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Chinks in the Armor
Our inbox had a couple of items in it this week, which, although of not grave concern, did create a tremor or two. These are clearly both company specific issues and not industry wide but are they instructive about the future?
It was the best of times, it was the worst of times…
On a macro level, times could not be better for the shipbuilding industry. There is high newbuilding activity in the global shipping and offshore segments. And, although economic conditions are generally favorable, there are recession concerns. Nevertheless, Aker Yards ASA, the world’s fifth largest shipbuilder in the world, reported 4Q earnings below consensus estimates and negative EBITDA for the full year. Of course, the company is disadvantaged by a different labor cost structure than its Far Eastern competitors, but it has wisely chosen to focus on niche segments, where it has strong market positions, and specialized vessels where there are high barriers to entry. And it has been very successful building a backlog of NOK 79 billion at year-end 2007. Of course, these positives do not alleviate the particular difficulties associated with this industry which include the before mentioned cost issues, the risks associated with fixed price contracts and the working capital issues associated with long lead-time projects.
The company attributes the poor results largely to operational challenges in Floro and Finland and more generally to a very high load at all yards as well as too many prototypes. In effect, capacity constraints and delays in both own and sub-contracted design caused poor efficiency in production. This was compounded by problems with suppliers. In particular, unusually high global demand for maritime equipment led to delays and quality issues for main components across the industry. In addition, Aker took loss provisions totaling NOK 750 million for the cruise and ferry business as well as the merchant vessel segment.
The company has initiated extensive measures to get back on track. To restore margins, Aker is gradually taking down the load, re-evaluating the existing schedule, avoiding too many prototypes, taking a more opportunistic approach to new ferry contracts and carefully monitoring the supply chain. As a consequence, the company is giving guidance that EBITDA margin for 2008 will be 4% and there will be no dividend for 2007.
Gulf Ship Finance Forum
That changed was evinced by the turn out of over 200 delegates for Marine Money’s 4th annual Gulf Ship Finance Forum. The delegates hailed from locally based business and from across the globe to talk about ship finance prospects in the Middle East. As many global banks struggle to meet their clients’ needs, many Gulf banks remain flush with the cash that continues to flow into the region. Interest has reached a peak, for both Shariah compliant and more traditional bank facilities. This gathering of experts in shipping and finance of the region was thus highly illuminating and instructive.
Dubai, Incorporated
“Rome wasn’t built in a day”, goes the common refrain. But in Dubai it is frequently followed up with something along the lines of “but no one ever told the Sheikh”. Anyone who has had the fortune to visit in the last decade can attest to the scale of the construction that has happened and is continuing to happen in this synthetic oasis. They also note that this Emirate is run more like a business than a state, its visitors and citizens frequently treated as clients and customers.
Norwegian Bond Update
Although there was some activity in February, volumes, according to Nordea’s Monthly High Yield Report, remain low and the expectation is to see less issuance by high yield shipping and offshore companies in 2008, given nervous credit fundamentals. In total, ten corporates have issued bonds thus far this year.
And as low as volumes may be, spreads are getting wider. The iTraxx 5-year Crossover Index of fifty European high yield credit default swaps is trading at record levels with an average spread of 545 bps during February, a 29% widening from January. The average 5 –year BB Euribor industrial credit spreads tightened by 1 bp while the 5- year B and CCC spreads widened by 73bps and 406 bps respectively during the month.
Or So We Thought…..
Until Deutsche Bank Shipfinancing (“DB Shipping”), which is made up of SHL and the ship financing department of Deutsche Bank, reported another record profit with regular income growing 10.8% to €56.5 million. Of greater importance in the long-term was the growth in volume of new lending which rose to €2.2 billion from €1.6 billion in 2006. From the standpoint of risk, there is little. Of the traditionally well-diversified portfolio, 70% of the risk was investment grade meaning no provisions for losses were made in 2007.
Building upon these successes, DB Shipping is expanding beyond its traditional markets in Germany and Scandinavia to further staff up its agency in Piraeus and to set up a major regional center in Singapore.
There has also been a shift beyond traditional ship finance products with new products taking on a greater significance. In conjunction with Lloyd Fonds, DB Shipping placed two funds last year with a total volume of €300 million. In addition, the company advised two international shipping companies in the listing for an initial public offering at the Singapore stock exchange for a value totaling some €340 million.
Not a bad performance given the turmoil in the financial markets.
Chinks in the Armor
Our inbox had a couple of items in it this week, which, although of not grave concern, did create a tremor or two. These are clearly both company specific issues and not industry wide but are they instructive about the future?
It was the best of times, it was the worst of times…
On a macro level, times could not be better for the shipbuilding industry. There is high newbuilding activity in the global shipping and offshore segments. And, although economic conditions are generally favorable, there are recession concerns. Nevertheless, Aker Yards ASA, the world’s fifth largest shipbuilder in the world, reported 4Q earnings below consensus estimates and negative EBITDA for the full year. Of course, the company is disadvantaged by a different labor cost structure than its Far Eastern competitors, but it has wisely chosen to focus on niche segments, where it has strong market positions, and specialized vessels where there are high barriers to entry. And it has been very successful building a backlog of NOK 79 billion at year-end 2007. Of course, these positives do not alleviate the particular difficulties associated with this industry which include the before mentioned cost issues, the risks associated with fixed price contracts and the working capital issues associated with long lead-time projects.
The Week in Review
The relatively quiet ship finance market over the past couple of months is beginning to show signs of life. The equity market this week picked up when K-Sea GP Holdings LP has filed for an IPO. Lehman Brothers and Citi are running the deal, which is set to raise up to $100 million. The company’s cash generating assets consist solely of partnership interests in US-listed K-Sea Transportation Partners, which currently operates a fleet of 73 tank barges, one tanker and 59 tugboats that serve a wide range of customers, including major oil companies, oil traders and refiners. We look forward to exploring this very interesting deal in more depth next week.
Course Deviation
Buried in financial transactions all the time, one often forgets that there are other aspects to the business that are not only interesting but in fact have an important role in the investment decision. Or if you will “all work and no play makes Jack a dull boy.” So, if you will forgive us we would like to deviate for a moment and relay a conversation we were fortunate to have with Dr. Kurt Klemme of MPC who is more involved on the operating side and who provided us with insights into the liner business and its evolving trades.
We were, of course extremely curious about their recently announced transaction for nine 13,100 TEU container vessels which will be chartered by Hanjin for 12 years. The cost of the vessels is in excess of $1 billion with delivery expected in 2011 to 2012.
Size matters and these are mammoths. It is all about cost per slot. Putting on our credit risk hat, which until recently was very hard to come by, we naturally raised the question of the limited trades, China to the United States and Europe, and redeployment. MPC, too, saw the risks in the larger sizes and chose to mitigate this risk by focusing solely on projects with long-term employment with a creditworthy counterparty. Moreover, we expect given the debt market these days that much of the risk will be taken out of the transaction through an accelerated amortization of the debt, during the contract period, to a reasonable residual.
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Spring Awakening
Like the weather, which was reasonably warm and had periods of sun, the German market, too, may be going through a spring awakening. Flowers are starting to come out and a sense of optimism is in the air. Now don’t get us wrong! The credit crisis has not disappeared nor has everyone in Hamburg buried his or her head in the sand. Equity capital here in Hamburg remains available for shipping projects on terms that seem unchanged. Debt, too, is available for the right projects, but the price is a reversion to what were normal terms before the liquidity spigot was turned on and everyone was chasing deals. Deals are being done and creative thought is focusing on how to access institutional capital.
Our first meeting was in a modern converted building, which much to our chagrin we learned was formerly a brewery. The office is so beautiful that we can almost forgive this sacrilege. Here the key discussion point was a focus on equity both old and new. The KG market is alive and well and continues to serve the targeted individual investors. However there is much untapped equity in the institutional arena including savings banks, insurance companies and pension funds. For institutions the preferred investment vehicle would be a public company of the type that Tobias König pioneered when he formed Marenave. To provide perspective, savings banks have a huge pool of money called Depot A, which needs to be invested with currently few investment or lending opportunities available. This particular market totals Euros 350 billion but unfortunately not all can be invested in shipping, as risk diversification is paramount. But even a small percentage put to work in this space would have a huge impact. This company is focusing on and promoting the expansion of the IPO market (i.e. more shipping IPOs listed in Hamburg) so that critical mass could be achieved. Once reached the banks can provide analyst coverage including buy and sell recommendations. At the end a liquid stock market will evolve in Hamburg.
Zim Prepares for HK IPO with Goldman Sachs, Morgan Stanley
Israel Corp said on Monday it is planning to float Zim Integrated Shipping Services either in Hong Kong or Tel Aviv. The major investment holding company in Israel said in a statement that no decisions have been made as to the timing, location and size of an offering, which also be dependent on the prevailing market conditions and regulatory approvals. Earlier, South China Morning Post reported Zim could raise as much as $500 million with the assistance of Goldman Sachs and Morgan Stanley
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