2H21 Outlook: Transportation: Freight Rate Upcycle to Prolong
In 2H21, goods and commodity traffic should continue increasing in response to inventory restocking and production expansion. At the same time, however, as transportation distances lengthen and shipping capacity remains limited due to a lack of new ship deliveries, the supplier-oriented market environment should continue in the marine transportation industry. Looking at the air transportation industry, as the long-awaited resumption of international flights approaches, expectations for demand recovery are rising. Considering the fleet reduction at domestic airlines, the air transportation industry should also see an environment favorable for suppliers.
We view concerns towards a peak-out of freight rates as being premature. Commodity inventory levels in the US remain low. Ship congestion, a lack of equipment, and low logistical efficiency are still in play. China’s control over commodity prices and suppression of steel production present concerns, but the increase in production in downstream markets (such as construction, automobiles, machinery, and shipbuilding) is a global trend, and this growth in production is expected to stimulate demand for commodities. Considering the production time of transportation vehicles, any short-term increase in transportation capacity will be limited.
We present Korean Air (KAL) and Pan Ocean as our sector top picks for 2H21, believing that both will see valuation re-ratings following long-term freight rate hikes. KAL is expected to enter a cycle of profit growth on the back of rising passenger yield, and its profit leverage has upped following its Asiana Airlines takeover. Pan Ocean is expected to experience a long-term freight rate upcycle thanks to the combination of brisk commodity trade volume in 2H21 and limited bulk carrier supply over the long term.
Top pick 1: Korean Air (003490.KS); TP of W39,000
The air cargo rate upcycle is to sustain until 3Q21 at least, and the upcycle could extend further depending on consumption recovery in 2H21.
Expectations are rising for an air passenger traffic recovery. KAL has already expanded capital through a rights offering, the disposal of non-operating assets, and its strong cargo business. Accordingly, shareholder value dilution risk is limited.
Air passenger traffic should begin recovering gradually from 2H21 thanks to rising vaccination rates, and the traffic growth should continue till 2023.
Given reduced fleet capacity at domestic airlines, a demand recovery is likely to outpace supply growth. KAL’s market share in the international flight market rises from 26% to 38%, following its Asiana Air takeover.
The merged entity’s passenger business sales stand at W12tn (2019 basis). KAL is to become the primary beneficiary of rising airfares and recovering passenger traffic.
Top pick 2: Pan Ocean (028670.KS); TP of W9,500
Supply-demand conditions in the bulk shipping market should improve, on: 1) recovering commodity demand; 2) extended travel distances; 3) limited supply growth following a sharp drop in newbuilding orders. Supply growth should decline to 2.5% in 2021 and 1% in 2022.
Major commodity consumers have been diversifying their suppliers to ensure stable supply streams. Due to China-Australia conflicts, the travel distance for China’s iron ore imports has extended, and spreads between Brazilian and Australian iron ore prices have expanded. Noting these factors, we believe the bulk shipping rate upcycle will sustain despite concerns over China’s steel production cut.
Pan Ocean’s bulk carrier fleet has grown from 186 at end-2020 to 240 today. Even though the firm is set to enjoy strong earnings leverage effects upon freight rate hikes, its shares are trading at low valuations due to uncertainties over the sustainability of the rate upcycle and low market confidence towards earnings generation.
We forecast that the rate upcycle will sustain for about two years, and believe that Pan Ocean’s shares deserve valuation re-rating.
Source: Business Korea