Analysis - declining cash levels could lead Maersk on a $5bn new equity quest
I have been thinking a lot about the cash and liquidity profile of Denmark’s AP ...
What comes next for CMA CGM? I asked my sources, following a formidable trading update last week.
“If an IPO doesn’t materialise within six months it will be a missed opportunity management will regret forever,” one London-based equity capital market (ECM) banker told me on Monday.
“The VIX [volatility] index is below 10 for the first time since last month – close to record lows, so the window is wide open until late 2017 or early first-quarter 2018, then who knows – but the time to get it done is before year-end. Period.”
That was a fair reply, I thought, if CMA CGM is serious about its order for new ultra-large container vessels (ULCVs), because its core operating cash flow profile markedly improved at the half-year point. But that doesn’t allow managers to take it easy, given what arguably remains a stretched balance sheet.
Adding nine ships to its fleet of 132 would mean expanding its non-current asset (NCA) base – most of which comprises core fixed assets, detailed in the table below – from about $12.6bn at the end of June.
As a reference, just under $13bn of NCAs currently represents almost 70% of total assets, which is typical in the industry; in comparison, NCAs stood at $9.4bn at the end of 2015, so it is evident that CMA CGM is trying to achieve greater scale, in an industry which is all about scale.
“The big guys control the assets, so they hold others to ransom in the supply chain,” the senior executive of a global freight forwarder recently commented.
“And that sums up nicely the mood in the freight forwarding community,” another senior manager noted when I shared this feedback, adding “the shippers are no better off”.
My preliminary observation here is that in order to shore up return on equity, leverage and scale are often the answer, and even more so perhaps in a market that over time will increasingly operate as an oligopoly and in which CMA CGM will clearly be a major player. We are not there yet, but surely this turnaround story – partly boosted by the integration of NOL and its troubled container shipping arm, APL – is far from over.
I wasn’t surprised that my banking source made such a bold statement with regard to an IPO – while the French carrier’s first-quarter results were certainly encouraging, prompting me to argue earlier this year that the stars were aligned for a long-waited IPO, its second-quarter and six-month figures were even better.
“Expectations and investment go hand-in-hand, and CMA CGM is now managing expectations,” my banking source also noted.
Previously, in December 2016, I said: “The debt-funded purchase of NOL and its APL container shipping line – an “acquisition without precedent”, as CMA CGM termed it – should start paying dividends in the first half of 2017 at the latest.”
And it did.
No pain, only gain
The improvement in the first half was simply mind-blowing, and while with Hapag, which I covered last week, I talked of a marginal embellishment in P&L number, CMA CGM is a case of hefty gains. Although, there is also a possibility the French carrier unwisely decided to bid up expectations, particularly in regard to upcoming orders for new ULCVs.
Notwithstanding its latest results, I still think it will have to pull out all the stops to pay for any new ships.
Make no mistake – on the one hand, the debt load remains a problem, while on the other hand it was overshadowed at half year by a solid all-round performance that proves CMA CGM knows what it is doing strategically, operationally and financially.
After a very difficult stint, in terms of managing mounting losses and debts, its executives are now exploiting more favourable pricing-volumes dynamic for carriers, proving wrong those who drafted bearish scenarios, including my worst-case.
Revenues grew at a steep pace in the six months ended 30 June, greatly outpacing the growth rate of its costs base, with EBITDA of almost $1bn in the first half, against $118.6m one year earlier.
However, not only is the improvement remarkable, but also necessary, given that some $4.7bn of principal on its outstanding debt, including finance leases, is due by 2020, as implied in the table below.
Meanwhile, costs rose significantly, despite new synergies.
Betting on free cash flow
Based on first half-year trends, its normalised free cash flow figure is roughly $1bn annually, or about $3.5bn to the end of 2020 from 30 June 2017, on a projected basis
That is simple maths, and equates to 3.5 years of free cash flow that will have to be devoted to paying down debt, as it did in the past – still, in this case, over $1.2bn of additional free cash flow would be needed to fully repay debts when they are due in 2020.
$1.2bn is roughly equal to its gross cash position, but CMA CGM, of course, won’t touch its cash pile, although the benefit in doing so would be to reduce its outstanding debts to about $4bn from $8.7bn currently, leading to a significantly more balanced capital structure.
Funding diversification goes to the heart of its capital allocation strategy, but it is not a problem for the French carrier, most likely because it will not redeem its debts in full when they mature, opting instead to roll over a large chunk of those – say 50% or so – maturing between 2019 and 2020 with debt securities of longer duration.
That would leave it with $3bn of principal to repay by mid-2020, which is covered by free cash flow, based on the aforementioned, bullish assumptions.
CMA CGM can easily refinance existing debts, but there is one caveat: given its credit rating – which is only marginally better than Hapag’s – interest expenses will continue to be significant. If you had not noticed, they almost doubled to $230m in the first half of 2017 against 2016’s comparable figures.
Under this scenario, the group will not generate enough free cash flow to buy the ULCVs it plans to add to its fleet, so very likely it will have to refinance more than 50% of its debt maturing between 2019 and 2020 as soon as mid-2018 – refinancing rounds usually happen one year ahead of maturity – while raising new equity within 12 months.
As it happened, it allocated all its free cash flow to sort out cash outflows from financing in the first half of the year, adding only a little amount of spare cash to its existing pile.
On a comparable basis, adjusted net debt rose, confirming trailing trends, to $7.2bn in the first half, as the table below shows.
Barring any proceeds from disposals, CMA CGM will be unable to finance its ambitious growth plans purely out of profits from ordinary container shipping operations.
In fact, either its free cash grows at a steeper pace than $1bn a year (there no track record here, and trying to predict cash flows in this market is a guesstimate at best), or it will have to fund its expansion plan via a cash call – which means that new equity might be raised to fund the expansion of its fleet, while free cash flow will be used to pay down debt.
That would be smarter than telling investors that IPO proceeds would be used to pay down debt, I reckon.
“Having management confirm CMA CGM will grow organically, surely new equity is needed sooner rather than later,” a banking source in continental Europe concluded.
So, I have come to the conclusion that it might need another billion dollars, or possibly two, even assuming free cash flow continues to rise as it has done in recent months, which in such a highly cyclical industry is an overly optimistic take, to say the least, in spite of very encouraging trends for the trade.
Before NOL was consolidated, I expected up to $1.2bn in EBITDA, under a best-case scenario.
Much also hinges on whether it will be able to negotiate a decent deal for new ULCVs.
“The discounted price to beat off the Koreans was $160m per unit,” The Loadstar‘s container shipping correspondent, Mike Wackett, told me when I asked if a fair cost estimate for nine new vessels of that kind would range between $1bn and $1.5bn.
Mr Wackett added: “They are ordering six ships, with the other three as options, so they will not pay any stage fees on those.”
It wasn’t so many moons ago that CMA CGM had to pay hefty cancellation penalties on ships they had ordered and then could not afford.