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Last week I compared the business of owning ships to being a bull in a bullfight. Since then, we have seen one of those rare occasions when the bull emerges from the bloodstained arena victorious – although it was put down afterwards.
The analogy stuck as I turned my attention to Israel’s ZIM Integrated Shipping Services, and the question of whether it is more likely to be sold to a major container shipping line than to be listed on the stock exchange by, say, 2020?
I have little doubt that the former is far more likely and, if I am right, Maersk Line and MSC are the most likely suitors – although I also believe the Haifa-headquartered carrier will continue try to plot its own course until its bankers smell blood… here’s the thing about bullfighting: nobody “wins”; it’s not a sport.
Equity close to zero
For the record, its owners cannot sell out anytime soon because a change of ownership would leave them empty-handed.
ZIM’s equity today, based on my calculations, is worth very close to zero, while its book value at the end of 2016 was negative to the tune of $100m – neither number bodes particularly well for a sale or float.
Nonetheless, I have sought feedback on a possible trade sale among my shipping and banking sources, and while none went as far as saying a takeover was just around the corner, neither did any think it was an idea so crazy as to not be worth contemplating.
Instead, I placed ZIM’s financials under the microscope to determine when a change of ownership might be necessary, given its stretched financials.
Despite persistent headwinds, the business has steadied since ZIM first drew my attention in early 2016, but its ships are not sailing in safe waters.
New chief executive and president Eli Glickman, set to start in a fortnight, has a lot to prove, and the scale of his task cannot be underestimated.
On the one hand, replacing Rafi Danieli will not be easy, given his outstanding work. On the other, ZIM’s public pronouncements continue to sound more bullish than they ought to and strike me as being overly aggressive – given bunker prices that depress margins and mitigate the benefits of rising rates; shrinking cash balances; and a capital structure that remains poorly balanced.
“Since the third-quarter 2016, we have been witnessing a positive trend in the industry with slightly improved freight rates in some trades. However, market conditions on the whole remained challenging and volatile,” ZIM noted at the end of the first quarter, adding that “slower growth of demand and worsening overcapacity” had not faded away.
This is a problem for such a small player in an industry where size is widely regarded as being the rule of thumb when it comes to being competitive. It currently sits 15th in Alphaliner’s global rankings, judged by fleet capacity, which is before the Japanese merger and Hamburg’s Sud’s absorption into Maersk are completed.
With a current operating capacity of 341,000 teu, ZIM is the smallest carrier offering intercontinental deepsea services, and is judged to have a global market share of 1.6%. Following it at number 16 is Taiwanese intra-Asia specialist Wan Hai, with a fleet capacity of 224,000 teu.
While I do not see ZIM as “the next Yang Ming”, it remains unclear to me how Mr Glickman – a man whose track record spans missile ship commander and naval attaché – is expected to chart the carrier’s tricky financial course, especially since it has yet to appoint a chief financial officer following the departure of Guy Eldar “for personal reasons”, at the beginning of March.
Undoubtedly, this is a pivotal time for ZIM. So far, it has not joined an ocean carrier alliance, but it is operating in part with THE Alliance, as well as MSC, to boost their joint Med-Europe services. This will bring obvious benefits, and hopefully move the needle financially.
Its core adjusted cash flows improved in the first quarter, but it still operated at a loss.
ZIM’s performance and budgeting are constrained by certain financial covenants that do not make life easy, due to the inherent cyclicality of its core business lines.
To start with, it has a “minimum liquidity” covenant, meaning the group is required to carry on the balance sheet a monthly minimum amount of cash and equivalents of at least $125m – this is tested every calendar month, and that’s not fun for management.
Cash flows, rather than cash and equivalents, bounced back nicely in the first quarter, but I’m afraid one swallow does not a summer make.
In the past two years, not only did ZIM burn up to $770,000 a day before capital expenditures were taken into account, but its cash balance trends have also continued to deteriorate.
Meanwhile, the short-term debt-to-gross cash multiple was about 1x at the end of 2016, and I suspect it continues to be in that ballpark today, given recent trends for its finances.
A second covenant, a fixed charge cover ratio, essentially represents core adjusted cash flows against “cash interest, scheduled repayments of indebtedness and charter hire lease costs”.
If you are puzzled by this definition, move on and pay attention to this (emphasis coming is mine, in bold): “The required ratio will be examined on March 31, 2018 onwards, and will gradually increase from 0.78:1 as required on March 31, 2018, to 0.99:1 as required on March 31, 2019, and remain in that level thereafter,” ZIM said after a quick look in its crystal ball
It previously forecast that the ratio “will gradually increase from 1.02:1 on December 31 2015, to 1.07:1 on December 31, 2018 (based on the last 12-month period)”, without saying how it would manage to achieve those levels.
Even such a miniscule rise in the fixed charged cover implies a significant surge in cash flows, which means ZIM is betting strongly on rising freight rates.
That, in turn, is important if it intends to meet the required level associated with its third covenant: the leverage ratio, or total debt-to-consolidated Ebitda.
“This ratio will gradually decrease from 8.8:1 on 30 June 2015 to 4.9:1 on December 31, 2018 (based on last 12-month period)”, it said following its corporate restructuring in 2014.
However, during 2015 and 2016, market conditions deteriorated, so “the company obtained amendments to the financial covenants described above, the most recent of which concluded late in 2016”.
But in the light of the recent market recovery, the horizon is not particularly bleak – for a couple of years at least. However, should this recovery not be sustained, its debt maturity profile gives it little room for manoeuvre and ZIM could well find itself at the mercy of its bankers, or seeking government intervention.
But now read this:
The required leverage ratio is now expected to be “examined on March 31, 2018 onwards, and will gradually decrease from 23.69:1, as required on March 31, 2018 to 6.64:1, as required on December 31, 2018, and remain in that level thereafter”.
Now, if “thereafter” comes to pass, there is the possibility – an outside one – that ZIM could find itself a takeover target, given how seldom the shipping markets reward carriers that sail solo.