersk (source: Yahoo Finance)

The laggard

AP Møller-Maersk Group (APMM), which derives most of its turnover from Maersk Line, is the laggard, based on cash flows management considerations, as the table below shows.

APMM cash flows and working capital

APMM cash flows and working capital

It said in its interim results that cash conversion of “40% (88%) was negatively impacted by increased working capital primarily in ocean following higher receivables due to timing effects as well as inventories impacted by the higher bunker prices. Free cash flow was negative $167m (positive $536m) given payments related to previously ordered vessels and terminal projects etc. of $708m ($892m)”.

(Note for the reader: as defined by APMM, “inventories mainly consist of bunker, containers (manufacturing), spare parts not qualifying for property, plant and equipment and other consumables. Inventories are measured at cost, primarily according to the FIFO method. The cost of finished goods and work in progress includes direct and indirect production costs”.)

The world’s largest carrier was also impacted by increased working capital due to timing effects around the balance sheet date, but “a positive cash flow impact from working capital is expected in Q3 2018”.

Last year, WCM in the first half was markedly better than one year earlier, and that was confirmed in the first nine months, but this year comparisons are more challenging.

APMM changes in WCM 1H17/1H16 (source: APMM)

APMM changes in WCM 1H17/1H16 (source: APMM)

APMM changes in WCM 1H18/1H17 (Source: APMM)

APMM changes in WCM 1H18/1H17 (Source: APMM)

Lately, its stock has become as entertain to watch as bitcoin, given its speculative and intrinsically cyclical nature. I am still bearish around these levels, by the way.

Bitcoin vs APMM (source: Yahoo Finance)

Bitcoin vs APMM (source: Yahoo Finance)

  

The possibility that a multi-billion cash call might ensue at some point to right the ship is real, as I discussed in my previous coverage – although the spotlight now is on its next corporate restructuring, more details of which should emerge next week.

The beast

Badly affected by weakness in the Chinese equity markets, Cosco Shipping – in the black by $6m in the first half – is in transformational mode, and its valuation is problematic also due to the little meaningful disclosure contained in its financials.

However, given broader trends so far this year for receivables, payables and inventories across the industry, it was hardly surprising to see that operating cash flow fell in the first half, while FcF was negative to the tune of almost $1bn, which may be due to working capital outflows.

Frankly, this could be little more than a nuisance for a state-owned company at a time when its privately owned peers are under pressure and Beijing orders banks to boost lending to exporters.

Cosco snapshot (source: Cosco)

Cosco snapshot (source: Cosco)

So when Cosco says that “the working capital and capital resources of the group have been and will continue to be generated from cash flows from operating activities, proceeds from new share issuance and debt financing from banks”, it glosses over the view that appalling trends for operating cash flows are undeniable, and it is only thanks to large cash inflows from new financing that the situation has not materially worsened in terms of cash balances around mid-year.

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