Consolidation in container shipping needs to continue if industry is to right itself, says AlixPartners study

(February 29, 2016) – The long-beleaguered financial state of the maritime container-shipping industry will likely worsen in 2016, and the only thing apt to cure the industry’s malaise is further consolidation. That’s according to a new report released today by AlixPartners, the global business-advisory firm. 

The firm’s annual outlook finds that growing vessel supply, led by the ongoing introduction of giant megaships, coupled with demand that shriveled in the second half of last year leaves with industry with massive overcapacity, falling profitability and precarious cash-flow levels.  At the same time, the study asserts that companies with M&A on their minds need to be proactive if hope to reap the kind of rewards winners in consolidated industries enjoy—or to prevent becoming acquisition targets themselves.  And, along the way, the study points to the successful consolidation of the U.S. airline industry as a possible template for the industry.

“For the first time in recent memory, the container-shipping industry is seeing the beginnings of the kind of consolidation that has brought increased and sustained profitability to winning players in other industries for years,” said Foster Finley, managing director at AlixPartners and co-head of the firm’s maritime practice.  “However, further consolidation and operational overhauls will be necessary if players in this industry, which as a whole remains deeply troubled, wish to reap the kind of benefits enjoyed in other industries.  In addition, these uncertain market conditions are casting a long shadow over the annual rate-negotiation cycle kicking off between major importers and their carrier bases.”

The Irony of Megaships 
According to the report, in part due to the continued introduction of megaships—vessels capable of carrying more than 18,000 twenty-foot-equivalent container units (TEUs)—industry capacity globally is expected to jump by 4.5% in 2016 and another 5.6% in 2017, while demand is expected to increase just 1% to 3% this year.  Ironically, says the study, the resulting overcapacity—and corresponding negative effect on profits—is in part the result of the industry’s drive in recent years to correct its chronic supply-and-demand imbalance by building these more-efficient but mammoth ships.  Moreover, says the report, this new capacity in major trade lanes is likely to continue to distort the supply-and-demand balance globally, as the slate of vessel deliveries scheduled for 2016 and 2017 remains robust while vessel-scrapping activities remain muted.

Per the demand side, notes the study, last year started off with promise, as carriers generally reported improved profits through the first half of 2015 on the backs of stronger freight rates and declining fuel costs. But the good times were short-lived, as traditional peak demand failed to materialize in the third quarter, leading to collapsing freight rates.  In fact, finds the study, industry revenue in the critical, preholiday third quarter has declined in each of the last three years, to $39.6 billion in 2015 vs. $45.9 billion in 2014 and $46.5 billion in 2013.  The drop-off last year represents a 16% decline.

Distressing Financials
As a result of these types of factors, the study finds that nearly all key financial indicators for the industry have declined.  It finds that industry profits, as measured by EBITDA (earnings before interest, taxes, depreciation and amortization), fell 7% in the latest 12-month period, including a whopping 35% decline in the all-important third quarter.  Perhaps of even more-immediate concern, it finds that cash from operations declined by almost twice as fast as EBITDA in the 12-month period—by 12%--indicating that carriers face working-capital challenges, often a precursor to bankruptcy. 

Speaking of bankruptcy, the study finds the industry as a whole in the “distress” zone according to an Altman Z-score analysis, a formula for predicting bankruptcy.  The industry has been mired in this lowest zone for the past five years, and hasn’t been in the “safe” zone since 2007, notes the report.   

A Consolidation Template
Given the already-challenged state of the industry and the turn for the worse of late of several key industry barometers, the AlixPartners study forecasts continued poor financial results for at least the remainder of 2016.  However, it also provides a possible consolidation template for industry companies not willing to live with what the study calls a “new normal” of anemic results.

According to the study, recent multibillion-dollar mergers such as Hapag-Lloyd A.G.’s acquisition of  Compania Sud Americana de Vapores S.A. (CSAV), CMA CGM S.A.’s purchase of Neptune Orient Lines Ltd. and the combination of China Shipping Container Lines Ltd. and China Ocean Shipping Co. (COSCO) are signs that, after a decade of muted M&A inactivity, the container-shipping industry could be ripe for a long-deferred consolidation—something, says the study, that could greatly benefit ambitious carriers and financial sponsors.

As a possible model, the study points to the consolidation of the U.S. airline industry, also an asset-intensive industry once plagued by rampant overcapacity, cut-throat pricing pressures, complex alliances, disparate fleets and hubs, and persistent financial losses—until individual companies and financial backers finally took consolidation actions, resulting in a much stronger industry today.    

To be sure, says the study, players need to be wary both of the costs of consolidation, particularly if fueled by debt, and of the difficulties of effective post-merger integration.  In fact, given today’s low profitability levels, it says it’s imperative that merging companies retain combined customer bases and realize substantial cost synergies—from fleets to IT systems—to successfully service debt burdens.  However, asserts the study, in an industry now facing “gale-force headwinds” and one in which everything from piecemeal cost-cutting to vessel-idling to slow-steaming has failed to yield truly transformative results, merely adhering to the status quo is likely the most dangerous strategy of all. 

Vital Measures 
The study concludes with a list of “vital measures” companies can take, no matter what their strategy, to be as prepared as possible for the year ahead.  The list includes:

• Shore up balance sheets, reducing debt loads and selling noncore assets;
• Repair income statements, including through more-thorough cost-cutting initiatives; and
• Uncover new opportunities, from exploiting lower slot costs to uncovering new markets.

Companies that successfully defend their balance sheets and income statements will likely be in prime positions as the industry reshapes itself, says the study.

About the Study
The AlixPartners study, Container Shipping Outlook 2016: Overcapacity Catches Industry in Undertow, reviewed the financial results of the world’s 17 publicly-traded ocean container-carriers.  Data for 2015 in the study is based on the 12-month-prior period through Sept. 30, 2015.

About AlixPartners 
AlixPartners is a leading global business-advisory firm of results-oriented professionals who specialize in creating value and restoring performance. We thrive on our ability to make a difference in high-impact situations and to deliver sustainable, bottom-line results. The firm’s expertise covers a wide range of businesses and industries whether they are healthy, challenged or distressed. Since 1981, we have taken a unique, small-team, action-oriented approach to helping corporate boards and management, law firms, investment banks and investors to respond to crucial business issues. For more information, visit www.alixpartners.com.