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Drewry container equity index snapped its three-year long winning streak in 1H22

In 1Q22, the supportive macroeconomic environment, which was backed by the strong consumer demand, was challenged suddenly by the war between Russia and Ukraine. Initially, liner stocks were resilient given the marginal contribution of both Russia and Ukraine to the world’s international trade, but soon this started to feed into energy prices, as Russia is a major energy exporter, pushing the already elevated inflation in major economies to multi-decade highs. To rein in inflation, central banks of major economies hiked interest rates, prompting speculation that aggressive monetary policy tightening could tip the world’s economy into the recession. Consequently, equity markets dipped worldwide and liner stocks were no different. The Drewry container equity index snapped its three-year long winning streak in 1H22. On a YTD basis (ending 28 June 2022), the index posted a decline of 23.1% (vs 2021: +127.7%, 2020: +79% and 2019: 36.2%).

Drewry container equity index is a market capitalisation weighted index of 12 companies including AP Moeller-Maersk A/S, Hapag Lloyd AG, Orient Overseas (International) Ltd, Evergreen Marine Corp Taiwan Ltd, Wan Hai Lines Ltd, Yang Ming Marine Transport Corp, HMM Co Ltd, Regional Container Lines, COSCO Shipping Holdings Co Ltd, SITC International Holdings Co Ltd, Matson Inc and Samudera Shipping Line Ltd.

With liner stocks down approximately 25% in 2022, the question that arises is whether this is the right time to invest in these stocks?

Despite looming risks, annual performance may once again be better than the previous year
According to our latest container market forecast published in June 2022, we believe the supply chain constraints will continue through 1H23. While this should help liner performance in the current year, there are concerns about higher costs of operations amid rising crude oil prices. We do expect some impact on the operating margins, but the overall annual performance may once again be better than the previous year (2021).

Major industry players have revised upwards their full-year 2022 guidance
In line with our expectations, container companies have posted robust results in 1Q22 with average revenue up by 79.4%, EBITDA by 174.4% and EBIT by 152.7%. With only one quarter into the year, the two major industry players – Maersk and Hapag-Lloyd – have already revised their full-year 2022 guidance upwards.

Huge liquidity reserves could cushion the downturn in freight rates
As a result of the high operating cash flows, balance sheets of all operators are flooded with cash which led to significant cash balances. In 2021, liners deployed this cash primarily to boost their operating capabilities by opting for both organic or inorganic (vertical + horizontal) growth instead of paying exceptionally high dividends or retiring debt. Despite this, the largest chunk of the overall income has been set aside for the rainy day. As a result, while the overall gross debt of the industry almost remained stable, most companies now have a net cash position (or negative net debt position), which could cushion the downturn in freight rates in the short-to-medium term. Furthermore, hindsight strongly suggests that in the recent past, many industry participants have opted for profitability instead of gaining market share, which clearly restricts the scope of any price war in the foreseeable future.

Altman Z-score suggest that liners are in the safe zone
The Altman Z-score, based on the latest quarterly data, of the sampled companies clearly indicates that all liner companies are in the safe zone.

DMFR uses a simple traffic light system to rank the risk profiles of companies based on their ‘Altman Z-score’, which is the output of a credit-strength test that gauges a company’s likelihood of bankruptcy. Z-score ranks each company’s risk profile based on five financial ratios: profitability, leverage, liquidity, solvency and activity to predict if a company has a high probability of being insolvent.

A Z-score at or above 2.99 indicates that the company is “safe” (green), based on these financial figures only. A Z-score between 1.8 and 2.99 indicates that one should exercise caution (orange), based on these financial figures only. A Z-score below 1.8 indicates a higher risk of the company going bankrupt – “distress zone” (red), based on these financial figures only.

Both P/B and EV/EBITDA suggest that the industry is presently trading in an undervalued zone
Drewry’s analysis highlights the robust industry fundamentals which present a strong case for investment in liner companies from a long-term perspective. We also looked at the relative valuation to confirm whether investors should consider investing in liner equities at the current industry valuations.

Analysing P/BV and EV/EBITDA of the broader Drewry container equity index suggests that the current industry valuation is below the long-term historical average, which provides an opportunity for equity investors. However, the downside risk could be a faster interest rate hike which will ultimately result in a recession and destroy consumer demand. We suggest a deep dive into company-specific factors to pick individual winners for investment.
Source: Drewry

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