On A Better Footing
No sharp improvement in industry outlook.
- Supply continues to be an issue with container fleet expected to expand by almost 7% in FY15, while demand growth is expected to be more sedate at 3-4%.
- Though bunker fuel prices have declined from US$600/MT in 2014 to about US$350/MT now, liners are increasingly passing on the savings to customers in a bid to win market share.
But delivering on cost control.
- Liner opex fell to US$2,242 per FEU in 2Q15, down 6% q-o-q and 14% y-o-y.
- NOL was able to record significant cost savings (around US$223m) in 2Q15 from better network planning, return of expensive charters and more targeted cargo selection strategy.
- Liner core EBITDA margin of 8.3% in 2Q15 is the best in several quarters.
- With the expected return of nine more chartered-in vessels in 2H15, we can expect further cost reductions to materialise.
Minor profitability looks achievable.
- Though freight rates, especially on the Asia-Europe lane, are still bouncing near multi-year lows, NOL’s strategy to sacrifice market share and focus on restoring profitability seems to be slowly yielding fruit.
- With the peak season coming up in 3Q, we see hopes of the liner returning to the black.
Valuation:
- Though core ROE will still be nowhere near desired levels in the near term, NOL’s competiveness is on the rise and a healthier balance sheet puts NOL on a better footing.
- With valuation at an attractive level of 0.6x P/BV, we believe NOL looks ripe for M&A activities as consolidation is surely the way forward for the container shipping industry.
- Maintain BUY with a TP of S$1.08 (0.8x P/BV).
Earnings Drivers:
Container volumes and rates are the key revenue drivers.
- Post-divestment of the logistics business, all of NOL’s revenue will be derived from its container shipping arm under the APL brand.
- The Transpacific (Asia-US) route is the biggest for NOL owing to legacy reasons, contributing around 50% to revenues.
- NOL is also fairly well entrenched on the Intra-Asia routes, but a relatively small player on the Asia-Europe route. It is now part of the G6 liner alliance, which allows it to share slots with five other liners.
- Currently, NOL operates about 90 ships, with an 80/20 owned/ chartered-in ratio. Over the last three years, the liner has added around 34 new ships in the 8,000-14,000 TEU capacity range, while returning expensive charters back to owners.
- To focus only on more profitable routes, volumes have dropped by around 6% in FY14 from FY12 levels.
- Volumes might drop further in the future if more chartered vessels are returned to owners.
- Freight rates have been dropping as well, as evident from the chart alongside, which is a function of market conditions, as explained below.
Container shipping demand-supply equation the main driver for freight rates.
- Container demand growth is a function of global GDP growth and after a couple of strong decades of close to double-digit growth leading up to 2008, it has leveled off at around 3-5% since 2011, as structural drivers have weakened.
- In contrast, containership supply growth has consistently outstripped demand growth, with a glut of high capacity fuel-efficient ships ordered in the recent past.
- With cost efficiencies being passed on to customers, freight rates are stuck in a structural downturn and have affected premier carriers like NOL – with high cost bases – to a greater degree.
Capacity discipline is a major issue in the industry.
- While we have seen efforts like the alliances between the top global container liners and some M&A activity to better consolidate the industry, there have been no major cuts in capacity or idling of ships.
- Carriers are still very much focused on maintaining market share by competing on price, and this ensures that general rate increases do not stick for any period of time and rate volatility is a permanent feature of the liner market.
Cost control has thus become increasingly important.
- With no control over market-determined freight rates, NOL has had to institute big cost-saving initiatives over the last two years, and very recently in 2Q15, achieved efficiency-related savings of around US$223m.
- A large part of this is driven by lower bunker consumption with better network planning and newer ships.
- However, NOL will have to continue cutting down on costs as it still lags most of its peers in terms of operating margins.
Balance Sheet:
Life beyond the logistics business.
- NOL recently divested the APL Logistics business for a good value of US$1.2bn, and reaped c.US$900m one-off gains in the process.
- While this resolves its near-term balance sheet stress to an extent – with net gearing declining from 2.3x to 1.1x – NOL will also lose around US$80m of EBITDA contribution per year, or around 30% of FY14's EBITDA level.
- This makes its earnings somewhat more vulnerable to swings in container shipping market and a potentially lower valuation peg as a pure-play liner.
Unlikely to order new vessels immediately.
- NOL is among the very few top liners not to order the ultra large containerships with carrying capacity of 18,000 TEU or higher.
- This will seemingly put it at a disadvantage on the Asia-Europe route in the future where these ships will have a cost advantage.
- However, despite the recent boost to its balance sheet, NOL seems intent not to join the “arms race” as of now and could look to charter in these ships if necessary from its alliance partners like MOL and OOCL.
Share Price Drivers:
Better earnings performance.
- The reduction in cost base for NOL over the past few quarters is encouraging, and could set the base for an improved earnings performance in the coming quarters.
- 3Q is typically the peak quarter for container shipping volumes and if rates react favourably, NOL’s liner division could return to the black.
M&A activity.
- NOL, with its access to cheap financing, strong base in the world’s 2nd largest container port, and its legacy dominance on the Transpacific trade route, could shape up to be an attractive partner for liners looking to consolidate their operations.
- Trading at just 0.6x P/BV, acquisition premium will be affordable to any potential acquirer.
Key Risks:
Big mergers are rare in the container-shipping industry.
- The industry is dominated by family-owned businesses and sovereign-wealth funds, who do not want to give up control and are typically better equipped to endure years of losses during long down cycles without going bankrupt.
Analyst: Suvro SARKAR
Source: http://www.dbsvickers.com/
