Monday, April 24, 2017


Analysis: COSCO may be unsinkable, but it's sailing in very choppy waters

China’s state-owned COSCO Shipping Holdings is unsinkable – yet its latest annual results, on 31 March, confirmed that 2017 could be, at best, a year of transition.
Continuing to sail through choppy waters, this container shipping powerhouse finds itself in the middle of a corporate restructuring that began at the end of 2015 and has yet to bear fruit.
In its annual results, it reminded us how the merger between the two biggest shipping groups in China was undertaken. On 4 May last year, it received “notification from China COSCO Holdings Corporation Limited (COSCO Group) that State-owned Assets Supervision and Administration Commission of the State Council (SASAC) has transferred its entire equity interest in COSCO Group at nil consideration to China COSCO Shipping Corporation Limited (COSCO Shipping), a state-owned enterprise established in the PRC and wholly-owned and controlled by SASAC”.
Essentially, the government had decided to flip a bunch of assets onto its balance sheet, while stripping, at higher corporate holding level, certain operations that might be more problematic than container shipping activities, particularly if the business cycle turns south.
Our take when the deal emerged can be found here, but it still remains unclear what the ultimate corporate structure will look like.

Unfavourable exogenous shocks played a part in a merger orchestrated by the government, but the writing was on the wall.
In 2013, China Cosco Holdings was forced to sell assets to avoid a possible de-listing spurred by two consecutive years of losses. It managed to find a way to stay afloat, but more structural intervention was already clearly necessary.
Now, in a difficult market where even Maersk has acknowledged the benefits of a leaner corporate tree, its container shipping fleet is the fourth-largest by capacity and adheres to the commonplace philosophy in container shipping that only through economies of scales are operators economically viable.
Then again, I wonder: do global growth prospects actually support this view?
The International Monetary Fund said in January that global growth for 2016 was estimated “at 3.1%… economic activity in both advanced economies and EMDEs is forecast to accelerate in 2017–18, with global growth projected to be 3.4% and 3.6%, respectively”.
It turned even more bullish this week, tweaking up slightly its growth forecasts for this year, but is that a game-changer for global trades?
The trend in recent years leaves little to the imagination – see the table below – while recession and geopolitical risks loom large in major countries whose economies hinge on fiscal and monetary policies that struggle to find a solid footing.
Source: The Economist
These macroeconomic risks will ultimately affect the box trades. Although The New York Times points to unusually expansive data showings by emerging markets since the turn of the year, “the emerging market story is harder to sell, and so grows the risk of investing in bigger ships”, one container shipping executive told me this week; while the chart below also testifies to a mixed picture for global economies.
Source: The Economist
Latest developments at Maersk are unsurprising, but it is the market leader and rivals are struggling to keep their debt levels down while investing to preserve competitiveness.
Size matters?
Size might – or might not – be the answer, but for the time being it’s interesting to note that Cosco Shipping Holdings highlighted a massive rise to the tune of Rmb14.6bn ($2.1bn) in reported revenues, which climbed to Rmb69.8bn ($10bn) in 2016 as a result of its merger deal.
Source: Cosco
One problem here is that its corporate structure has changed significantly in the past 18 months, so comparable figures cannot be a gauge of performance – although that also means its mounting losses of Rmb9.9bn ($1.4bn) should be taken with a pinch of salt.
After all, the merger was so complex that Seatrade defined it as “one of the most complicated deals in the history of China’s capital market”.
Lots to do
The picture that emerges from its financials points to certain critical areas where drastic intervention is needed. For example, the cost of goods and services (COGS) last year was higher than revenues – these costs usually exclude most or all operating expenses.
As it keeps track of the integration and divestment of certain other assets, financial discipline is of paramount importance – COGS will continue to be a key performance line to watch, because the group was loss-making even before selling, general and administrative costs (Rmb4bn) and net finance costs (Rmb1.8bn) were taken in into account – combined, these two items made up over 50% of annual losses.
Unsurprisingly, its balance sheet shows that property, plant and equipment fell, while long-term and short-term borrowing stood at Rmb57.3bn ($7.3bn), down almost Rmb30bn against one year earlier, which is a good sign.
It said: “Under the situation of the appreciation of the US dollar, in order to reduce exchange rate risk, since the second half of 2015, the company has been adopting measures for adjusting the debt structure, reducing the balance of US dollar loans and adjusting the structure of bank deposit by increasing the balance of US dollar deposits.”
Excluding proceeds from disposals, core free cash flow was negative to the tune of about Rmb4bn – about half a billion dollars annually – and that means it burned over $1m a day last year. However, its gross cash balances were virtually unchanged at Rmb33.8bn ($4.6bn), which gives it plenty of time to fix its accounts.