Triple Merger Of Japan's 3 Container Shippers Highlight Industry Turmoil

Triple Merger Of Japan's 3 Container Shippers Highlight Industry Turmoil https://seekingalpha.com/article/4018784?source=ansh $NPNYY, $MSLOF, $KAIKY, $YANG

James Caitlin
Nov 3 2016, 10:09
Includes: NPNYY, MSLOF, KAIKY, YANG
Summary

Nippon Yusen KK, Mitsui O.S.K. Lines Ltd. and Kawasaki Kisen Kaisha Ltd. announced a new JV that will combine their container shipping operations.
The new company would become the world's sixth largest box carrier controlling 7% of the global container shipping fleet with a combined 1.4 million TEU's.
The three firms said they would invest ¥300bn ($2.85bn) in the venture, which is expected to deliver savings of ‎¥110bn ($1bn) annually.
Note: This article was originally published November 1st on Value Investor's Edge, a Seeking Alpha subscription service.

Overview

Still in the early stages of a massive downturn in the container shipping segment, three Japanese companies have announced their intention to combine liner operations in an effort to improve operational efficiency and capitalize on the scale of their fleet.

This follows the Hanjin Shipping Bankruptcy which at the time was the 7th largest container shipping operator in the world and now holds the title for the largest container shipping failure in history.

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The root cause for this downturn in the container shipping segment, and ultimately Hanjin's demise, can be traced to an oversupply of available vessels coupled with anemic global trade growth.

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Source: NYK Press Release

The combination has sent charter rates to low levels which are often below basic operating costs and far less than what is needed to break even when taking into account financing costs for these vessels.

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Source: NYK Press Release

Owners are understandably concerned as they continue to burn cash while these vessels depreciate in value. Some of this depreciation is tied to the lifespan of the vessels while part of it can also be traced to falling vessels values which often have a direct correlation to current charter rates.

The Agreement

In the NYK press release, the companies acknowledged this move is an effort to combat "an environment that is adverse to container line profitability." Furthermore, they noted that "under these circumstances, three companies have now decided to integrate their respective container shipping on an equal footing to ensure future stable, efficient and competitive business operations."

The combined entity will be formed by July 1st and operational by April 2018. It will have 256 vessels, including the chartered in fleet, becoming the second largest carrier in Asia behind China Cosco Shipping Corporation.

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On a brief side note China Cosco Shipping Corporation was created in January of 2016 following the merger of former state-controlled rivals COSCO and China Shipping Group, but more on that later.

The term 'chartered in' refers to vessels leased from a different party which are then leased out to others. This strategy ideally would allow the middle-man to capture the difference between a lower initial lease rate and the following charters thus increasing profitability. During times of high rates this strategy can produce some attractive returns, however, during these depressed periods it can have a negative impact on the bottom line.

According to Vessels Value, the premier maritime valuation institution, the directly owned fleet excluding the chartered in fleet actually numbers 134 vessels with approximately 1.05 million TEU's with a combined value of just over $6 billion.

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Source: Vessels Value

Nippon Yusen (OTCPK:NPNYY) will own 38 percent of the JV while Kawasaki Kisen Kaisha (OTCPK:KAIKY) and Mitsui OSK (OTC:MSLOF) will each hold 31 percent. Currently these companies serve 84, 67, and 92 different countries around the world, respectively.

Therefore, this merger will not only face scrutiny from Japanese authorities, as it combines the three major liner fleets in Japan, but also from governments around the world which will likely include China, the USA, and the European Union.

Mitigating Losses

All the three Japanese companies are forecasting operating losses for this fiscal year. Combined losses are expected to total ¥84bn with Nippon Yusen expecting a loss of ¥25.5bn, Kawasaki Kisen ¥44bn, and Mitsui OSK ¥15bn.

According to the announcement the new JV will benefit "by taking advantage of scale merit and realize integration effect of approximately 110 billion Japanese Yen annually."

The effect on stocks was immediate and following the announcement Nippon Yusen closed up 6.4 percent, Mitsui OSK rose 5.6 percent and Kawasaki Kisen ended up 0.4 percent.

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2016 - The Year of Consolidation

The chart below illustrates some interesting developments in the container shipping segment and includes chartered in vessels.

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Source: NYK Press Release

Vessels Value noted that if we remove the chartered in fleet, 4 out of the top 5 companies now in existence or expected to merge will be the result of consolidation efforts.

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Source: Vessels Value

As noted earlier, China Cosco Shipping emerged in January following the merger of state-controlled rivals COSCO and China Shipping Group.

On June 10th, 2016 the CMA CGM Group assumed control of NOL, a Singapore listed company which at the time was 12 in the world for container shipping. NOL is renowned for its APL brand, present in more than 80 countries and employing around 7,000 people.

In July, Hapag-Lloyd and United Arab Shipping Company signed a merger agreement that created the world's fifth-largest container shipping line. The merged carrier has a fleet of 237 (including chartered in) vessels with a total capacity of around 1.6 million 20-foot-equivalent units, an annual transport volume of 10 million TEU's.

The merger was a result of the rapidly deteriorating market as Q1 saw Hapag-Lloyd report a 42.8 million-euro net loss against a 128.2-million-euro profit in the previous year.

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Michael Behrendt, chairman of Hapag-Lloyd's supervisory board noted that the merger will create annual synergies of "at least" $400 million and save a "significant" amount of capital expenditure for the company.

Alliances Grow Stronger

Though alliance members still compete on price and are forbidden to market services together members can cooperate operationally.

Ideally, alliances allow carriers to pool their vessels so that they can better fill their ships and gain the greater economies of scale. This pooling has become increasingly important as mega-ships have been hitting the water and their operational advantage rests on filling them to capacity.

There are currently three alliances of which 42% of the world's TEU capacity (totaling 23,859,810 TEU's) is now currently a part, according to Vessels Value.

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Source: Vessels Value

As noted earlier the increasing size of these liners has been an influential part in the formation of these alliances. Notice that the 1,350 vessels that are a part of these alliances are just 25% of the 5,355 vessels that compose the global fleet.

It is through these synergies that members hope to gain increasing operational efficiency which should help them weather the storm.

Let's Speculate

Taiwan is home to three major container shipping companies that have also been experiencing difficulty. Evergreeen Marine Corp. (OTC:EVGQF), and Yang Ming are two that have seen red emerge on their earnings reports since Q1. Evergreen is part of the Ocean Alliance but even that hasn't kept it from producing losses. Wan Hai Lines has been running a tighter ship and is still profitable, but might benefit from a merger.

One company that is in the driver's seat when it comes to acquisitions is Maersk Line, which has put that strategy back on the table. Its desire to expand market share at a time when there is very little organic growth could mean that several floundering companies with younger fleets are increasingly attractive to the world's leading container shipping company. Acquisitions are perhaps the best option to continue growing as they have pledged to decrease new build orders in an effort to curtail the overcapacity in the market.

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Conclusion

The depth of this latest downturn has left many companies scrambling for solutions. Many feel the best option may be consolidation.

While the latest round of consolidation may appear on the surface to reduce domestic competition in China and now Japan, two of the largest markets for liners, they still must compete on a global scale. Therefore, rates are likely to remain depressed and shippers are right to seek solutions through other means.

Tadaaki Naito, the president of Nippon Yusen, at a joint news conference in Tokyo stated "If we don't want the number of Japanese shipping companies to be zero, we need to create one strong, splendid company."

The coming years will likely see increasing restructuring and mergers as companies seek to mitigate the damage brought on by this historic downturn, which is even eclipsing the horrific market in the 1950's and 1960's.

Weak demand and excess capacity have created this bear market and it is still in the early stages. While reducing OPEX costs through greater operational efficiency is a good start, it is by no means a cure for this situation.

The only solution will come once supply and demand begin trending toward equilibrium and this can only come about through an increase in demand for goods carried by these vessels or curtailing fleet growth through demolitions or a thinning order book.

Fortunately, it looks like a thinning order book may be set to impact this segment in a couple years as orders for new vessels have fallen drastically. This could pave the way for a rebalancing further down the road. The question now becomes when will that actually occur and who will be left standing? Those taking a proactive approach early on through restructuring or consolidation will likely have better odds.