German Container Liner Hapag-Lloyd Outlook Revised To Positive On Debt Reduction; Ratings Affirmed
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Research Update:
German Container Liner Hapag-Lloyd Outlook
Revised To Positive On Debt Reduction; Ratings
Affirmed
November 29, 2019
Rating Action Overview
PRIMARY CREDIT ANALYST
- Hapag-Lloyd's improved EBITDA performance, coupled with debt reduction from free operating Aliaksandra Vashkevich
cash flow (FOCF), will result in stronger credit metrics in 2019 than we previously expected. Frankfurt
+ 49 693 399 9178
- We believe that Hapag-Lloyd's proactive and effective measures to steadily reduce cost per
Aliaksandra.Vashkevich
container transported, combined with potential to further cut debt thanks to low capital @spglobal.com
expenditure (capex) requirements, could translate to credit metrics commensurate with a
SECONDARY CONTACT
higher rating, despite operational headwinds in 2020.
Izabela Listowska
- We are therefore revising our outlook on Hapag-Lloyd to positive from stable and affirming our Frankfurt
'B+' long-term issuer credit rating and 'B-' issue rating on the company's senior unsecured (49) 69-33-999-127
debt. izabela.listowska
@spglobal.com
- The positive outlook reflects our view that Hapag-Lloyd could maintain S&P Global
ADDITIONAL CONTACT
Ratings-adjusted funds from operations (FFO) to debt of more than 20%, which is our threshold
Industrial Ratings Europe
for a 'BB-' rating, if container shipping industry price discipline enables the company to largely
Corporate_Admin_London
pass through higher International Maritime Organization (IMO) 2020 compliance-related fuel @spglobal.com
expenses and it keeps allocating discretionary cash flow to debt reduction.
Rating Action Rationale
Hapag-Lloyd will achieve higher EBITDA this year despite sluggish global demand and trade
volumes. In the first nine months of 2019, Hapag-Lloyd reported EBITDA (pre-International
Financial Reporting Standards [IFRS] 16) of €1.17 billion, which represents a significant
improvement compared with €812 million in the first nine months of 2018. Under our base case,
we expect this positive trend will continue toward year-end 2019, with reported EBITDA
(pre-IFRS16) of €1.5 billion-€1.6 billion for the full year. This is well above the €1.14 billion
reported in 2018 and moderately better than our previous forecast of close to €1.5 billion. Two
main factors support the company's earnings improvement. In the first nine months of 2019,
www.spglobal.com/ratingsdirect November 29, 2019 1Research Update: German Container Liner Hapag-Lloyd Outlook Revised To Positive On Debt Reduction; Ratings Affirmed Hapag-Lloyd achieved about 4% higher freight rates year on year.This could indicate relatively healthy pricing discipline among container liners, which is particularly important in times of sluggish demand. We note that global container trade growth is slowing toward low-single-digit rates, with Hapag-Lloyd increasing its transported volumes by only 2%-3% compared with 2018 (on a like-for-like basis excluding the effect of the liner's conscious decision to downsize its intra-Asia footprint this year). The company has also trimmed operating expenses supporting its profitability. Hapag-Lloyd's ability to steadily reduce unit costs and recover low-sulfur fuel price inflation could stabilize earnings in 2020-2021. Hapag-Lloyd's ability to realize operational efficiencies and steadily reduce unit costs, effectively integrate acquired liners (for example, United Arab Shipping Co. was integrated five months after the transaction closed), unlock fleet and route optimization synergies from acquisitions, and achieve slot cost advantages mitigate the company's earnings' volatility to some extent. We note that Hapag-Lloyd has identified further cost savings of $350 million-$400 million under its "Strategy 2023" that we believe management will likely realize, given its successful track record. Factoring into our forecast Hapag-Lloyd's continued tight rein on cost control, we anticipate relatively stable EBITDA generation over 2020-2021. That said our base case remains susceptible to Hapag-Lloyd's consistent ability to pass fuel-cost inflation to customers, as the industry shifts to the new regulation under IMO 2020 requiring the use of more expensive compliant fuel. IMO 2020 regulation setting a 0.5% fuel-sulfur content cap will likely mean fuel bills increase from January 2020. This means that all container liners must seek to recover cost inflation. The consolidation that has reshaped the container shipping industry, with the top-five players holding about 65% market share in 2018 compared with about 30% 15 years ago, should normally lead to disciplined tariff setting and allow healthy profitability during the transition period and beyond. Nevertheless, the risk exists that some players might aspire to expand their market share at the expense of profitable rates, as the industry copes with fuel-cost inflation. The company has the capacity to deleverage and increase headroom under the improved credit measures for potential operational underperformance and unforeseen setbacks. Under our base-case, Hapag-Lloyd's operating cash flows could outpace low capex requirements, which are thanks to the well-invested and competitive asset base, in 2020. The company's FOCF generation capacity creates scope for a further net debt reduction, which would provide more financial leeway under the improved credit measures for potential operational underperformance and unforeseen setbacks, while maintaining adjusted FFO to debt above 20% over the next two years. This ratio is within our thresholds for the higher 'BB-' rating. At the same time, we would view such increased financial flexibility as critical for an upgrade. Under our base-case forecast, we believe Hapag-Lloyd could achieve adjusted FFO to debt of 20%-23% over 2019-2020, which is at the low end of the financial profile range consistent with the higher rating. Rising fuel prices, the inability to recover IMO 2020-related bunker cost inflation, and cooling economic growth pose risks. We realize that the shipping industry is tied to cyclical supply-and-demand conditions and that the company's 2019 EBITDA performance might not be sustainable. We forecast only moderately lower reported EBITDA (pre-IFRS16) of about €1.4 billion in 2020 and a similar number in 2021, compared with €1.5 billion-€1.6 billion in 2019. Nevertheless, there are factors that separately or combined pose risks to our base case and Hapag-Lloyd's ability to sustain improved credit measures. We note that shipping companies face potential risks including the higher oil prices due to geopolitical tensions; being unable to fully www.spglobal.com/ratingsdirect November 29, 2019 2
Research Update: German Container Liner Hapag-Lloyd Outlook Revised To Positive On Debt Reduction; Ratings Affirmed pass through IMO 2020-related bunker cost inflation; and cooling economic growth from ongoing trade conflicts, which might depress trade volumes more than we forecast. Therefore, we consider a key challenge for Hapag-Lloyd will be turning the strength of its credit measures into lasting value. This will depend on the company's ability to continue lowering unit costs to counterbalance the industry's volatility. Maintaining prudent financial policy and continuing to lower debt, underpinned by balanced investment decisions, is a critical and stabilizing factor of credit quality. The company has stated its intention to maintain its net debt to EBITDA (pre-IFRS16) target below 3.5x, compared with 3.2x achieved in the 12 months ending Sept. 30, 2019, while coping with operational headwinds. This compares with our base-case projection of adjusted debt to EBITDA staying at about 3.5x over the next two years. Given our below 4.0x leverage guideline for an upgrade, our forecast points to limited debt capacity under the potential higher 'BB-' rating. Our forecast is based on the assumption that Hapag-Lloyd will continue deleveraging and post S&P Global Ratings-adjusted debt (including IFRS16 effects and excluding cash) of €6.9 billion in 2019 and €6.4 billion in 2020, compared with €7.2 billion in 2018. Hapag-Lloyd's business profile remains constrained by the shipping industry's high risk and capital intensity. Although we recognize Hapag-Lloyd's enhanced operating efficiency, decreased unit costs, and improved profitability (defined by absolute EBITDA margin/return on capital levels and volatility of these measures) over the past few quarters, we do not consider this track record to be sufficiently long to revise our assessment of the business risk profile upward at this point. This is most importantly because it does not capture any major cyclical downturn. The company's profitability remains susceptible to the industry's cyclical swings, high exposure to fluctuations in running costs, and limited ability to quickly adjust operating base to falling demand and freight rates. That said, as the fifth-largest player in the industry in terms of capacity, Hapag-Lloyd benefits from a large, fairly new, and diverse fleet, and strong customer diversification. The company operates globally through a broad and strategically located route network that helps it ride out regional downturns. We believe that significant consolidation in the container liner industry over recent years could help Hapag-Lloyd to achieve consistently less volatile profits through the industry cycle. We also consider the company's ability to continue reducing the cost per container transported, demonstrated by a strong track record of outperforming its cost-reduction targets. Outlook The positive outlook reflects a one-in-three likelihood that we could upgrade Hapag-Lloyd over the next 12 months. Upside scenario We could raise the rating if we believed that Hapag-Lloyd would maintain adjusted FFO to debt of more than 20%, which is our threshold for a 'BB-' rating. This would be contingent on generally improved pricing discipline in the container shipping industry, allowing Hapag-Lloyd to largely pass through higher IMO 2020 compliance-related fuel expenses, and the company's continued allocation of discretionary cash flow to debt reduction. Given the industry's inherent volatility, an upgrade would also depend on Hapag-Lloyd's ability to structurally reduce debt and achieve an ample cushion under the credit measures for potential fluctuations in EBITDA, combined with www.spglobal.com/ratingsdirect November 29, 2019 3
Research Update: German Container Liner Hapag-Lloyd Outlook Revised To Positive On Debt Reduction; Ratings Affirmed stronger liquidity. Furthermore, we would need to be convinced that management's financial policy does not allow for significant increases in leverage compared with current lowered levels. This means that the company will not embark on any unexpected significant debt-financed fleet expansion and that shareholder remuneration will remain prudent. Downside scenario We would revise the outlook to stable if Hapag-Lloyd's earnings weakened, due to, for example, much lower trade volumes than we anticipate, deteriorated freight rate conditions, and the inability to offset fuel-cost inflation because of ineffective pass through efforts or a failure to realize cost efficiencies. This would mean adjusted FFO to debt deteriorated to less than 20%, with limited prospects of improvement. An outlook revision to stable would also be likely if we noted any unexpected deviations in terms of financial policy that would prevent credit measures remaining consistent with a higher rating. Company Description Hapag-Lloyd is a leading global container liner, with 231 modern ships, 11.9 million twenty-foot equivalent units (TEUs) of cargo transported per year, and about 12,950 employees in 392 offices spanning 129 countries. The company has a fleet with a total capacity of 1.67 million TEUs, as well as a container stock of more than 2.5 million TEUs, including one of the world's largest and most modern reefer container fleets. Its global network provides connections between more than 600 ports on every continent. Hapag-Lloyd is owned by CSAV (27.8%), Klaus Michael Kühne including Kühne Holding AG and Kühne Maritime GmbH (29.2%), Qatar Investment Authority (14.5%), HGV Hamburger Gesellschaft für Vermögens- und Beteiligungsmanagement mbH (13.9%), and Saudi Arabia's Public Investment Fund (10.2%), with a 4.5% free float. Our Base-Case Scenario Our base-case scenario is based on S&P Global Ratings' economic forecasts for GDP growth, combined with company-specific factors that we believe will allow Hapag-Lloyd to continue expanding largely in line with the industry at low-single-digit growth rates. - Worldwide economic growth will remain vital to the shipping industry. Given the global nature of shipping sector demand, we consider our economic forecasts for GDP growth of all major contributors to global trade volumes. We forecast real GDP growth in the eurozone of 1.2% in 2019 and 1.1% in 2020 (versus 1.9% in 2018), real GDP growth in the U.S. of 2.3% in 2019 and 1.7% in 2020 (2.9% in 2018), real GDP growth in China of 6.2% in 2019 and 5.8% in 2020 (6.6% in 2018), and continued slower economic growth in Asia-Pacific of 5.0% in 2019 and 2020 (5.5% in 2018). We also consider real GDP growth in Latin America of 0.9% in 2019 and 1.8% in 2020 (1.6% in 2018). - A shift in overall shipping demand-and-supply conditions toward ocean carriers. With no incentive to place new large orders amid muted contracting activity since late 2015, the containership order book is at a historical low, currently 10% of the total global fleet. Combined with funding constraints and more stringent regulation to cut sulfur emissions to 0.5% as of www.spglobal.com/ratingsdirect November 29, 2019 4
Research Update: German Container Liner Hapag-Lloyd Outlook Revised To Positive On Debt Reduction; Ratings Affirmed January 2020, these factors will likely help restore the demand-and-supply balance in the containership segment by 2020. That said, we see a risk of softer demand stemming from the ongoing U.S.-China trade tensions. - Annual growth rates in Hapag-Lloyd's transported volumes of about 3% in 2020-2021 based on global GDP growth trends, compared with 1.0%-1.5% we expect in 2019. - Hapag-Lloyd's deployed capacity to remain flat at 1.6 million TEUs-1.7 million TEUs in 2020-2021. - No growth in fixed-bunker freight rate per TEU in 2020 and 2021 after a low-single-digit increase this year, constrained by the accelerated delivery of new large ships. We believe deliveries of containerships with more than 15,000 TEUs of capacity will constrain freight rates. In particular, these will affect the main Asia-Europe and transpacific shipping lanes, despite the likely favorable demand-and-supply balance in the industry in general. - Given supply pressure from the deliveries of ultra-large containerships, freight rates will ultimately depend on shipping companies' capacity management and rate-setting decisions, especially with higher bunker fuel prices from January 2020 under IMO 2020. The most recent supply measures, including blank sailings, to curb industry capacity demonstrate such disciplined behavior, in our view. - A flat crude oil price of $60 per barrel (/bbl) in 2020 and a decline to $55/bbl in 2021, versus $60/bbl in 2019. For illustrative purposes, we assume largely stable annual bunker fuel expenses in 2019-2021 at about €1.6 billion. This is to capture our view that future bunker cost increases or decreases (typically closely linked to crude oil price movements) will either be passed through or returned to customers via higher or lower freight rates. We also assume that Hapag-Lloyd can largely pass through higher IMO 2020-compliance-related bunker costs. Furthermore, we expect increasing fuel efficiency to offset the effect of volume growth, leading to lower fuel consumption per TEU. - Cost per container (excluding bunker expense) to reduce by about 1.0% annually on average over 2019-2021, compared with a 4% reduction in 2018. This reflects management's demonstrated cost controls, including the realization of further efficiency gains, which will counterbalance inflationary pressures. - Annual capex averaging up to €500 million in 2019-2021, up from €330 million in 2018, mainly for new containers, ship retrofits and modifications, and dry docks. There is currently no commitment for new containerships, which should help to realize FOCF for deleveraging. Based on our base-case assumptions, we arrive at the following S&P Global Ratings-adjusted credit measures: - FFO to debt of 20%-23% in 2019-2020, compared with 15%-16% in 2018. - Debt to EBITDA of 3.4x-3.5x in 2019-2020, compared with about 4.7x in 2018. Liquidity Hapag-Lloyd's liquidity remains adequate, with source to uses of 1.6x-1.7x including committed capex only. We nevertheless believe that Hapag-Lloyd's liquidity coverage is susceptible to the company performing below our aforementioned base-case operating scenario. Our liquidity assessment also reflects Hapag-Lloyd's proactive and timely treasury management and uninterrupted access to asset-backed financing, which should support the smooth renewal of www.spglobal.com/ratingsdirect November 29, 2019 5
Research Update: German Container Liner Hapag-Lloyd Outlook Revised To Positive On Debt Reduction; Ratings Affirmed existing container revolving credit line (RCF) and asset-backed securities (ABS) that all expire in 2020. We estimate that Hapag-Lloyd's principal liquidity sources during the 12 months from Sept. 30, 2019, comprise: - On-balance-sheet available cash of about €272 million, after deducting $350 million of minimum cash requirements under a bank covenant. - Availability of about €500 million under undrawn credit lines maturing beyond 12 months. - Operating cash flows (after interest paid and dividends received) of €1.0 billion-€1.1 billion, as in our base-case forecast. We estimate that Hapag-Lloyd's principal liquidity uses during the same period comprise: - Short-term maturities and scheduled amortizations of about €900 million. - Capex for vessels/containers (only committed), scrubbers, and maintenance of about €200 million. Covenants Hapag-Lloyd passed its financial covenant tests as of Sept. 30, 2019. Maintenance financial covenants on bank debt stipulate limits such as a minimum ratio of fair-market vessel or container value to debt, and the higher value of 30% of total assets and equity of €2.75 billion. The company had about €6.7 billion in equity as of Sept. 30, 2019. Other covenants stipulate minimum liquid funds of $350 million, with the company holding about €1.1 billion in liquidity reserves (consisting of cash, cash equivalents, and unused credit facilities) on the test date. We expect the company will pass the next covenant test in December 2019 and in 2020. There are no leverage-ratio and interest-coverage covenants. Ratings Score Snapshot Issuer Credit Rating: B+/Positive/-- Business risk: Weak - Country risk: Intermediate - Industry risk: High - Competitive position: Fair Financial risk: Significant - Cash flow/leverage: Significant Anchor: bb- Modifiers - Diversification/portfolio effect: Neutral (no impact) - Capital structure: Neutral (no impact) - Financial policy: Neutral (no impact) www.spglobal.com/ratingsdirect November 29, 2019 6
Research Update: German Container Liner Hapag-Lloyd Outlook Revised To Positive On Debt Reduction; Ratings Affirmed
- Liquidity: Adequate (no impact)
- Management and governance: Satisfactory (no impact)
- Comparable rating analysis: Negative (-1 notch)
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Ratings List
Ratings Affirmed; Outlook Action
To From
Hapag-Lloyd AG
Issuer Credit Rating B+/Positive/-- B+/Stable/--
Senior Unsecured B-
Recovery Rating 6(0%)
Certain terms used in this report, particularly certain adjectives used to express our view on rating relevant factors,
have specific meanings ascribed to them in our criteria, and should therefore be read in conjunction with such
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www.spglobal.com/ratingsdirect November 29, 2019 7Research Update: German Container Liner Hapag-Lloyd Outlook Revised To Positive On Debt Reduction; Ratings Affirmed
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