Dire Straits

Some shipping companies are navigating the slump in global trade better than others.
Janet KersnarApril 2, 2009

When steelmakers in China placed big orders for iron ore from abroad in February, global shipping companies held their collective breath. After a five-year stretch of extraordinarily strong growth, shipping firms are being pummelled by the downturn in global manufacturing that began last year. Catching many off guard, business in some markets fell by as much as 25% almost overnight, and the prices charged to customers fell even more: daily charter rates for capesize ships, the largest bulk-carrier class, tumbled to $3,000 in November from $230,000 in May. Meanwhile, the Baltic Dry Index—a key barometer of commodity shipping rates and a leading economic indicator reflecting demand for raw materials worldwide—hit its lowest point in more than 20 years, plunging to663 in December, from a record of 11,793 the previous spring. It has since recovered, but remains about 90% down from its earlier high.

Among the many reasons why the wind has been knocked out of shipping’s sails is the massive slowdown in output by the manufacturing powerhouses in China. “China was not sucking as much raw material in, so the shippers shipping raw materials in, and the container companies transporting containers out, watched as their rates just died,” as Clive Hinds, head of the UK shipping industry group at PricewaterhouseCoopers, notes. “No company can operate well with that sort of volatility.”

And it’s not just rates that have been dying. Great Ocean Container Lines in Hong Kong, South Korea’s Samsung Logix, Senator Lines in Germany and Altas Shipping of Denmark are just a few of the companies that have filed for bankruptcy or gone into liquidation recently. Those still afloat have had to act swiftly to salvage their businesses, launching all manner of measures to address the drop in demand, from selling assets at fire sale prices to wriggling out of contracts with shipyards on vessels ordered months ago, even if that means forfeiting down payments and calling in lawyers.

In the end, the Chinese steelmakers’ cautious February orders didn’t offer much hope that global trade would be booming again anytime soon. Freight rates remain a fraction of what they were a year ago, many fleets are idle and shippers continue to live in fear of customer defaults.

Not that they haven’t dealt with boom-bust cycles before. But this time is different, many say. “We’ve had downturns in the shipping market in the past, but there would be a downturn in one sector while another would be reasonably buoyant,” says Nigel Gardiner, managing director of publishing at Drewry Shipping Consultants. “What’s unusual about this one is that it’s global and across all centres of shipping. Another nine months of this and you’ll see more bankruptcies, more M&A, more asset disposals with companies selling off ships at deflated prices, and so on.”

As shippers brace themselves for the worst-case scenario, some have already written off 2009. As Niels Stolt-Nielsen, CEO of Oslo-based chemical-tanker company Stolt-Nielsen, told analysts after announcing fourth quarter results in January, “Given the current global economic environment, we see little cause for optimism. I hope I’m wrong that 2010 is going to be a tough year.”

Given the speed at which the downturn has hit their sector, shipping CFOs have little time to debate whether he is right or wrong. A hugely fragmented sector, shipping companies fall into two main groups-relatively small firms that have only recently gone public and the long-established, listed players such as Stolt-Nielsen. The CFOs of the latter have the greatest scope-at sea and on land-to influence three key factors that will see them through the downturn: financing, revenue and costs.

Shape up or ship out

At sea, CFOs’ concerns aren’t what they used to be. During the boom years, rapidly escalating seafarer wages vied with staggeringly high fuel prices for the top place on their list of worries. Not so long ago, for example, many CFOs required their captains to save fuel by reducing speed a few knots, or “slow-steaming” as it’s known in the industry.

Hedging is another strategy that has changed dramatically since the first half of 2008, says PwC’s Hinds. “What a lot of companies did was to buy more bunkers forward. At the time everyone was saying demand was going to go up, and rates were going to reach $800 or $900, so it would have seemed like a very sensible thing to do. Unfortunately a few months later the price was $250, and a lot of companies had fixed their price at $700.”

How times change. Shippers now need to look for different ways both to cut costs and soak up capacity. Some are adding extra port calls, while others are taking the more drastic step of laying up ships. But all are focusing on coverage—that is, the number of days of future business that they can lock in with contractual commitments from customers.

Not everyone agrees about how much coverage is good for a company, particularly given the precarious future of many of their customers and the wild swings in shipping rates. Rather, some shipping groups argue that spot, or single-voyage, contracts can provide shippers with more flexibility, and warn that there are hazards of having too much coverage, as dry-bulk operator Atlas Shipping learned to its cost. When it filed for bankruptcy in December, it cited agreements for long-term, pre-crisis freight rates that would have led to losses of $3m a week.

Yet some shipping CFOs, such as Michael Tønnes Jørgensen of Norden in Denmark, believe that the peace of mind that longer-term contracts offer outweighs the risks. “We have a reputation for having long-term contracts with counterparties,” he says of the $4.2 billion company. “That’s a positive thing for us because it gives us basic business that is countercyclical.” Last year, in fact, Norden entered into a number of “contracts of affreightment” with industrial companies, covering more than 30,000 shipping days between 2008 and 2023, and now its dry cargo business-which accounts for nearly all its revenue-is covered 101% in 2009, 39% in 2010 and 19% in 2011. Among the major contracts it closed recently is a 15-year agreement to transport 15m tonnes of coal to Taiwan, starting in 2011.

Norden is nonetheless wary of the risks it takes on with such long-lasting agreements, placing credit risk management at the forefront of its relationship with 125 counterparties, none of which accounts for more than 10% of the company’s revenue. Norden awards each of them an internal rating, which among other things determines the general duration of contracts. For the 61% of its dry cargo counterparties with A ratings, contracts are generally allowed to last up to three years; B ratings—which cover around 20% of its counterparties—allow contracts to last up to one year; and C ratings—15% of the total—are allowed only single-voyage contracts. The small number of counterparties with D ratings languish on its blacklist.

But as it’s likely that even A ratings will be under pressure in the months ahead, “the key here is flexibility,” concedes Jørgensen, who says that when good customers hit bad times, Norden is in regular contact, exploring whether to defer or even cancel orders. “Unfortunately we also have customers who don’t pick up the phone,” he says. “Then we have only one way out and that is to go through the legal system.”

That sinking feeling

On land, shipping CFOs have a lot less flexibility than they’d like. As in previous downturns, Jan Engelhardtsen, Stolt-Nielsen’s CFO, says companies such as his are reducing fleet sizes by returning ships that are on loan or have been leased. They’re also squeezing money out of older vessels by recycling them, even though the prices aren’t as high as they were. What’s different today, however, is that because the downturn is global, they’re not able to redeploy ships to healthier shipping routes. They’re also not able simply to sell off their ships as they once might have. Because of a dramatic mismatch between supply and demand, prices have been sinking fast. According to Lloyd’s List, a London-based industry newspaper, a ten-year-old, 1,700 teu (20-foot-equivalent) ship that could have been sold for around $28m in early 2008 may be worth just $11m today. The 4,750 teu vessel NYK Procyon was sold earlier this year for $10.5m, about a fifth of what it might have fetched in early 2008, the paper reported.

For this the industry has itself to blame. According to Drewry’s Gardiner, “The shipowners misread the signals in terms of ordering new ships, [placing orders] way beyond what was required in terms of normal deletion through age and obsolescence.” (See chart at the end of this article.)

And the problem could get worse before it gets better. Shipyards around the world reported the largest orderbook for new ships on record in 2008, and those vessels are now starting to find their way into the marketplace. For example, in dry bulk the orderbook is now around 70% of the existing fleet, according to Drewry. The influx of new ships is expected to begin in the second half of this year, then ramp up in 2010 and 2011.

But experts also predict that many of the vessels won’t be delivered because of the shippers’ own financial problems or delays at the shipyards. In fact, out of a total bulk-carrier orderbook of 3,400, 298 have already been cancelled since the downturn began last autumn.

A lack of banks willing to finance the new ships is one reason for the cancellations. A March report by Norwegian broker Lorentzen & Stemoco cited Carl Steen, head of shipping at Nordea Bank, asserting at a recent conference that at least half of the dry-bulk orderbook does not have financing.

Meanwhile, amid falling asset values, several shipping companies are in negotiations with banks over waivers on loan-to-asset value covenants. Such firms include dry-bulk owner and operator Excel Maritime, TBS Shipping and DryShips, each citing banking negotiations as the reason for delaying fourth quarter and annual results because they want to avoid recording long-term debt as short-term debt.

“After liquidity, this is probably the greatest challenge for most shipping companies,” says Stolt-Nielsen’s Engelhardtsen. “We’re in a specialised segment of shipping in which there are relatively few sales transactions, which makes it challenging to generate reference prices for our assets. A better approach, in our view, is to focus on future cash flows generated by our ships as a means of assessing market value.” But, he adds, this is “taking some work on our part to help banks understand this.”

For his part, Roland Andersen, CFO of $1.2 billion (€912m) Torm, a Copenhagen-based product tank shipper, says he’s not surprised that the companies which fell into the trap of embarking on big, long-term investment programmes without committed funding from their banks are now regretting it. “It’s been a massive wake-up call, especially for the more loosely run shipping companies,” and “particularly in the northern parts of Europe, where some companies were used to [depending on] uncommitted facilities based on a handshake with their banks.” As for Torm, he says it has no loan-to-value covenants and its orderbook—which included 20 vessels as of the end of 2008—can be financed through existing credit facilities.

What’s more, it rolled out an even stricter capex approval process, one that involves “the guys in finance,” and dispels any doubts about many shipping CFOs’ expertise in navigating the downturn. As part of a groupwide programme expected to deliver up to $60m of savings annually from next year, more of the investment-approval process is now undergoing “greater scrutiny” at head office. Is this in response to pressure from external forces, such as banks or the investor community? “No, it’s coming from me,” says Andersen. “We want more control. I want us to be more prudent and cost-focused. That’s just the way you’ve got to do it.”

As for what to do now, Norden’s Jørgensen recommends battening down the hatches and riding out the storm. “I cannot predict how [asset] prices will fall. We have 62 purchase options [on ships] and we have an upside on our owned tonnage as well. We have more than $800m in cash and essentially no debt.” In other words, he says, “we’re prepared for the downturn, and we’re prepared for an upturn.”

Janet Kersnar is Editor-in-Chief of CFO Europe

Choppy waters

Among all the risks that shipping CFOs have had to worry about in recent months, an unexpectedly severe one is piracy. In February, Peter Chalk, a senior policy analyst at the RAND Corporation, a non-profit research organisation, noted that 889 crew members were abducted last year, the highest figure on record and a 207% increase from 2007. In Somalia, where piracy has been particularly rampant, pirates are projected to have received at least $20m in ransom payments in 2008, with the deal for the release of Saudi-registered Sirius Star allegedly totalling an unprecedented $3m. According to some experts, Somali pirates are currently holding 11 vessels and 210 crew for ransom.

Shipping companies have responded in a number of ways. In January CMA CGM, a French container shipper, slapped a surcharge on shipments passing through Somalia’s Gulf of Aden to offset higher insurance premiums and security costs for travel through the region. AP Møller Maersk, meanwhile, has diverted some of its vessels around the Cape of Good Hope to avoid piracy hot spots along Africa’s east coast. Other shippers are requiring their vessels to sail in convoys or travel at a high speed through pirate danger zones.

Those danger zones are not confined to east Africa. While the Horn of Africa and the Gulf of Aden accounted for nearly 40% of all attacks reported in 2008, other high-risk areas include Nigeria/Gulf of Guinea, Indonesia, India, Bangladesh and Tanzania, which collectively accounted for 59% of all non-Horn of Africa/Gulf of Aden incidents last year. According to insurance broker Aon, which recently launched a new insurance line to cover loss of earnings due to piracy, the average duration of vessel seizure is 60 days.

Orderbook versus existing fleet