TRANSPORTCEO - 02/04/2019
IMO 2020 = M&A?
Financially vulnerable carriers could be pushed into M&A by the extra costs associated with the new low-sulphur fuel law. If that happens, how might competition on key trades be affected?
Most of the major carriers have now reported full-year 2018 financial results and thanks to a 4Q18 rising trend in demand and freight rates, boosted by the sugar-rush of the threatened US tariffs, the industry was able to return a small profit in the region of $1.5 billion, as reported in Drewry’s newly published Container Forecaster report.
Welcome as that second-half revival was, attention is now focused on the prospects for this year and beyond that what impact the new IMO low-sulphur fuel regulation will have on profitability in 2020.
The industry still hasn’t fully recovered from the global financial crash and the devastating losses incurred thereafter. The Table 1 of carriers’ most recent financial stability Altman Z-score shows that many are still reside in the so-called “distress zone”.
As the deadline for the IMO 2020 mandate draws nearer carriers are inevitably getting jittery about its overall impact. Are they in a position to deal with myriad of extra associated costs such as unrecoverable BAFs, capex costs to install scrubbers and extra funding requirement for bunker credit, among others?
Without wanting to be too alarmist, there is the potential for IMO 2020 to inspire another major carrier bankruptcy and/or trigger more defensive M&A. It could turn out that the IMO will inadvertently push industry consolidation along, closer to where it needs to be in order to achieve sustainable profitability.
The last round of M&A that started with the merger of Chinese carriers Cosco and CSCL in 2016 and concluded with the integration of the Japanese carriers NYK, MOL and K Line into the Ocean Network Express (ONE) in 1Q18, made some headway in the consolidation process to the extent that the leading seven carriers now control approximately three-quarters of the world’s containership fleet.
However, while previous M&A has handed near-full control of the global market to a handful of lines, there is still varying degrees of competition at a trade-route level. Significantly, that is the case in some of main large-volume and revenue generating East-West routes.
Using the Herfindahl-Hirschman Index (HHI) method (see footnotes in Figure 1 for more details) only one trade in our sample, the relatively small Europe-East Coast South America southbound trade resides in the “highly concentrated” bandwidth. Most of the key East-West trades fall into the “competitive” description.
Figure 1: Herfindahl-Hirschman Index (HHI) for selected container trades, based on effective headhaul capacity, January 2019
Notes: Based on effective capacity, treating subsidiaries as part of the parent i.e. APL is included within CMA CGM; No accounting for slot charter agreements; agreements;
The Herfindahl-Hirschman Index (HHI) is a commonly accepted measure of market concentration, calculated by squaring the market share (in this case the effective headhaul capacity as a proxy) of each company competing in a market, and then summing the resulting numbers, ranging from close to zero to 10,000 (indicative of a monopoly).
The higher the number the lower the competition, or more concentrated a market is considered to be.
Key: <1,500 = competitive marketplace 1,500-2,500 = moderately concentrated marketplace >2,500 = highly concentrated marketplace
The problem for carriers is that in competitive markets they are subject to the vagaries of supply and demand, which is often outside their control. Conversely, in a concentrated market with few rivals carriers do not seem to live or die by those fundamental economic principles so much.
Figures 2 and 3 show the different utilisation and spot rate monthly trends during 2018 for one competitive trade (Asia-North Europe) and one highly concentrated trade (Europe-ECSA). The first chart implies a fairly strong correlation between utilisation and rates in Asia-North Europe where volatile swings in prices generally followed the erratic movement in load factors. Carriers in this prominent lane are at the mercy of the market. Yet, for carriers in the Europe-ECSA trade where utilisation is far lower, spending most of the year hovering between 50% and 60%, they were still able to secure steady price increases throughout the year. It seems that there is a clear premium to be had for operating in such a shallow pool.
Figure 2: Westbound Asia to North Europe utilisation v rates (monthly averages)
Figure 3: Southbound Europe to East Coast South America utilisation v rates (monthly averages)
So, bearing in mind the potential for more IMO-induced consolidation, what would it take to budge some of those key East-West trades out of the competitive zone and into new territory that might allow them to become price givers rather than takers?
To play this game we need to consider some plausible transactions. The possibility of any takeovers among the top 7 lines is remote in our opinion, primarily due to the likelihood of such deals being shot down by competition regulators. However, in our analysis we found that without at least one such deal the HHI needle barely moved so we have included a combined CMA CGM and Hapag-Lloyd entity as there was interest from the French carrier last year. The other fantasy transactions we have used are Cosco buying PIL and other deals based on common nationality; bringing together the Taiwanese lines Evergreen, Yang Ming and Wan Hai, while also pairing HMM and SM Line from South Korea.
The next step is to use our base trade capacity data from January 2019 and see what happens when we combine all of those carriers. For the purpose of this analysis we have limited it to the Asia-North Europe and Asia-West Coast North America trades. It should be noted that capacity shares will be different by the time IMO 2020 is implemented as carriers will have taken delivery of new ships and moved others around so some caution should be applied.
The result of this academic pursuit is that even these deals (which we think stretch the realms of plausibility) would only be sufficient to move these trades into the moderately concentrated zone of the HHI. Carriers would gain some modicum of pricing power, but certainly not enough to be able call the shots.
Table 1: HHI by trade after "plausible" M&A
Even if IMO 2020 does spur another round of industry consolidation, the chances are that there will still be enough carriers left to prevent the big trades from being highly concentrated. It will require a couple of highly unlikely mega M&As to really move the dial.
Los efectos secundarios de la fecha límite de IMO 2020.Los efectos secundarios de la fecha límite de IMO 2020, para el azufre.
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