State of Ocean Container Supply Chain: Part II

According to a recent AlixPartners report, due to the continued introduction of mega vessels—capable of carrying more than 18,000 twenty-foot-equivalent container units (TEUs)—industry capacity globally is expected to jump by 4.5% in 2016 and another 5.6% in 2017, while demand is expected to increase just 1% to 3% this year.

Ironically, says the study, the resulting overcapacity, and corresponding negative effect on profits, is in part the result of the industry’s drive in recent years to correct its chronic supply-and-demand imbalance by building these more-efficient, but mammoth ships.

Moreover, states the report, this new capacity in major trade lanes is likely to continue to distort the supply-and-demand balance globally, as the slate of vessel deliveries scheduled for 2016 and 2017 remains robust. In the meantime, vessel-scrapping activities remain muted.

Per the demand side, note AlixPartners analysts, last year started off with promise, as carriers generally reported improved profits through the first half of 2015 on the backs of stronger freight rates and declining fuel costs. However, the good times were short-lived, as traditional peak demand failed to materialize in the third quarter, leading to collapsing freight rates.

In fact, industry revenue in the critical, pre-holiday third quarter has declined in each of the last three years, to $39.6 billion in 2015 verses $45.9 billion in 2014 and $46.5 billion in 2013. The drop-off last year represents a 16% decline.
As a result of these types of factors, the study finds that nearly all of the key financial indicators for the ocean carrier market have declined. It finds that industry profits, as measured by EBITDA, fell 7% in the latest 12-month period, including a whopping 35% decline in the all-important third quarter.

Perhaps of even more-immediate concern, it finds that cash from operations declined by almost twice as fast as EBITDA in the 12-month period (by 12%), indicating that carriers face working-capital challenges, often a precursor to bankruptcy.

Given the already-challenged state of the industry, and the turn for the worse of several key industry barometers, AlixPartners analysts forecast continued poor financial results for at least the remainder of 2016. However, it also provides a possible consolidation template for industry companies not willing to live with what the study calls a “new normal” of anemic results.

Recent multibillion-dollar mergers such as Hapag-Lloyd A.G.’s acquisition of Compania Sud Americana de Vapores S.A. (CSAV), CMA CGM S.A.’s purchase of Neptune Orient Lines Ltd., and the combination of China Shipping Container Lines Ltd. and China Ocean Shipping Co. (COSCO) are signs that, after a decade of muted merger and acquisition inactivity, the container-shipping industry was ripe for a long-deferred consolidation.

As a possible model, Alixpartners points to the consolidation of the U.S. airline industry, also an asset-intensive industry once plagued by rampant overcapacity, cut-throat pricing pressures, and complex alliances, that is until individual companies and financial backers finally took consolidation actions, resulting in the much stronger industry that we see today. 

To be sure, says Finlay, players need to be wary both of the costs of consolidation, particularly if fueled by debt, and of the difficulties of effective post-merger integration. “In fact, given today’s low profitability levels, it’s imperative that merging companies retain combined customer bases and realize substantial cost synergies—from fleets to IT systems—to successfully service debt burden,” he sayd.
However, asserts the study, in an industry now facing “gale-force headwinds,” and one in which where everything from piecemeal cost-cutting to slow-steaming has failed to yield truly transformative results, merely adhering to the status quo is likely the most dangerous strategy of all.

The Alixpartners study concludes with a list of “vital measures” ocean carries can take, no matter what their strategy, to be as prepared as possible for the year ahead. The list includes:
—Shore up balance sheets, reducing debt loads and selling noncore assets.

—Repair income statements, including through more-thorough cost-cutting initiatives.

—Uncover new opportunities, from exploiting lower slot costs to uncovering new markets.

“Carriers that successfully defend their balance sheets and income statements will likely be in prime positions as the industry reshapes itself,” adds Finley.

At the same time, however, ocean carriers must urgently address the poor quality of service afforded to shippers since the consolidation of the world’s top liners into “super alliances,” says the Global Shippers’ Forum (GSF).
The GSF is calling for the establishment of a “Maritime Industries Supply Chain Forum” at an international level to address the full range of challenges facing the sector.

“Shippers have generally supported cooperation through consortia and vessel-sharing agreements as the appropriate means of rationalizing costs, provided that they themselves receive a share of the benefits in terms of enhanced quality and a wider range of services made available to customers,” says Chris Welsh, secretary general of the Global Shippers’ Forum.

Several years since the introduction of mega vessels, Welsh contends that shippers continue to experience poor quality services and disruption to their supply chains through the bunching of vessels, “void sailings” and other delays.

And one year since the publication of the Organization for Economic Co-operation and Development International Transport Forum’s report on “The Impact of Mega Ships,” there has been no serious response by the shipping industry to the issues it identified—namely the wider external costs imposed by mega ships and alliances of others in the supply chain, including shippers, port, terminal operators and governments.

“The onus is on the industry to demonstrate that the bigger ships and alliance business model is the best response to the economic and financial challenges faced by carriers, but also adds value to customers,” says Welsh. “We believe cooperation between the main international stakeholders in a new maritime industries forum would enable the wider maritime supply chain to develop solutions to the problems presented by bigger ships and alliances in a constructive and consensual manner.”

Welsh and other shippers conclude that the perceived wisdom is that bigger ships and alliances are good for competition because of the benefits they are said to confer. If the reality is that they add costs because of the negative externalities they impose on others, then that perception may change.

“If they restrict choice through reduced service competition, then other regulatory or competition policy approaches may be necessary to deal with the competition issues raised by mega vessels and alliances,” adds Welsh.