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Restoring Profitability to Container Shipping

Charting a New Course

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Executives in the container-shipping industry would probably like to forget 2011. Many carriers suffered record losses and depleted their cash reserves; some were close to bankruptcy. But such struggles are not new. For years carriers have wrestled with earning back the cost of capital, and in 2009 they were confronted with a crisis caused by a significant drop in demand. Last year, their distress resulted primarily from intense competition and price wars triggered by carriers’ reactions to a self-inflicted supply-and-demand imbalance.

In 2011, the arrival of new vessels ordered years earlier boosted capacity by 1 million twenty-foot-equivalent units (TEUs) for 16 of the largest publicly-listed carriers—an increase of 8.7 percent over 2010 levels. Carriers had placed these orders planning to increase market share. Carriers didn’t simply add nominal capacity, however; this capacity came in the form of new ultralarge vessels. Carriers were continuing their pursuit of lower unit costs.

But when demand didn’t keep up with supply, carriers decreased freight rates to ensure maximum utilization even at the expense of profits. Price wars ensued, the most intense one occurring on the highly competitive trade lane between the Far East and Europe, where rates fell by 60 percent. A recent study estimates that the rate cuts cost the industry US$11.4 billion. For the 16 largest publicly listed carriers, the cuts contributed to combined operating losses of US$5 billion in 2011, with an average operating loss per carrier of US$311 million. (See Exhibit 1.)

exhibit

The losses marked an abrupt turnaround from 2010, when these 16 carriers earned a record US$7.1 billion. Debt-to-equity ratios for ten of the carriers rose above one. Rating agencies responded by lowering their ratings for several of the carriers, which raised the cost of capital. Overall, the major carriers survived the year through slow steaming (throttling engines to save fuel) and organizational and debt restructurings. Several carriers also received massive cash injections from owners and governments, however, their combined cash reserves decreased by almost 20 percent.

The crisis has continued in 2012. Carriers did manage to raise freight rates and idle capacity during the first half of the year. However, carriers have been reinstating capacity in the latter half despite the risk of intensifying competition and driving down rates once again.

Oddly, in 2011 the underlying market environment was better than the industry’s struggles would suggest. Global container traffic grew at a healthy clip of 6.5 percent. Even though this was slower than the growth rate of 9.5 percent during the previous 20-year period, it is a figure that most industries would envy.

How could an industry that operated in a fundamentally healthy market perform so poorly? One needs to look no further than the data. For example, a 30 percent increase in bunker prices over a seven-month period in 2011 (February through August) combined with the steep decline in freight rates on the Far East-to-Europe trade lane was more than carriers’ profit margins could bear. (See Exhibit 2.)

exhibit

To be sure, as an industry with low margins, container shipping is inherently sensitive to cost and rate volatility. But we believe that the events of 2011 and 2012 show that the industry’s economic problems are largely self-inflicted; they are not an inevitable consequence of market forces beyond its control. Failing to sustain a supply-and-demand equilibrium—and then responding with strategic moves that intensified competition when there was a surplus of capacity and growth was slowing—would be a recipe for disaster in any industry.

In this report, we look at how the industry is harming its own economics by following misguided practices and discuss how other factors conspire to make profitability more elusive than in related industries. Then we examine how these challenges are aggravated by the fact that carriers (acting like charter companies) often invest in capacity to earn returns from asset management rather than transport operations. We also discuss the challenging near-term outlook, which includes macroeconomic threats, continued pricing pressure in a fragmented industry, and various unfavorable commercial, operational, and financial conditions. We conclude by looking at the strategy, commercial, and operations initiatives each carrier should undertake to chart a new course—for itself and the industry as a whole—toward improved and sustainable profitability.

Alphaliner Weekly Newsletter 2012 (1).
Alphaliner Weekly Newsletter 2012 (47).
SeaIntel SundaySpotlight, March 11, 2012.
Alphaliner Weekly Newsletter 2012 (15); BCG ValueScience Center.
Drewry Maritime Research, Container Forecaster 4Q11, December 22, 2011.

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