shipping merger Size a Double-Edged Sword

Investors worry that the merger of Hapag-Lloyd and United Arab Shipping Company will be hard to achieve. But the move, though expensive, brings benefits for the German company.
Hapag Lloyd containers are stacked at the shipping terminal Altenwerder in Hamburg's harbor.

Analysts recently welcomed the planned merger of German shipping firm Hapag-Lloyd and United Arab Shipping Company as a move that will help both companies weather a downturn in the shipping business.

On July 5, Warburg analyst Christian Cohr noted financial progress at Hamburg's Hapag-Lloyd, a container shipping company that would cement its position as the fifth-largest global ocean carrier with the acquisition. He also wrote that there were signs of a recovery in shipping, which has been stricken by excess capacity, and recommended investors buy the share.

But three weeks later that horizon is clouded. Mr. Cohrs set a share price target of €31.50, but Hapag-Lloyd's shares are barely half that, selling for €16.60 at the end of the week.

But it isn't just a profit warning that has since routed investors – chief executive Rolf Habben Jansen told investors this year's operating profit would not be "significantly higher" than last year's €366 million ($402 million), on July 18.

Now the merger with United Arab Shipping Company (UASC), expected by the end of the year, also has them feeling unsettled.

Freight rates are 19 percent lower than last year, meaning they will likely hit a historic low.

The merger agreement, which was signed on July 18, brings benefits for Hapag-Lloyd. It will secure the company a fixed spot among the top five in the industry, with 237 ships and a sales target of €10.9 billion. The German-Chilean company will also benefit from a stronger position on markets in the Middle East, given UASC answers to investors from the Gulf, including Qatari and Saudi Arabian sovereign wealth funds. Cost synergies are also expected in the long term, providing an estimated $400 million a year starting in 2019.

But skepticism remains. Hapag-Lloyd will acquire 14 mega ships as part of the merger, which it will pay for by increasing its debt by about €4 billion, as Moody's calculated. Moody's expert Maria Maslovsky expects net debt to increase from 4.3 to 6.7 times operating profit, prompting the rating agency to drop its outlook for the company's credit rating, from "positive" to "stable." However, the value itself is five points below a safe investment. With a rating of B2, Hapag-Lloyd is considered "highly speculative," while its unsecured bonds, rated Caa1, are considered "at high risk for default."

Shareholders probably won't be pleased to hear that the merger will lead to a capital increase. UASC will receive 28 percent of shares in the entire company, which dilutes dividends – if there are any at all. Mr. Habben Jansen said on July 18 that this is unlikely this year.

Nor is the outlook for the industry as a whole as promising as Warburg had hoped. According to the Hapag chief executive, freight rates are 19 percent lower than last year, meaning they will likely hit a historic low. In addition, fuel prices are rising again, after declines in the last few months.

It is traditionally difficult for shipping companies to pass on these additional costs to customers. Analysts at NordLB also warn of a further slowdown in world trade, now that the United Kingdom has voted to leave the European Union.

It's all come as a surprise, and hit the market hard: no analyst who valued Hapag-Lloyd in the last six months recommended selling the stock. On the contrary, half of them even encouraged investors to buy back the securities. On average, the experts arrived at a price target of almost €23.77 per share – which would be tantamount to a markup of 18.8 percent over the issue price on November 6, 2015. Instead, the shares are currently trading at 16.8 percent lower than the issue price.

When Germany's largest container shipping company is compared with listed competitors, Hapag-Lloyd is already fairly valued. Based on profit expectations for 2016, which analysts estimate at 95 cents per share for Hapag-Lloyd, the company is currently at a price-earnings ratio of 17.47. Danish shipping company Maersk, world market leader on the seas, is estimated at approximately the same value, at 17.8. Japan's NYK Line reached price to earnings ratio of 17.4 at the end of the year. So how Hapag-Lloyd can gain the potential to distance itself from competitors in terms of its price to earnings ratio remains unknown.


Christoph Schlautmann covers the logistics and waste management sectors for Handelsblatt. To contact the author: [email protected]