Ports, Terminals, Shipping Lines: Who Do Investors Favor?
In hindsight, it can easily be illustrated that even though macro-economic hindrances originate from different sources, they all tend to challenge (in one form or the other) the established rules. By now, we all must have read a lot about the pandemic and its related effects and should be comfortable classifying FY20 as one of the strangest years in human history. Even though consumer confidence took a beating, economic stimulus and altered buying patterns kept the ball rolling. The shipping industry, which forms the kernel of international trade, too witnessed a year of unforeseen volatility. In this update, we look at two closely allied sectors – container shipping, and container ports & terminals – to see their performances through the eyes of an equity investor.
Drewry’s Liner index outperformed Ports & Terminals
Comparing Drewry’s Liner index with the Port index demonstrates that the former has unequivocally beaten the latter in FY20 (Liner: +119.6% vs Port index: -22.4%). The gap widened further as we moved into FY21 with the Liner index inching ahead, driven by rising freight rates, robust profitability, and surging demand caused by the pandemic-driven shift in consumption habits towards goods.
Digging into details of the Liners’ outperformance, let us look at key drivers behind this gap:
1. Superior performance of container shipping
The container shipping sector is going through a purple patch like never before generating an industry-wide EBIT of about USD 27bn, with an operating margin of 13.0% for FY20. The fundamentals remain strong with liners set to enjoy a prolonged cycle of profitability extending into at least the next couple of years. Even if the chips are down, it looks highly unlikely that shipping lines will go back to the deeply loss-making cycle again. This was clearly evident in the second quarter of 2020 when carriers found a way to be profitable, despite plunging demand, by deploying robust capacity management techniques.
While capacity management strategies such as suspending services, blanking scheduled sailings, and re-routing vessels were effective for the container shipping industry, they negatively impacted other related parties. From the shippers’ perspective, service cuts and reduced supply capacity meant space limitations to transport goods and delays in delivery dates, affecting their supply commitments.
The port and terminal sector, on the other hand, was faced with multiple problems including lockdown restrictions, limited availability of labor, and volatile vessel arrivals, resulting in port congestion across major trade routes.
Growth in global container port throughput decelerated to -1% in 2020, down from 2% in 2019 and 5% in 2018. In 2020, some 793 mteu was handled by container ports worldwide, reflecting a reduction of 9 mteu over 2019.
This reduced throughput impacted the revenues of port operators. As we moved into FY21, the variance between revenue growth between Liners and Ports & terminal operators continued to increase.
Record freight rates and the liner shipping industry’s higher degree of operating leverage meant that increased sales translated into big profits. It should be noted that under a high fixed cost structure, incremental sales beyond the break-even point are converted into incremental profits. Despite the significant increase in profitability, the average Liner industry EBIT margin (13% in FY20) lagged behind the Port operators (24% in FY20), with the port sector generally benefitting from limited competition, stable cost structure, and higher ability to service a focused market.
2. Constant tussle between shipping lines and container shipping ports
Since container shipping firms operate in an increasingly competitive and market-driven environment, they not only aim to lower their shipping costs, but also enhance their services to increase their competitiveness.
For ports, the number of ship calls is an important factor because it influences the volume of cargo that can be moved through a port. A port with a higher degree of connectivity is attractive to both importers and exporters and can help boost the port’s market share. However, with the recent consolidation in the liner shipping industry, ports are losing their bargaining power which is reflected in their declining EBITDA margins.
3. Liner’s debt reduction attracted more attention despite better gearing of ports and terminal operators
The sharp economic downturn in 2Q20 led the central bankers to ease the liquidity situation in order to mitigate the falling consumer confidence. Port and terminal operators, which typically operate at low net gearing (net debt/equity), remai