Dash-dot-dash. In shipping parlance this message (in Morse code, or raising the blue and yellow “Kilo” flag) means ‘I have something to communicate with you’.
And in early August China signalled its own maritime intentions loud and clear (“Lima Charlie”) when the listed entities of the China Shipping Group and China Cosco were suspended pending a merger.
A tie-up between the two had been rumoured since earlier in the year, though it prompted official denials.Investors thought otherwise, and the shares of both companies saw sudden spikes before their suspension on August 10, with China Cosco rising 28.3% over four trading sessions and China Shipping Container Lines (CSCL) up 28.5%.
China Securities Journal and Shanghai-based website Ship.sh were first to flag the news, with Caixin Weekly subsequently reporting that a ‘leading reform group’ has been set up under CSCL chairman Xu Lirong. This will comprise three members from CSCL and two from Cosco, and aims to publish a preliminary plan within three months.
A merger of the two shipping groups may make sense. While China currently accounts for about 12% of global trade, it has a lesser 9.4% share of the global container shipping industry and 5.8% of the dry bulk business.
Analysts estimate that a merger would propel China Cosco and CSCL from sixth and seventh places in the global rankings to fourth in container shipping with a combined 7.9% market share and first in dry bulk shipping with 4.15% of the market.
This will leave the new entity in a much better position to take business off its European rivals in container shipping, where Denmark’s APM-Maersk leads with a 15.5% share of overall capacity, followed by Switzerland’s MSC on 13.4% and France’s CMA CGM on 9%.
The Europeans were more active in M&A last year, with Maersk’s acquisition of the Anglo-Dutch company P&O Nedlloyd – followed by the takeover of Canada’s CP Ships by Germany’s Hapag-Lloyd. However, this merger activity has done little to reverse the six-year downturn in the industry, which has seen freight rates fall to all-time lows.
On July 24, the Shanghai Container Freight Rate Index (SCFI) traded down to 549, its lowest level since it was established in 2009 and almost a third of the 1,600 high it reached in May 2010.
Shipping analyst Alphaline says that while the global shipping firms have tried hard to raise rates, their efforts have been continually undermined by new capacity additions. A further 25 new ultra-large vessels with 13,800 to 18,000 TEUs (‘twenty-foot equivalent units’, a measure used to describe containerisation capacity) are due to set sail over the next six months.
Total TEU capacity is expected to rise from 19.4 million to 21.7 million by the end of 2017, an annual increase of 6% compared to about 4.5% in anticipated demand growth over the same period. Maersk, which led the trend towards larger vessels, has 20 on order, as has MSC. CSCL has placed orders for five.
One trend playing in the industry’s favour has been the decline in oil prices, enabling the larger companies to post positive operating margins once again. CSCL, for example, has swung from an operating margin of -2.6% in the first quarter of last year to 4% in the first quarter of 2015. Return on capital has also inched back into positive territory.
But analysts say the prospective merger won’t prove as straightforward as the recent tie-up between China’s two train manufacturers CSR and CNR. The two shipping groups not only have a larger number of listed entities, but they also belong to rival shipping alliances (CSCL is part of Ocean 3 with CMA CGM and UASC, while Cosco is part of the CKYHE Asian alliance of Taiwanese and Korean shippers including Evergreen and Yangming Marine). Nor is there any guarantee that a remodelled entity will perform any better than the current duo, which have struggled to improve their margins despite slow steaming, low interest rates on their debts and significant government support. “Even with the merger, the overcapacity problem will still be there,” Um Kyung A, an analyst at Shinyoung Securities in Seoul, told Bloomberg. “It’s not like the number of ships in their fleet will be cut because of the merger. Rather, it’s probably going to delay a recovery even more.”
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