Container shipping equities: what is the current state of affairs?
With the US elections recently concluded, we had a very interesting trading experience in the markets mainly because of vaccine enthusiasm combined with post-election volatility reduction which led to a massive gain in container shipping stocks. The average share price return of the 12 selected liner operators on YTD basis was more than +70%. The Drewry liner equity index has registered a cumulative gain of 16% since the beginning of November until 16 November which speaks volume about the market sentiment.
Rally is strong, but will it continue?
Drewry’s liner shipping equity index displays a strong correlation with the World Container Index (WCI). While the average composite index of the WCI, assessed by Drewry (until 19 November), is $1,963 per 40ft container, which is $478 higher than the five-year average of $1,485 per 40ft container, Drewry’s composite WCI index increased by 4.9% weekly and 100.7% year on year to $2,834.73 per 40ft container.
Drewry expects port congestion and peak season surcharges to push freight rates higher as trade volumes gradually return to normal. The increase in container handling at ports (both at gateway and transhipment ports) has put unusually high pressure on terminal infrastructure leading to significant congestion. A case in point is Australian terminals, which are experiencing high congestion due to the ongoing dispute between the worker union and terminal operators including DP World, Patricks and Hutchinson. This led to levying of congestion charges at the ports of Brisbane, Melbourne, Sydney, Fremantle and Adelaide which took freight rates on Shanghai- Melbourne up by 60% year on year in October.
Also, traders are eager to fulfil their business obligations while trying to overcome the losses incurred in 1H20. To meet the requirements of the trade, shipping lines have reinstated sailings which were withdrawn in 1H20 owing to COVID-19 lockdowns. Freight rates continued the upward trend for 1Q20 and 2Q20, and as businesses started returning to normalcy in 3Q20, these rates reached unprecedented levels because of non-availability of empty containers.
Meanwhile, a surge in Asian imports bound for US retailers that are stocking up for the holidays is leading to anacute shortage of shipping capacity for US exporters, with agricultural producers nowstruggling to find the containers they need to send their products to overseas buyers. Container shipping companies seeking to keep pace with the strong demand for goods from China are rushing to unpack and return the containers to Asia, leaving fewer boxes available for American exporters to stuff with soybeans, lumber, cottonand other products.
How do the financials appear?
Major container lines across the board have reported their best third-quarter earnings since 2010 as a combination of factors including capacity discipline, shortage of container boxes, higher freight rates and lower operating costs created a perfect environment for lines to be profitable. Aggregate profit for 11 companies analysed came in at $4.53billion for the first nine months of 2020 versus just $488billion during the same period in 2019.
Maersk group, for example, reported its single best quarter since it transformed from a being conglomerate in 2016 to a global integrator of container logistics with its net income rising 82% year on year.
Could 4Q20 be even better than 3Q20?
Evidence of a strong 4Q20 is the monthly revenue growth of the three Taiwanese carriers as they recorded their best year-on-year revenue growth for October. While Wan Hai posted revenue growth of 32% year on year, Evergreen and Yang Ming registered growths of 27% and 24% year on year, respectively.
Separately, according to Maersk’s CEO Søren Skou, the container market is getting even better and they expect to deliver a 4Q that is even stronger than their 3Q performance. Maersk group now expects full-year 2020 EBITDA before restructuring and integration costs to range between $8.0billion and $8.5billion (previously $7.5-8.0billion as announced on 13 October).
What is the 2021 earnings outlook?
Despite the news surrounding the second wave of the pandemic hitting some countries, we remain positive on carrier earnings in 2021. Now whether the carriers will be able to match this year’s performance or even exceed expectations depends on lot of factors but we do believe that the industry should be able to make decent money (about $6 billion of operating profit) based on some of the positive data indicators related to contract rates. Certain early bids show that carriers are quoting Transpacific contract rates for 2021 which are about 60% higher than current contract rates. This is not surprising, given the very high spot rate levels now which means carriers should enjoy high freight rates next year as well. In addition, with oil prices still at around the $40bbl mark, this should support the cost side in the form of lower bunker fuel prices.
How could low oil prices impact container shipping companies?
While the true impact of the second wave of COVID-19 is unclear, weakening oil prices will have a risk-mitigating impact. Oil prices have been under pressure recently due to concerns that a second wave could hit demand further, but a series of announcements by Pfizer-BioNtech, Moderna and AstraZeneca-Oxford University related to the progress on vaccines have created some positive sentiment. However, the first significant impact will not be felt until well into the second half of 2021, based on last week’s price movements in the futures market.
The current Brent crude oil price shows a declining trend, and we believe the low oil prices will continue to favour container shipping companies in the form of lower bunker costs well until 1Q21 (as there is a lag between the commodity price changes and their actual impact on bunker fuel).
As crude oil and shipping stock prices share an inverse correlation, when oil prices rises, company valuations fall and vice versa. The relationship has largely held true between Drewry liner shipping equity index and Brent crude oil.
What is the impact of US elections on container shipping stocks?
Since early November, there was heightened speculation about who the next US president would be, and we have not seen any major deviation from the usual momentum that the stocks have displayed. All major stocks including those with high exposure to China continue to strengthen.
To give historical context to the relation between US elections and stock prices, we have shown a comparison between the movement of stocks during November 2016 when Donald Trump won the elections and conclude that the elections have no major impact on major container shipping stock prices. Rather strong fundamentals are currently driving the upward movement of container shipping stocks.
As it stands Joe Bidens is well placed to become the next President of the US while the ex-President Trump is turning to the law for a recount of votes. He alleges voter fraud, but without evidence.
Be that as it may, we believe that a Biden administration may adjust China policy, returning to a multi-lateral policy rather than the current unilateral approach, and he may even reverse the tariffs that have hurt US companies and consumers.
Also, Joe Biden being a Democrat may favour more stimulus packages for COVID-19. We have seen that fiscal stimulus has already inflated container shipping demand, benefitting ocean carriers through record-high spot rates. The federal government’s use of debt to subsidise consumer spending is indirectly subsidising earnings of transport companies.
All these aspects would impact stocks such as Maersk and Evergreen Marine which have significant exposure to the Transpacific trade.
Recent orders of ULCVs and what does it mean?
Despite some occasional forays into new orders where certain liner companies, such as OOCL (new build vessel orders) and MSC (second-hand vessel orders), the overall trend for capex has been trending downwards in 2020.
That said, the current orderbook-to-fleet ratio is the lowest this century, and there are very few confirmed orders for delivery after 2021 indicating the need for additional new orders. A few extra ULCVs are unlikely to negatively impact the market, but in general we believe the attention will be on smaller units that offer deployment flexibility. The renewed interest in newbuilds is unsurprising given the current buoyancy of the container market, as any order frenzy would signal that the market has not broken away from its previous cyclical pattern. A glut of capacity (either ships or containers), as economics tells us, will be punished with lower prices.
In our view, investing in expensive assets such as ships will always be a gamble because shipowners do not have advance knowledge of the conditions in which those assets will operate. It is hoped that over the 20+ years lifecycle there will be more good years than bad, but every new influx has the potential to destabilise the market, one way or the other.
The ‘sins’ of the past, when it comes to newbuild containership contracting, can always be seen in the present and this year is no exception. The heavy contracting of 2013-15, when mega-ships were all the rage and some 5.4 million teu was ordered, meant that the industry was banking on a strong demand run in the intervening years, which did not materialise. The unprecedented capacity management tactics by carriers in 2020 can be viewed as the correction required for betting too hard on one side just a few years earlier.
When will the container shortage situation improve?
According to freight forwarders, container shortage has increasingly become their primary concern– the lack of available empty equipment in export locations likely to lead to further schedule and sailing disruption. In our view, the problem is less about the actual shortage of containers and more about lack of availability caused by operational bottlenecks. Production of containers is ramping up but until the operational challenges are fixed this issue is likely to stick around for as long as demand runs high.