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Spurred by a recent history of deal-making, 2017 was a transformational year for Hapag-Lloyd, and it managed to shore up its core business over the past 12 months. However, could future M&A involve the takeover of other ancillary assets?

How about the purchase, for instance, of a freight forwarder, given the increasing paucity of suitable targets in the container shipping industry?

In principle, I would suggest that such an option should not be written off, considering the current competitive environment, and could make a lot of sense given Hapag-Lloyd’s track record in terms of financial engineering.

Synergies

Admittedly, with the first quarter of 2018 already behind us, its short- to mid-term capital allocation plans have become more intriguing.

Financially, the German container line is better positioned than previously, thanks to the consolidation of Chile’s CSAV and UASC of the Middle East, particularly when we focus on its current financial position and heavy investment needs against comparable figures, and projections, between 2014 and 2016.

But just as the ocean carriers continue to battle for market share, certain risks are unlikely to subside before 2020, and it is easy to speculate that its enticing annual headline numbers, released at the end of March, implicitly point to the possibility that as soon as UASC-related synergies have fully materialised, deal-making talk will once more emerge.

Hapag-Lloyd's transformation

Hapag-Lloyd’s transformation (Source Hapag-Lloyd)

Damco

The tie-up with UASC and a broader recovery in ocean trades last year contributed to a rise in its share price, which at one point was more than double its IPO level, reaching a record of €40 a share in September, before falling to the low €30s.

In terms of capital allocation, one likely challenge is the fact that there are simply fewer assets to buy in order to compete with its four largest rivals worldwide – and in this context, I am ruling out buybacks of a certain size due to certain financial constraints, although a progressively higher dividend remains a possibility.

A relatively lighter asset base would help it marginally improve its return on capital invested (ROIC) – a key metric in the industry and it was well below acceptable levels last year – but, more importantly, could act as a countercyclical buffer, if the right story is sold to investors. Running the ruler over a scenario according to which Hapag-Lloyd could add freight forwarding activities to its asset mix has made a lot of sense to me in the past few days.

Of all possible options, the most realistic target is Damco, which is owned by Denmark’s AP Møller-Maersk Group (APMM) and was led for almost six years by Hapag-Lloyd chief executive Rolf Habben Jansen before he began his current job.

Shenanigans

A countercyclical deal targeting a company that has lowly capital needs would be consistent with its philosophy of little additional investment in new vessels. While both carriers both large and smaller continue to attract headlines highlighting their ambitious organic growth plans (which may be funded by local governments if events do not go according to plan), Hapag-Lloyd has refrained from placing orders given that its trailing performance was clearly transformed by the consolidation of UASC and its orderbook.

I would be greatly surprised if the German carrier placed any new ultra-larger container vessel (ULCV) orders, and the company itself has ruled this out in recent trading updates.

Last year’s volume growth was largely inorganic, boosting virtually all financial metrics, although freight rates were under pressure. As it grew, its geo mix also expanded.

Mapping trades (Source Hapag-Lloyd)

Mapping trades (Source Hapag-Lloyd)

Its balance sheet remained stretched, however, and although it has sought to reassure analysts – claiming that it had started to address its debt problem – it is still heavily exposed to cyclical swings, while also adding, almost inevitably, complexity to its chain of control.

leverage (Source Hapag-Lloyd)

leverage (Source Hapag-Lloyd)

complexity (Source Hapag-Lloyd)

complexity (Source Hapag-Lloyd)

In all this, there are variables the company can control, while others cannot be accurately predicted…

Value levers, 1 of 2 (Source Hapag-Lloyd)

Value levers, 1 of 2 (Source Hapag-Lloyd)

Value levers, 2 of 2 (Source Hapag-Lloyd)

Value levers, 2 of 2 (Source Hapag-Lloyd)

Trailing Ebit/Ebitda and margins (Source Hapag-Lloyd)

Trailing ebit/ebitda and margins (Source Hapag-Lloyd)

… and there are other obvious financial risks, highlighted below.

Equity position and credit rating risk (Source Hapag-Lloyd)

Equity position and credit rating risk (Source Hapag-Lloyd)

Its recent projections caught my attention because it is clear that ROIC must rise, given the structural imbalance between ROIC (too low) and cost of capital (not low enough), which is a bad combination on the road to value creation.

Hapag ROIC and otheres (Source Hapag-Lloyd) 

Hapag ROIC and others (Source Hapag-Lloyd)

Taking this into account, it is easy to suggest that safe haven assets would naturally continue to outperform Hapag-Lloyd’s share price if volatility in the financial markets is here to stay.

Hapag vs JPY (Source Yahoo Finance)

Hapag vs JPY (Source Yahoo Finance)

Shocking the market

More importantly, though, trading multiples arbitrage is what really matters here under a scenario according to which Hapag-Lloyd would diversify from its core business.

Damco – which ranks just outside the top 15 in the global league tables for freight forwarders, based on data from Transport Intelligence – would likely command a fair value of between $1.5bn and $2bn. That’s up to 30% of Hapag-Lloyd’s current market cap. Regardless of how a deal might be financed, an acquisition of that magnitude could help the German carrier drive shareholder value. As a reference, its own stock trades at a 50% discount against major freight forwarders’ projected multiples, based on adjusted operating cash flows metrics.

Hapag-Lloyd shareholders are used to financial engineering, but typically in recent years, the M&A lever was pulled to pursue horizontal integration of services. Adding a freight forwarder to its books would represent a meaningful change and one that might even be instrumental to what I consider to be a possible next step in an industry that has changed more in five years than ever before: a merger between APMM and Hapag-Lloyd, that is.

The supply chain management and forwarding activities of Damco are currently part of APMM’s core transport and logistics unit, but whether the freight forwarder will continue to be treated as core in the future remains unknown until Maersk manages to wrap its ambitious corporate restructuring plan.

Here’s how this might play out: Denmark’s largest company needs new equity to repair its balance sheet and Hapag-Lloyd might come to the rescue and entertain M&A to de-risk its own balance sheet by raising new equity to partly fund, say, a $2bn deal for Damco, which would add $2.6bn to its top line (€9.9bn in 2017).

If Damco is properly managed and returns to its 2016 performance, it would offer above-average ROIC versus container shipping activities, but it would not be a game-changer in that respect.

Based on my calculations, I estimate a restructured Damco could add around 5-10% to Hapag-Lloyd’s net operating profit after tax (NOPAT, at $438m in 2017) and pre-UASC synergies, which would mean only 20 basis points accretion in terms of ROIC (to 3.3% to 3.1%), but would provide the basis for deeper talks between APMM and Hapag-Lloyd and a possible valuation fillip in terms of trading multiples.

Damco financial snapshot (Source Maersk)

Damco financial snapshot (Source Maersk)

Tricky stuff

One key element here would be the ability to shore-up cash flows and returns (at least marginally) while heavy investment, in the form of capital expenditures, remains low for longer. Alongside a solid capital structure and a “sound liquidity and equity base”, Hapag-Lloyd says that one of its core targets is to “achieve sustainable cash flows”, and this is the trickiest part of its ambition on an organic and inorganic growth basis.

Damco did not shine last year in term of profits and cash flows, but in the fourth quarter it reported a 12% increase in revenue to $737m ($657m, Q4 16), mainly driven by 8% growth in supply chain management volumes and 16% growth in air freight volumes. “The air freight growth is supported by strong turnaround of air freight activities in China. Ocean volumes ended 2% below same quarter last year,” it added. It has changed a lot over the years, so are executives in Hamburg and Copenhagen ready to open talks?

Damco history (Source Maersk)

Damco history (Source Maersk)

One side issue, of course, would be how to manage that relationship with the two alliances, Hapag-Lloyd being part of the THE Alliance and Maersk in the 2M. But it’s too early to speculate on that. So, much depends on the future plans of Mr Habben Jansen, who is only 51 years old and appears well set at the helm of Hapag-Lloyd. Following a reorganisation of the board, he is “now responsible for global sales activities”, and clearly he knows what works and what doesn’t at Damco.

COMMENTS 12


Leave a Reply

  • Alan

    April 17, 2018 at 2:33 pm

    Why would APM sell when their strategy is to integrate all their container logistics businesses, and become more asset lite themselves?

    Reply
    • a.pasetti@yahoo.co.uk

      April 17, 2018 at 2:51 pm

      Good question, Alan, thanks very much for that. Firstly, it’s still unclear what APMM thinks is core and non-core, even in its T&L unit, in my view. Then, as I mentioned in the story, because it might need the cash and Damco has always been a laggard in its portfolio, among other things. That’s one way to look at it.

      Reply
    • Dawid

      April 18, 2018 at 8:25 am

      Interesting speculation Alessandro 🙂
      Same question came to my mind Alan. At first thought i doubted that could have any logical sense for Maersk other than cash flow. On the other hand, if you think of integrated TSL model by shipping line, it makes sense to integrate forwarding products, such as intermodal, customs brokerage and insurance. But warehousing and distribution, airfreight and supply chain bring no immediate synergies to shipping line. So why not to sell 4PL company and establish a new, pure forwarding unit.

      Reply
      • a.pasetti@yahoo.co.uk

        April 18, 2018 at 8:38 am

        Thanks for your contribution, Dawid.

        If you combine what I wrote in the article with the the two comments here, it should be clear what kind of synergies I predict for APMM/HL after a Damco deal, but you are absolutely right, that would not be the main driver of a tie-up.

        I am not sure I understand what you mean here:

        “So why not to sell 4PL company and establish a new, pure forwarding unit.”

        You mean APMM could do that (a spin-off?)?

        Thanks for stopping by.

        Reply
  • brian

    April 17, 2018 at 9:48 pm

    Might look like a possibility to an outsider but APMT/Damco and Maersk Line are the future of APM as a team. Ralf HJ already had a shot at Damco and it didn’t go so well, can say he really knows what doesn’t work. Would think that Hapag would be concerned to even have this story out there since they are so heavily reliant on the large German/European FF’s for their very existence. What Maersk went through last year with the cyber attack would have killed most companies never mind just denting their balance sheet.

    Reply
    • a.pasetti@yahoo.co.uk

      April 18, 2018 at 7:51 am

      Thanks for your valuable feedback Brian. We might have to agree to disagree, though.

      Maersk has done very well promising structural changes, but has been poor in terms of execution. As a matter of fact, what Maersk went through last year with the cyber attack happened to Maersk and not to many other companies in the T&L industry, and then when you think of FedEx (just to name a big T&L player that had similar problems), the cyber issue was much better managed. The family doesn’t understand how the different units should be run and what kind of managers Maersk needs to be a successful restructuring story. This has been the case for decades, so it doesn’t surprise me, but as billions of assets are shed there remains little fat on the bone and hey — this reminds me a lot GE, a company in an existential crisis, whose corporate structure has contributed to destroy value for years.

      Finally, to your point that, “as a team. Ralf HJ already had a shot at Damco and it didn’t go so well”… you should acknowledge that he took over in the aftermath of the biggest financial crisis of this century, so it was never meant to be easy. Thanks for stopping by.

      Reply
      • Nk

        April 18, 2018 at 10:49 pm

        Is there a possibility of acquiring Damco by Hapag Lloyd or Hapag Lloyd may introduce a new freight forwarding unit separately ??

        Reply
        • a.pasetti@yahoo.co.uk

          April 19, 2018 at 8:44 am

          Good one, Nk. I guess we can speculate about both scenarios, but it would be easier to buy (M&A) rather than build, given the replacement value of FF assets of a certain size, although there are caveats including the risk that a buyer might lose some contracts already secured by the target. Some of the market participants (in the trade) I talked to have minimised this aspect as a potential side issue, particularly if some of the major shippers, rather than the leading carriers, ever decided to add freight forwarding services to their mix. Thanks much for your question.

          Reply
      • Sumeet

        April 21, 2018 at 2:41 pm

        I agree the family doesnt really understand the paradigm shift in business and has placed trust in wrong hqnds . Maersk is too much of an old boys club to even survive leave alone disrupt an industry .

        Reply
        • a.pasetti@yahoo.co.uk

          April 22, 2018 at 9:55 am

          Thanks for your comment, Sumeet.

          Reply
  • a.kout@web.de

    April 22, 2018 at 7:19 am

    Damco is still too close to Maersk if you speak with either former Damco managers
    or manager familair with Damco.Focus of Damco still lies more on ocean thanr air-and is not balanced out, so in our mind interesting if you need economies of scale in terms of buying power on ocean,air they really lack volumes. The neutral aspect in terms of sales approaches to industry customers should not be underestimated too, additionally Damco is not really a very promising freight forwarder if you look financial results ad in particular to EBITA.
    Its not really complicate from the competition side to sell Damco as a part of Maersk, a shipping line raising eyebrows with shippers.Have a more closer look
    which volumes Damco still materializes with Maersk its still more than 60% not really convincing.
    A.Kout
    Akclimited

    Reply
    • a.pasetti@yahoo.co.uk

      April 22, 2018 at 10:04 am

      Interesting views, A.Kout. Re “and is not balanced out,” — yes and no, Damco ranks 20th in air and 10th in sea freight, and where it lacks volumes it enjoys plenty of growth. As far as your view that “Damco is not really a very promising freight forwarder if you look financial results ad in particular to EBITA.” –> Damco a couple of years ago found a way to address a poor financial performance, but then another management reshuffle took place and we all know how it’s gone so far…

      What do you mean with this? “Its not really complicate from the competition side to sell Damco as a part of Maersk, a shipping line raising eyebrows with shippers.”

      Thanks much for your comment, A.Kout.

      Reply
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