News for the seafarers
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Quarterly net losses could be around the corner for container lines, but EBITDA will stay high even if carriers dip into the red.
The post How much will container lines ‘earn’ in 2023? It depends on the metric appeared first on FreightWaves.
Berkshire Hathaway’s Charlie Munger once famously said, “Every time you hear ‘EBITDA,’ just substitute the phrase ‘bullshit earnings.’”
Public shipping companies in different segments highlight different earnings metrics. Tanker and dry bulk owners focus on adjusted net income. Listed container shipping lines often highlight adjusted earnings before interest, taxes, depreciation and amortization.
EBITDA has been criticized for decades — Munger’s quote is from Berkshire Hathaway’s 2003 annual meeting — but it has become an even more problematic metric for container shipping lines due to accounting and industry-specific changes over the past four years.
The International Financial Reporting Standards implemented Rule 16 (IFRS 16) on lease accounting in January 2019.
Since then, vessel charters with terms exceeding one year that are considered “right-of-use” assets have been accounted for in shipping lines’ income statements under depreciation and interest expenses, mainly depreciation.
Prior to IFRS 16, carriers’ lease expenses were accounted for under operating costs. EBITDA takes operating costs into account, but not depreciation.
A year after IFRS 16 came into play, the pandemic ensued. COVID changed consumer buying patterns, sparking a boom in freight rates. That, in turn, led to a surge in demand for chartered vessels, an unprecedented spike in lease rates, and ultimately, a dramatic increase in charter durations.
Nonoperating owners (NOOs), the companies that lease ships to liners, held all the power. Freight rates reached stratospheric heights, and liner companies needed chartered ships to secure the historically high freight income.
By March 2022, the Harpex index, which measures container-ship charter rates, was eight times higher than pre-COVID levels.
Not only were liners forced to pay NOOs historically expensive leasing rates — inflating liner leasing costs — they were also forced to accept longer charter durations, with ships being locked up for five-year terms at the peak.
As a consequence, shipping lines have even more lease payment expenses counted as depreciation and interest on their income statements. And because of longer charter durations, the accounting effect of higher leasing rates on EBITDA will persist for years.
The problem with EBITDA for container shipping is that it includes the positive effect of freight revenue earned by liner companies from their leased ships, but excludes the negative effect of charter payments carriers make to NOOs for the vessels that allow them to earn the freight revenue.
Not surprisingly, container liner EBITDA has skyrocketed.
Israeli carrier Zim (NYSE: ZIM) is the most extreme example. Most carriers own roughly half their fleet and charter the rest. Zim charters 94% of its fleet, according to its annual report filed Tuesday.
Not only have Zim’s leasing costs increased due to higher rates charged by NOOs, but it has also significantly increased the number of ships it charters, from 106 qualifying as right-of-use assets at the end of 2021 to 136 at the end of last year.
Another metric, earnings before interest and taxes, shows the effect, as it covers the lease cost effect of long-term charters on depreciation (although not on interest).
Zim’s adjusted EBITDA exceeded its adjusted EBIT by $1.4 billion last year. The carrier’s depreciation jumped 81% in 2022 versus 2021, “primarily due to an increase … related to right-of-use assets, mainly vessels.”
Zim forecasts its adjusted EBITDA for 2023 will be between $1.8 billion and $2.2 billion. In contrast, it estimates adjusted EBIT will be $100 million-$500 million. The difference between the midpoint of these ranges: $1.7 billion.
Other shipping lines show the same divergence between EBITDA and EBIT, but to a lesser degree due to their lower reliance on chartered ships than Zim.
Maersk’s 2022 adjusted EBITDA was $36.8 billion, its adjusted EBIT $31.2 billion. Depreciation of right-of-use assets increased $1.1 billion year on year, according to Maersk’s annual report.
Hapag-Lloyd’s EBITDA in 2022 was $20.5 billion, its EBIT $18.5 billion.
Hapag-Lloyd said in its annual report that depreciation and amortization increased by 16% in 2022 versus 2021 “primarily due to the year-on-year rise in the percentage of vessels chartered in on a medium-term basis at simultaneously higher charter rates.”
Beyond EBIT, the next level of accuracy for shipping line financial metrics is net income, which includes the bottom-line effects of interest and taxes.
Taxes are generally not a major issue for most international shipping companies, although Zim, once again, is an outlier.
Shipping expert John McCown explained in his latest quarterly review of container shipping earnings: “International shipping companies normally pay to the flag state in which their vessels are registered a fixed annual fee related to deadweight tonnage in lieu of income taxes.
“A noteworthy exception is Zim, as most of its vessels fly the Israeli flag, which does not have a tonnage tax regime. As a result, Zim has a more typical income tax expense, which is a function of pretax income.”
Zim had $1.4 billion in income tax expenses last year. As a result, it shows a wide disparity between net income and EBIT, and an even wider disparity between net income and EBITDA.
Zim posted net income of $4.6 billion last year. Its adjusted EBIT was $1.5 billion higher than that. Its adjusted EBITDA was $2.9 billion higher than its net income.
How much will container lines “earn” in 2023? It depends on the metric.
Sometimes, press reports loosely refer to EBITDA as earnings. The latest guidance from Zim led to a headline stating that the company “expects to earn a cool two billion this year,” referring to the midpoint of its adjusted EBITDA guidance.
In contrast, Bloomberg consensus as of Thursday was for Zim to earn net income of $58.6 million. That’s still a big improvement from its $13 million net loss in 2019, pre-COVID, but it’s much closer to the threshold between profit and loss.
There will be considerable focus in the coming quarters on when falling freight rates push container lines into the red. Carriers will still be reporting positive EBITDA when that happens.
Jefferies analyst Omar Nokta currently predicts Zim will earn a net profit of $89.9 million this year. He expects net losses in the first half offset by profits in the second. Nokta predicts full-year EBITDA will still be in the 10 figures, at $1.75 billion.
Even if large container lines do start posting net losses, they haven’t lost the windfall they earned during the COVID boom, nor will they face anything akin to financial distress anytime soon.
The top container lines have never had more cash. Zim has amassed $4.6 billion in cash in the wake of the boom ($3.9 billion including the effect of the dividend to be paid April 4). Hapag-Lloyd has liquidity of $17 billion, up from $1.2 billion at the end of 2019. Maersk’s liquidity is a whopping $28 billion.
As Citi Global Head of Shipping Michael Parker said in Lori Ann LaRocco’s “Dynasties of the Sea,” “No shipping company went bankrupt because it was unprofitable.” They go bankrupt when they “run out of cash.”
Click for more articles by Greg Miller
The post How much will container lines ‘earn’ in 2023? It depends on the metric appeared first on FreightWaves.
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Two container shipping experts give their take on how the hangover after the pandemic boom could play out.
The post Container trade’s next turn: Price wars, cheap contracts, new ships appeared first on FreightWaves.
What does the future hold for container shipping alliances and price competition among ocean carriers? How low will spot and long-term freight rates go in the Asia-U.S. trade? And what happens when a massive wave of new container vessels starts hitting the water in the months ahead?
These are just some of the issues addressed by Vespucci Maritime CEO Lars Jensen and Xeneta CEO Patrik Berglund during FreightWaves’ Global Supply Chain Week (GSCW) virtual forum on Tuesday.
The decision to terminate the 2M shipping alliance between the world’s two largest carriers, MSC and Maersk, “is just the first domino to fall,” predicted Jensen, one of the world’s top experts on container shipping.
While 2M is scheduled to continue until January 2025, he expects the breakup to be apparent sooner.
“To me, it’s like you have two parties who have agreed to divorce who say, ‘By the way, we’re going to divorce, but not until two years down the line.’ They’re going to go out and find other friends in 2023.
“I don’t see 2M effectively operating as 2M until January 2025 and then suddenly dissolving. It’s going to be a gradual dissolution, basically starting now.”
Jensen believes 2M’s decision will “cascade over to the other two alliances [Ocean Alliance and THE Alliance], where the carriers will be sitting in their headquarters right now, contemplating, ‘Am I in the right alliance or is this the time to shake things up?’ I think the answer is going to be: This is time to shake things up.”
Full interview with Vespucci Maritime CEO Lars Jensen.
But an alliance shakeup does not guarantee lower rates for cargo shippers, he maintained. “I would caution shippers not to focus on alliances versus nonalliances as a link to whether rates are high or low. I don’t see very much of a link between those two.
“The extremely high rates we saw [during the pandemic] had nothing to do with alliances or nonalliances and everything to do with physical unavailability of vessels due to congestion.” The boom in 2021-22 was a “historical aberration we are unlikely to see again,” said Jensen.
During the second quarter of 2020, when COVID lockdowns in the U.S. and Europe peaked, container alliances proved very adept at “blanking” (canceling) sailings to artificially reduce supply to match demand, limiting rate reductions.
Some analysts predicted carriers would be able to prevent a severe collapse in rates after the COVID boom by following the same playbook, but they have not.
“In 2020, I wonder whether it was a move based on fear, when COVID hit and we all expected consumption to drop significantly,” said Berglund, whose company compiles data on short- and long-term freight rates.
“What happened was they pulled out as much [capacity] as they could because they were scared that the volume wouldn’t be there, but it turned out that there was significantly more volume than in a normal market. That’s what created the squeeze, rather than necessarily shrewd business behavior.”
Full interview with Xeneta CEO Patrik Berglund.
“This time around, it’s almost the opposite, because now it’s less volume than anybody anticipated and they can’t pull out capacity quickly enough, even though they know that’s the recipe to turn this around. We are seeing significant blankings, but we do not see enough.”
Jensen maintained that today’s price war among carriers does not mean they haven’t learned their lesson on capacity management.
Blanking sailings is “a tool that carriers have become much better at using,” said Jensen. “In the aftermath of Chinese New Year, we have seen a dramatic increase in the amount of blank sailings, although likely not quite enough given just how much the market has collapsed.”
Carriers learned their big lesson before the pandemic, not because of it, said Jensen. That earlier lesson was, “You need a reasonable degree of consolidation so you can use blank sailings … to create a more stable environment for the carriers.” However, “that doesn’t mean you can avoid price wars,” he explained.
“Prior to consolidation of the market, the normal state of affairs was a price war most of the time.” Following consolidation, “there will still always be a carrier that finds it to its own advantage to grow [market share] and of course it will pursue that, so [consolidation and capacity management] doesn’t mean you will never see price wars. It just means the chance you have price wars [will be less] and the duration of them will likely be shorter than in the past.”
The current price war has led to a nose-dive in rates, particularly in the trans-Pacific market.
“It’s hard to argue that we’re at least not close to the bottom,” said Berglund. According to Xeneta’s data (as of Feb. 8), average Asia-West Coast spot rates were around $1,400-$1,500 per forty-foot equivalent unit, “but if you look at the lower end of the market, it’s closing in on around $1,000 — so there’s not a lot more here for carriers to give. We’re getting into a painful area in the spot market.”
Carrier profits remained exceptionally high in the fourth quarter despite the spot-rate free fall due to continued support from annual contract rates. Most Asia-Europe annual rates reset on Jan. 1, most trans-Pacific annual rates on May 1. The plunge in spot rates means the next round of contract rates will reset much lower.
“I expect [long-term rates] to drop down to the short-term market average, but from there, the big-volume BCOs [beneficial cargo owners] will not be satisfied,” said Berglund. He pointed out that despite the crash in spot rates, “the lower end of the long-term market [paid by the big-volume U.S. importers] still sits below the short-term average.”
He continued: “If the spot market stays where it is, they [big-volume importers] will require a discount versus the small-volume importers. That is something carriers have historically agreed to, because they [larger BCOs] move more volume and they have a bigger spend with them.
“So, the biggest concern the carriers should have now is how they can jack up the short-term market to avoid massive losses on those long-term contracts that will be forced upon them.”
Last year, many shippers negotiated Asia-U.S. contracts well before May 1, given the ongoing supply chain crisis at that time. This year, the timing will be different.
“It’s going to be a late negotiation,” Jensen affirmed. “There is not a great deal of urgency on the side of customers to sign contracts as rates are continuing to go down in an extremely weak market. Why would you want to sign in a market that is still going down and you’re getting to levels where spot rates are now below pre-pandemic levels?
“What we should also not forget is that there’s not just a rational side but more of an emotional side. There is clearly a sentiment of payback on the side of a lot of the shippers out there, looking at what they went through in the last two years.”
A key factor weighing on current market sentiment is the looming tidal wave new container ships poised to hit the market. More container-ship tonnage is on order than at any point in history. These new vessels will start entering service in the coming months, with heavy deliveries continuing throughout 2024.
Container lines contracted new vessels after years of under-ordering in the pre-pandemic era, when carrier balance sheets were very weak. The COVID boom gave carriers the financial strength to order replacement ships that will be much more fuel efficient — promising much lower operating costs — and in many cases will feature dual-fuel capabilities allowing carriers to “future proof” assets against environmental rules.
To make room for new vessels, carriers will presumably allow existing charters for the older ships they lease to expire and will scrap the older ships they own.
Asked whether carriers can use such strategies to avoid overcapacity when all the newbuildings are delivered, Jensen replied, “The short answer is no.”
He said, “The reality is that this is a cyclical industry. Back at the end of 2019, most of the headlines were about the historically low orderbook. If you look at the hypothetical case where the pandemic never happened, you would have gone into a normal cyclical upturn because of a very, very low orderbook.
“And, as always happens when you reach the apex of an upturn, carriers make money, they order more ships and it takes a couple of years to get them, so what we are seeing now is where we would have ended up anyhow, irrespective of the pandemic.”
Jensen sounded more sanguine about the looming newbuilding barrage than most other analysts. “This is a normal cyclical downturn and it’s going to be depressing markets in 2023 and 2024, but I don’t see it as a particularly unique situation,” he said.
Click for more articles by Greg Miller
The post Container trade’s next turn: Price wars, cheap contracts, new ships appeared first on FreightWaves.