Introduction to Shipping Container segment
This is a relatively new shipping sector since the innovation of the ISO container transport introduced by Sea-Land in North America in the middle of the 1950s. Ocean containers allow to have small ocean shipments and allow the transport of multiple types of commodities, from consumer durable goods to industrial and automotive parts, to perishable cargo in refrigerated containers. This makes the sector other shipping segments Dry bulk, tankers, LNG, or Car carriers, where they are focused on transporting few commodities high in large volumes
The container shipping sector is highly company-concentrated, this is the result of consolidation during the last 40 years, where today the top 8 shipping lines control over 80% of the global capacity.
Current market status
During the Covid-19 crisis, there was a spending behaviour change from demanding more durable goods and fewer services, together with the lack of labour and supply available created a historical peak of ocean freight rates when they peaked on November 2021, the rates remained at high levels until May 2022
Price for 40’ containers as per various indexes (SCFI, S&P Platts, WCI and CCFI) – Source Linerlytica week 50-22
The historical increase in ocean freight rates came from a combination of booming demand from the US, with a change in consumer behaviour caused by COVID, where the population was forced to stay at home.
During the COVID Omicron wave (December 2021 to February 2022) US and European retailers faced large delays from the bottlenecks created at the ports and factories, this pushed even more demand to order well in advance goods since lead times doubled their time, and this is the reason why volumes and demand were very strong during the first quarter of 2022.
In Q2-2022 the trend started to change, and Western economies were lifting Covid mobility and travel restrictions, the first consequence was the change of consumer spending from “stay at home” or discretionary goods to services like travel and restaurants and holidays.
At the same time during March, a more contagious Covid variant, Omicron started to spread in China, and this caused a closedown of factories, ports and cities in China, increasing the congestion and reducing the bookings for ocean containers to North America and Europe.
High inflation in Europe and US started to become a serious problem and first the Federal reserve and then the European central bank started to hike interest rates, this reduced demand for discretionary goods and retailers and industrial companies start to be concerned about the inventory that they are holding (this is caused by two factors, the nominal inventory is increasing by the effect of inflation and also by a sudden stop of consumption from customers.
During the second half of 2022 in container shipping, business ocean freight rates softened since volumes have been reduced, and the reduction in volumes is also alleviating the congestion of vessels in the ports and other supply constraints, releasing more space and capacity, this has led on December to bring back container spot rates at price levels before covid.
The most direct consequence of the fall in prices is a big pressure on long-term contractual rates. Some shipping lines, like Maersk, were smart and pushed importers to secure long-term contracts during the peak the rates
Future of the container shipping segment?
After the post-Covid lock downs retailers are now 100% focused to reduce inventory levels If we check the USA “Inventory to Sales ratio” (one of the demand indicators of container transport), we see that levels are still below pre-pandemic levels, mainly caused for the inflation (nominal inventory have grown together with nominal sales)
When we look at the volume of cargo/merchandise sold, we see a reduction in 2022, but still, it is a healthy demand above pre-pandemic and historical levels.
The seasonality has been screwed due to the congestion levels. Seasonality follows the retail market when the peak season starts in May to November (Christmas campaign) and volumes are lower during the rest of the year, last year’s peak season started before due to an increase by 2 times of lead times, and retailers were forced to order well in advance and in large quantities to secure supply, so all the cargo for peak season in 2022 was already shipped by the end on July, which is typically when peak season starts
We can foresee if volumes are still dropping there will be a “bouncing” effect during H2 of 2023 caused by a potential lack of inventory and rates/demand might go up again next year.
With the volume reduction, we see that liners are managing capacity and reducing services, which shows that they will react to avoid losses in the future.
How to play the current market situation in the container segment?
There are two extreme approaches in the market by two shipping lines, the first one ZIM (number 10 in the world) very exposed to the spot market, only 25% of their capacity Is secure with one-year contracts and the rest is moving on spot which is usually negotiated on a weekly to monthly basis.
2021 and the beginning of 2022, ZIM was the best performing company with the highest rate per container and the most profitable, we can see that they have “peaked” in Q1-22 and since then numbers are getting worse with the softening of the spot market, after seeing Q4, we can expect a 40% decrease in their selling rates and current spot levels are below their operating cost. We will not recommend to short the stock since it is probably the one most punished this year, and they could report losses in 2023 due to their heavy exposure to spot rates
If the market rebounds due to a lack of inventories again and a potential effect of missing empty containers after all vessel cancellations, this could be positive for ZIM during the H2-23.
ZIM, selling rate per container (TEU) and cost per container, source ZIM financial updates
This is the second largest shipping company in terms of capacity, they decided to play the cycle by securing long-term deals with customers instead of trying to sell at the highest rate, as per their last update, they have secured 71% of their volumes on contracts on the high side, they will enable Maersk to secure a profit for 2023. Maersk has positioned itself to sell other logistics services like airfreight, warehousing and trucking. But in comparison, this business is not relevant compared to the importance of revenue that the shipping business still has.
Maersk peaked in revenue in Q3-22, and we expect a reduction from there, but they will be able to keep margins for a longer time
Maersk, selling rate per container (TEU) and cost per container, source Maersk financial updates
Play the Maersk dividend
Maersk reported on Q3-22 a cash position of USD 22,9 Bn for the quarter with an expectation of FCF for 2022 above USD 24 Bn, they have a CAPEX for 2022/23 of USD 9 Bn to USD 10 Bn for the period.
There is a confirmation of a USD 12 Bn share buyback program until 2025 and a dividend policy payout of 30% to 50% of the underlying net result.
With the reported numbers and being conservative on a net result of USD 27 Bn for the period that means a dividend per share between $2.29 to $3,39 at a stock trading at $ 11,51, this can be a yield of 20% to 30% at current stock price.
The annual report will be released on 8 February 2023 and it will be interesting to position for a short-term position around the dividend announcement for trading position.
Main Author: Arcadio Martinez (@Tatin17)
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