A just-released McKinsey & Company report has urged further consolidation in the container shipping industry as oversupply continues to destroy value in the industry.
This warning comes despite unprecedented levels of merger and acquisition (M&A) activity over recent years.
The report, ‘Container shipping: More mergers, better mergers’, highlights how the container shipping sector has struggled to give value to shareholders. The report authors suggest low rates of return has destroyed around $100bn in shareholder value of the last two decades.
Many of the challenges and issues facing the industry highlighted in this new report were considered in depth in another Forward with Toll article dedicated to McKinsey analysis.
This recent report is less optimistic for the container sector than other industry commentators have articulated of late. For instance, Drewry recently reported that container lines are in line to make around $7bn of profits during 2017, and anticipate a similar performance in 2018, as published in The Loadstar.
This upturn in industry fortunes is based on an upswing in demand conditions, which Drewry anticipates will continue in the short term. According to Trevor Crowe, director, market research, Clarkson Research Services Ltd, demand conditions in the container shipping sector should remain favourable during 2018, after a robust upturn in 2017.
Crowe intimated that demand growth should outstrip additions to capacity levels for the next two years on the trot.
He added, “We currently project that container trade growth will continue to outpace the expansion in containership fleet capacity in 2018. Trade volumes should mushroom by 5.0% in 2018, while capacity growth is projected to grow by 4.1%. During 2019, we expect a 4.7% upturn in trade growth versus a 2.3% upswing in capacity growth.”
This analysis should bode well for the container liners, freight rates and industry profitability. However, the McKinsey report is less optimistic. For instance, projections for levels of overall supply and demand show a continued large gap for several years, according to report co-author, Steve Saxon, partner, McKinsey & Company.
He stressed, “Many industry watchers are predicting the end of the destructive freight rate environment. Unfortunately, we are not so optimistic.”
In the report, Saxon cites examples of the value derived from the generation of operational synergies from merger activity. However, despite the recent bout of merger activity, with the combined fleet capacity of the top five industry players rising to 67 percent of total market, Saxon believes present industry concentration levels are below “the level correlated with higher returns”.
He warns that funding flows to the container shipping sector may be stifled if value destruction remains unchecked.
He added, “Liners need not fear mergers, although they do need to approach them strategically and with an eye toward best practices.”
The report offers companies guidelines for conducting a successful container M&A:
- Select the right target with a clear investment thesis
- Conduct due diligence
- Structure the right deal
– Standard acquisition
– Joint ventures
– Partial integrations
– Charter arrangements
- Fight for your fair value
- Think through your negotiation strategy
Key actions that ensure a successful integration are also considered in detail in the report. For instance, companies should pay attention to cultural differences, and use these insights to facilitate cultural integration and communication. A key conclusion is that liners must avoid the mistakes of past mergers and build on the experience of others.
One company that has been involved in merger activity of late is the Danish-based shipping goliath, Maersk Line.
Søren Skou, CEO of A.P. Moller – Maersk, commenting during the release of the company’s 2017 financial performance, highlighted how the company had been involved in $14bn worth of M&A transactions, including the acquisition of Hamburg Sud to the conglomerate. He also pinpointed integration synergies generated from cooperation between Maersk Line and APM Terminals of about $0.1bn, and the challenges emanating from the cyber attack and operational issues in key hubs.
The acquisition of Hamburg Süd is an integral part of the Maersk growth strategy. Together, the two carriers have around 19% global capacity market share, more than 4 million TEUs in container capacity. The Germany-based carrier will remain an independent brand. Cost synergies derived from the merger are expected to be between $350-400m by 2019.
Skou explained, “After a successful acquisition of Hamburg Süd, the integration is off to a good start, with both carriers growing volumes during the first months. A smooth integration of Hamburg Süd remains a top priority for 2018,” says Skou.
The Maersk group had to cope with numerous “operational challenges” throughout the year, not least a much-publicised and financially damaging cyber attack.
When taken in isolation, the Maersk’s container shipping sector is driving ‘underlying profit’ for the group, according to a company statement. The group stated growing revenue and improving profit in A.P. Moller-Maersk was primarily driven by Maersk Line. The company’s Annual Report 2017 revealed underlying profit for the continuing operations was $356m, as opposed to a loss of $496m during 2016. The company revealed this profit comprised $1bn related to the transport and logistics business.
Skou recognises the need for ongoing development of the group. He commented, “We have taken the first steps towards the integration of our container shipping, ports and logistics businesses and our digital transformation is taking shape.”
One leading industry analyst has highlighted the importance of freight rates to the profitability of Maersk.
Frode Morkedal, managing director, Equity Research Managing Director, Equity Research, Clarksons Platou Securities AS, commented, “Given the huge scale of the business, which transports annually about 26 million TEU (including Hamburg Süd), just a 10% uplift in rates adds approximately $2.6bn to annual net profit.”
Morkedal suggests economic data indicates container freight rates may inflate later in 2018. He added, “In my view, return of idle vessels last year significantly held back rates. With the idle pool almost absorbed, we believe headwinds from high fleet growth should subside, particularly from the third quarter 2018 onwards.”