MAERSK VS HAPAG-LLOYD, AS THE NUMBERS SHOW

Analysis: Maersk vs Hapag-Lloyd with D-Day just round the corner

By Alessandro Pasetti

27/11/2017

Reaction in the financial markets said it all when AP Møller-Maersk Group (APMM) and Hapag-Lloyd reported their quarterly figures on 7 and 14 November respectively.
APMM stock fell 7% in just one trading session, while Hapag shares soared over 10% at one point soon after its trading update was published. But that rally was short-lived and the hefty paper gains were swiftly pared in less than 24 hours.

Hapag share price in the wake of Q3 results (Source Yahoo Finance)

Volatility in their share prices is not just a nuisance for the trade. It comes as the shares of freight forwarders could have topped this year, which signals more downside risk throughout the supply chain.
The valuation of the main listed players with ocean exposure – clear market leader Kuehne + Nagel, DSV, Panalpina as well as their US rivals – clearly demonstrates a shipping market that is as unpredictable as ever.

Share price performance of the main listed freight forwarders with ocean operations: DSV, Kuehne + Nagel, Panalpina, Expeditors and CHRW (Source Yahoo Finance)

The container shipping trade, I gather, is perceived as being increasingly speculative by investors, and rightly so, because mounting uncertainty about future capacity and prospects of possibly rising bunker prices – which I consider to be “bad inflation” affecting operating costs rather than benefitting top lines – does not bode well for profitability, and inevitably makes me wonder whether another wave of consolidation is due sooner rather than later.
There are many moving parts here, but the problem today is that, while the first wave of M&A over the course of last year forced many players to lever up bidding for scale and synergies, the second wave of the consolidation tsunami could be more violent, with potentially devastating effects on supply chains globally.
In this context, if you think the demise of Hanjin was the tip of the iceberg – well, think again.
Am I too bearish?
I generally lean to being a tad too bearish, but the spread between short-term and long-term interest rates in the US and other developed economies points to little “good inflation” kicking around (the one that boosts revenues more than costs), despite years of quantitative easing that is slowly but surely coming to an end, and that means operating expenses for many capital-heavy businesses, such as shipping lines, will become heavier over time.

10/2 year interest rates spread; shaded areas indicate recession in the US, which historically brings pain globally (Source FRED)

Undoubtedly, this is a business long cycle characterised by unusually low interest rates, and e-commerce trends continue to boost consumption, so it may take time for a worst-case scenario to materialise, but further evidence of the eroding container freight rate environment has not passed unnoticed and the outlook remains mixed.
Trust me, if container shipping trends and the valuation of the majors turns out to be a leading indicator, you’d be better taking a year off, or just retire early, in 2018.
Investment
Cyber woes were already priced in APMM’s valuation before quarterly results hit the wires, so these were only side issues in its interim update.
In a way, APMM is more problematic than Hapag, due to a conglomerate structure that has been only partly addressed since management split it between good (transport and logistics) and bad assets (energy).
Despite the effort, which was remarkable, the stock of the Danish behemoth is now down almost 30% from the 2.5-year high it hit earlier this summer, and its year-to-date performance, too, reads -17% – meanwhile, Hapag’s remains comfortably above IPO mainly thanks to the integration of UASC, which secured the combined entity precious cash, but also loaded it with a huge amount of debt.

Maersk share price (Source Yahoo Finance)

Maersk Line is particularly important because it remains the market leader and dictates global strategies for the others. While it now expects a “positive underlying profit”, heavy capital investment needs remain significant, and could be higher if it goes for market share more proactively.
As it said, “gross capital expenditure for 2017 is now expected to be around US$4.5bn ($3.1bn)”, based on figures according to which both profits and capex are adjusted for the discontinued operations of Maersk Oil, Maersk Tankers and Maersk Drilling.
Maersk Line noted it “expects an improvement of around $1bn in underlying profit (previously in excess of $1bn) compared with 2016 (loss of $384m)”, adding that the change relates to expected continuing higher cost, to recover services and reliability after the cyber­ attack, combined with increasing bunker costs.
The guidance for 2017 excludes the acquisition of Hamburg Süd, and comes as global demand for sea­borne container transportation is projected to increase 4-5%.
The company also acknowledged guidance “is subject to considerable uncertainty, not least due to developments in the global economy and the container freight rates”.
Despite that, it’s investing top dollar in its growing fleet.
Fundamentals
Unsurprisingly, APMM’s free cash flow is under pressure lately and paltry returns on invested capital have been the outcome at group level, and Maersk Line has a lot to do with that performance, given that the ‘new Maersk’s’ success mainly hinges on its container shipping activities.

APMM free cash flow, return on invested capital, break-down by unit for the first nine months of the year (Source APMM Q3 results)

On this basis, trends were not particularly encouraging in the third quarter, as the table below shows.

APMM free cash flow, return on invested capital, break-down by unit in the third quarter (Source APMM Q3 results)

Capacity grew, but the picture remains mixed.

APMM volumes, rates, fuel costs ((Source APMM Q3 results)

Meanwhile, some regulatory risk continues to surround its multi-billion purchase of Hamburg Süd and I am afraid that rising oil prices are more important than freight rates trends here, although some experts have suggested otherwise.

Oil trends (USO) vs Maersk and Hapag stock price (Yahoo finance)

By comparison, Hapag’s ROIC figures are not great either.

Hapag-Lloyd ROIC, cash balances, and other figures (Source Hapag Q3 results)

Its latest update confirmed that its fleet grew, volumes were up, and margins strengthened, but all that glisters is not gold.
Headline free cash flow is much better than previously – although one caveat is that core free cash flow, which should not factor in cash inflows of €357m from deal-making, is significantly lower than headline figures suggest.

Hapag FcF (Source Hapag Q3 results)

And that is relevant, because its ebitda rose almost 19% since the end of 2016, but its net debt pile is 71% higher than at the turn of the year, as the table below shows, implying a demanding 6x projected net leverage, based on my calculations.

Hapag ebitda, net debt, others (Source Hapag Q3 results)

Return on invested capital is still well below acceptable levels when gauged against its weighted average cost of capital, or WACC, which traditionally is in the high single-digit range. This is the first warning flag, and also a key variable worth paying attention to going forward – another, of course, is its amount of debt, as I previously argued.
Also, cash balances look much nicer than before, but that is a gift from UASC, which confirms the Middle Eastern carrier was acquired to prevent a possible cash drought, while filling up the debt can and pushing it down the road – brilliant financial engineering rather than a sound corporate strategy, in my view.

Hapag cash balances (Source Hapag Q3 results)

Ultimately, D-day could be around the corner: my model still flashes a worst-case scenario for a technical recession in the US in the third quarter of 2018, which could spread globally.
So, we’ll soon learn if Hapag was smart and whether Maersk could be even smarter by flipping some of Hamburg Süd’s assets to third parties at a paper gain, if and when the takeover goes through.
Until then, good luck if you are invested in either.