Is Yang Ming The Next Hanjin?

Is Yang Ming The Next Hanjin?
James Caitlin
Feb 8 2017, 09:00
Includes: DAC, NMM, SSW
Summary

Like most container shipping companies, Yang Ming has been struggling to stay afloat.
Mounting losses and a massive debt overhang increasingly pose a major threat to the survival of the world's eighth-largest container shipper.
Could Yang Ming be the next Hanjin? If so, what companies will be impacted by this development?
Note: This article was originally published January 25th on Value Investor's Edge, a Seeking Alpha subscription service.

Overview

The entire container shipping segment has been under pressure lately. The root cause for this downturn in the container shipping segment can be traced to an oversupply of available vessels coupled with anemic global trade growth.

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.

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.

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This situation has grown considerably worse over the past 18 months and has little chance of correcting any time soon.

Background

I began writing about the upcoming market turmoil facing the container shipping industry back on June 3rd of 2015. In my article entitled Another Oversupply Problem In Shipping Developing, I noted that the order book for large vessels was a growing concern.

In my conclusion I wrote that "if you find yourself invested in one of the companies that utilizes containerships it would be wise to check in frequently to see how the order book is progressing which could have a major impact on rates going forward."

This was followed up with several other articles which continued to outline the increasingly bearish outlook for the segment.

In October of 2015, I released Container Shipping Market Macro Outlook which confirmed "we are seeing a growing lack of demand coupled with a capacity overhang which is contributing to declining rates and increasing idle containership capacity."

In January of 2016 we saw the Container Shipping Market Macro Outlook For 2016 which noted that "TEU availability hitting the water as a result of this increased carrying capacity is unprecedented."

Finally, in my latest installment entitled Dramatic Slowing Of Global Trade To Impact An Already Struggling Container Shipping Segment I reported: "With approximately 3.5 million TEUs on order and set to hit the water in the coming years, competition will only become more fierce."

Fallout

I have said many times before that shipping companies do not exist in a vacuum. They are subject to the macro environment in which they operate.

This current adverse environment has had a profound impact on several companies across the globe.

Among them was Hyundai Merchant Marine which narrowly avoided bankruptcy due to major restructuring and agreements to reduce charter rates on numerous contracts. I warned about that situation in a February 8th, 2016 article, published well ahead of the turmoil set to erupt later that year.

Additionally, on June 1st 2016, I wrote an article entitled "Hanjin Shipping Vessel Arrest Foreshadows More Hard Times For Korean Shipping." This article discussed a recent seizure of a single vessel off the coast of South Africa, The Hanjin Paradip, an 82,158 dwt bulker. It was detained in Richards Bay on May 24th due to unpaid charter fees.

Hanjin tried to downplay the development and it was quickly resolved. However, I remained skeptical and in my conclusion I wrote:

"this could be foreshadowing a more dire (and rapidly deteriorating) situation in Hanjin than many had previously anticipated."

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Just a short time later Hanjin did indeed file for bankruptcy. At the time Hanjin was the 7th largest container shipping operator in the world and now holds the title for the largest container shipping failure in history.

Now it appears that Yang Ming's survival, currently the world's 8th largest boxshipper, is rightfully being called into question. Any sort of failure on the part of this company will send shock waves once again through a container shipping segment already in tatters.

Mounting Losses

Since 2009, Yang Ming has accumulated approximately $1.2 billion in losses. 2016 has been particularly painful with a reported loss in Q1 of $112 million. This was followed up by a Q2 loss of $150 million. Finally, Yang Ming recorded a $144 million loss in the third quarter.

Q4 numbers have yet to be released but the trend is clear in an environment that continues to produce losses on a massive scale. Altogether, 2016 should see over a half billion in losses.

Bloomberg noted that even in this terrible environment Yang Ming's operating losses are "immense."

(click to enlarge)

Source: Bloomberg

The macro outlook for container shippers remains bleak in 2017.

Yang Ming tried to take an optimistic outlook:

While the predictions for 2017 appear to show some improvements for carriers, Yang Ming remains prepared to take any measure necessary to maintain its competitiveness, without sacrificing its dedication to its customers.

Those improvements come from a paltry difference between expected vessel supply increases (in terms of TEU) compared to that of demand growth. Axia capital markets, in its weekly shipping update, noted that containership supply growth is expected to come in at 3.7% for 2017, with demand growth projected to be 3.9%. This 0.2% is hardly enough to begin to correct a situation that can only be characterized as dire.

While high rates of scrapping may help the situation, as they often occur when markets are faced with a prolonged loss-making environment, analysts still believe that any sort of meaningful recovery may be two or three years away.

There is also another path to a more speedy recovery as noted by Drewry:

The gradual recovery in freight markets is a much-needed and positive development for the container shipping sector in our view, but it is likely to be partially at the expense of the weaker players, especially companies that are still heavily leveraged and carry heavy debt burdens.

Which naturally begs the question, which company is the most leveraged?

Leverage

Yang Ming holds the dubious title for the most leveraged carrier on the water.

A report from Drewry Financial Research Services stated that Yang Ming "takes the slot left vacant by Hanjin Shipping as it has the most leveraged balance sheet in the industry." Furthermore, Drewry pointed out that the company had a net gearing of 437% at the end of the third quarter of 2016.

That is about 3.5 times greater than the industry average of 124% and is nearly five times that of its closest regional peer, Evergreen.

Drewry concludes:

Yang Ming's high debt is a great cause for concern for us, given the heightened financial risks. Even with recovery in the underlying freight market, the debt burden without a restructuring is a red flag and a clear sell signal for us.

Recapitalization

Yang Ming, however, objected strenuously to the negative forecast, sharing not only its strategy for solvency through a fresh round of capital injections and stock restructuring, but also its access to a government fund of $1.9 billion, its plans for management pay cuts and promising ongoing reliability.

The Yang Ming board announced in November that it will slash executives' pay by 50 per cent and reduce the salaries of senior line managers by 30 per cent.

This was followed by the announcement that Yang Ming sold a corporate office building in Taipei's Neihu District for TWD1.89bn ($59.6m) as part of efforts to mitigate its losses.

Furthermore, it is noteworthy that the Yang Ming customer advisory said the line was not in default of any obligations. "Yang Ming has never approached its creditors with any demands to restructure any part of its debt, and Yang Ming does not have any intention to do so going forward."

Additionally, the $1.9 billion lifeline being offered by the Taiwanese government has bolstered confidence which the carrier hopes will translate into support for a capital injection plan.

When addressing this injection Yang Ming stated:

The first stage of this injection of capital will be from various government and private entities, including banks and financial institutions. Yang Ming will issue new stock to these investors, and with the new capital Yang Ming expects immediate benefits to its balance sheets. With this strong showing of government support, it is also expected to help enhance additional private sector investment in Yang Ming.

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However, as noted earlier, weaker carriers going under could be part of a solution for expediting a recovery. In the past, analysts such as Alphaliner's executive consultant Tan Hua Joo have hit out at state intervention claiming it would only "serve to prolong" the market downturn.

Consolidation

2016 was the year of consolidation in the container shipping industry.

China Cosco Shipping Corporation was created in January of 2016 following the merger of former 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 TEUs.

This trend was punctuated by the triple merger between Nippon Yusen KK, Mitsui O.S.K. Lines Ltd. and Kawasaki Kisen Kaisha Ltd. 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."

On top of consolidation, the growth of "Alliances" has been another key feature designed to mitigate damage from this latest downturn.

Though alliance members still compete on price and are forbidden to market services together members can co-operate 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.

Though Yang Ming has realized the benefits of belonging to an alliance it is resisting efforts to take part in consolidation.

The Maritime Executive reports:

Yang Ming chairman Bronson Hsieh dismisses the possibility that his carrier could join forces with Evergreen. "Would Evergreen merge with Yang Ming? I don't think it's possible because, don't forget, Yang Ming has one third of its share owned by government. Are you going to buy a company owned by the government?" he asked, speaking to JOC in November. On Wednesday, Hsieh told a press conference that the line would remain small and independent, emphasizing that "a merger has never been an option for Yang Ming, and it won't be."

Evergreen is also not likely too keen on merging as it is privately owned and probably wants to avoid government involvement. Additionally, as noted earlier, Evergreen remains in significantly better financial health compared to Yang Ming.

The unwillingness or perhaps inability to merge with other carriers means that Yang Ming's relatively small market share makes it less able to achieve the economies of scale and lower unit costs required to compete in an oversupplied and low freight rate environment.

But, Hsieh disputes that notion and said smaller carriers did not automatically have to be merged and small lines could still be profitable. With 2.8% of global market share Yang Ming isn't necessarily small, but due to the recent round of consolidation is dwarfed by some of the mega mergers which have recently taken place.

Companies Impacted

The recent Hajin bankruptcy sent shock waves around the global supply chain as cargo was stranded out at sea, sent to wrong ports, and held in lieu of payment which often had to be provided physically by the recipient.

This situation makes it likely that those utilizing container shipping services will be weary of engaging with companies facing a similar dilemma.

Some US listed companies indeed do business with Yang Ming.

Seaspan Corporation (NYSE:SSW) has eight vessels chartered out to Yang Ming, including one newbuild, which are all on long-term contracts at rates that cannot be replicated in today's market.

According to Seaspan's latest 20-F, these vessels accounted for 6.3% of 2015's total revenue. At that time 6 vessels composed that figure with charter rates totaling $46,800/day for the 14,000 TEU vessels. Once again, this rate would be nearly impossible to replicate in today's market.

Navios Maritime Partners LP (NYSE:NMM) is another company with ties to Yang Ming. NMM just can't seem to catch a break lately. The majority of its fleet consists of dry bulk vessels which have been navigating the worst downturn in that segments history. Its sole bright spot for a while had been lucrative charters for its small container ship fleet, consisting of eight vessels. But the trouble out of Hyundai Merchant Marine saw five of those charters reduced and now trouble from Yang Ming has called two other charters into question. Those two charters are for 8,204 TEU vessels with rates at $34,266/day. Once again is a rate that will be nearly impossible to replicate in today's market.

Finally, Danaos Corporation (NYSE:DAC) also has some exposure to Yang Ming with six of its 59 vessels chartered out to it - four of which are set to expire in 2019 with the other two contracted out till 2028. Neither charter rates nor the revenue percentage they compose were not readily accessible through its quarterly reports or latest 20-F.

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Conclusion

A prolonged downturn in the container segment, coupled with poor financials, has created a troubling situation at Yang Ming. Losses will continue to mount and there is no speedy road to recovery in sight.

While the Taiwanese government has offered a helping hand and management is attempting to find solutions through cost savings and recapitalization, it remains to be seen if these actions will be enough to keep this particular company afloat.

At this point the mere threat of another Hanjin-like event may deter some parties from utilizing Yang Ming's services, which could further erode this company's standing and financial well-being.

Several companies have links to Yang Ming and could be impacted in a couple ways, the most obvious being if Yang Ming declares bankruptcy nullifying charters that would be impossible to replicate. But the precedent set by HMM to renegotiate charters in an effort to avoid bankruptcy also stands as a possibility.

For those investors with ties to Yang Ming or even companies doing business with Yang Ming, this situation should be watched closely.