This week, I will not talk about the over-commented US raising interest rates. Rather, there have been quite a few mergers in an industry which is central to our economies. I will tell you a bit more about this sector and why it deserves this title.
Worst in the world?
Imagine an industry where investments in productive assets are very large, so large in fact that buying one extra unit of capacity can bankrupt you if you misjudged the market. Your fixed costs are massive: your asset need constant care and will lose value and operational efficiency if you do not tend to it for just a few weeks. Having your asset idle will cost you nearly as much money as having it in operation, therefore you need jobs constantly to cover the large expenses.
There is a lot of competition on the market: the service you offer is not differentiated – everybody offers the same thing. Your only lifeline is your price (lower than rivals if possible).
For all that, the margin you can generate is probably 10-15% in great years (Apple margins are above 40%) and -10% or even lower in recessions – actually, over the cycle, you will be around break-even.
In the long run, one positive is that there is structural growth. However, your and your rivals’ capacity is often growing as fast if not faster than demand, preventing prices to rise durably. More recently, some larger players have been able to increase capacity quickly by adding larger assets with much lower costs of operations: basically, they can generate a 5pp better margin than you, meaning they can gain market share by cutting prices.
Sadly, you have no other choice than cutting your prices to keep some business. You too are looking at buying these similar large assets so you can compete on price with these larger rivals. However, your smaller size means that you are taking a much larger risk. For you it is quit or double.
Would you invest in this industry?
Yet, despite the adverse fundamentals, maritime shipping is still attracting a lot of investor and banks’ money. I think it is a worse industry than airlines, another industry you may have thought of by reading these lines. At least in airlines, there is some differentiation in service and routes offered.
A quick nomenclature of shipping is helpful at this point:
Shipping is so bad that it is nearly impossible for a stockmarket investor to make good money in these stocks in the long run, whatever category you are looking at. The largest container shipping company globally is Maersk Lines, from Denmark. Maersk are the true market leader, the only company profitable in downturns. Since 1990, world container trade has expanded by close to 10% annually. Maersk has risen from outside the top 10 shipping companies in 1990 to global leadership by 2000, a position it has strengthened since.
Yet, the share price of the parent company has been rising by 8.5% per annum during that period. The best company could not grow its worth as fast as the market where it is becoming dominant! Imagine how it looks down below!
A new hope?
As I eluded earlier, this industry has been traditionally very fragmented. However, we have seen over the last few years many mergers and acquisitions which are progressively reshaping the industry. Take container shipping again. The table below shows the growing control of the top firms on this market.
This has been possible because the leading players have been investing in much larger ships, which costs less per TEU to operate, creating efficiency enabling them to lower prices and gain market share, which was reinvested into bigger and bigger ships – pushing down shipping rates further and squeezing out weaker players out of the market.
Current ships are massive. The Triple E container ships can hold 18,000 containers, enough to carry 180m IPADs or 36,000 cars or 108m pairs of shoes in one go. The ULCC tanker ships can carry up to 2m barrels of oil (enough to fill one million bath tubs).
This scale is helpful because it helps lower the cost of maritime shipping. For instance, the chart below displays the Baltic Dry Index, reflecting the cost of shipping dry bulk. As you can see, over the last 30 years, while there have been fluctuations, the index is nearly twice below the inception price of 1000. This is not taking into account inflation, which was 2.6% annually over the period. This means shipping dry bulk has cost clients 4.7% less each year other the last 31 years!
Last but not least.
To me, an industry were your price falls by nearly 5% a year deserves the title of worst industry in the world. However, the suffering of the ship investors and bankers is our gain, since it allowed a rapid expansion of global trade which in turn helps us buy inexpensive Chinese gadgets for our Secret Santa at work. To finish, two surprising facts about global shipping. First 15% of the global fleet is owned by the Greeks. Second, the next biggest container shipping company globally is MSC of Switzerland, a country with no access to the sea!
Thank you very much for reading me all these weeks. The Little Friday Stories will take a break for the festive season and come back on the 8th of January 2016.