Container capacity growth is projected to peak at 9% in 2Q18E, followed by a slowdown to low-single digit growth for 2H18E-FY21E. With stronger than expected demand growth of 10% on East-West trades, container freight rates have remained resilient, with SCFI down 10% and CCFI stable YTD. We continue to expect rates will recover in a tightening market from 2H18E, resulting in surging FCF yields to 12% for Maersk and 18% for Hapag Lloyd by FY19E.
In the Eye of the Storm. We continue to believe the container shipping sector is set to benefit from a rapidly improving market balance, with capacity growth projected to peak at 9% in 2Q18E, after 8% growth in 1Q18, followed by a slowdown to low-single digit capacity growth for 2H18E-FY21E, based on today’s record-low order book. Any new vessel orders are unlikely to be delivered before FY21E, in view of a focus on relatively larger fuel-efficient vessels with LNG powered engines ahead of IMO 2020. Container demand is expected to grow by 4%-5% this year, with some downside risk in view of increased protectionism (although the targeted products for increased tariffs are estimated to account for only c6% of container trade between China and the US). Demand is currently tracking ahead of expectations, with East-West volume growth of 10.0% in 1Q18 (vs. 2.0% in 1Q17).
New vessel ordering. Our capacity projections include all recent large vessel orders from MSC, CMA CGM and Evergreen, with a combined capacity of 680,000 TEU, as well as the planned Hyundai order for 352,000 TEU, with delivery expected in FY21E. We estimate the Hyundai order is worth c$2.5bn, which will likely be funded with support from the Korean state, as Hyundai’s balance sheet looks stretched. Relatively high leverage in the sector, with net debt at around 6.0x FY17 EBITDA, should limit further vessel ordering. Note that CMA CGM announced it will take a 25% stake in CEVA Logistics (along the lines of Maersk’s strategy), which is expected to be valued at over $3.0bn according to recent press reports.
Resilient container freight rates. Container freight rates have remained relatively resilient so far this year, with the SCFI 10% lower y/y and CCFI relatively stable, reflecting higher Asia-Europe contract rates. According to Hapag Lloyd and Maersk, Asia-Europe contract rates more than compensated for higher bunker prices, which are up 12% y/y and 5% q/q. With capacity expected to tighten from 2H18E, we believe the outlook for container freight rates is favourable, and are still assuming a relatively stable rate for FY18E, followed by a 5% higher rate for FY19E. We assume a 2% higher net freight rate for FY20E, after higher bunker costs under IMO 2020 sulfur regulation.
1Q18E expected to be profitable. We are projecting strong 1Q18E earnings momentum on the back of recent M&A, with EBITDA growth of 60% for Hapag Lloyd (due 14 May) and 53% for Maersk Line (due 17 May). After higher D&A following recent M&A, we are projecting EBIT just ahead of break-even at €17m for Hapag Lloyd (0.6% EBIT margin) and $67m for Maersk Line (0.9% EBIT margin).
Valuation / risk factors. Hapag Lloyd and Maersk are trading at 8.2x and 6.8x FY18E EV/EBITDA, implying discounts of 24% and 36% to container shipping peers. We are projecting surging equity FCF yields to 12% for Maersk and 18% for Hapag Lloyd by FY19E, assuming a 5% higher container freight rate. Risk factors include irrational vessel ordering (with state support), overcapacity, escalating protectionism, increasing fuel costs under IMO 2020, acquisition integration risks and general macro economic risks.