Zombie apocalypse

With Korea’s Hanjin Shipping filing for court receivership last week, the assumption that major container lines will always find a way to survive has been rocked.

In 2009 when the container industry posted operating losses of nearly $20 billion and many lines were said to be minutes from bankruptcy, none died. The “zombie” carriers’ survival methods were varied and complex, ranging from off-hiring ships to requesting government support, but ultimately they worked.

Having survived the worst crisis the industry has ever faced the assumption grew in strength that major carriers could not be killed off. While some smaller players have fallen by the wayside this decade none were remotely in the same league as Hanjin Shipping, which with a containership fleet of around 100 ships and total capacity of 620,000 teu (see Table 1) ranks it seventh in the world.

Table 1
Hanjin Shipping containership fleet, as of 31 December 2015

Source: Hanjin Shipping

Hanjin’s move into administration shatters the complacency that major carriers are immune to failure and can stomach prolonged years of low rates and financial losses.

It was this complacency that blinded most to the very real possibility of Hanjin’s demise. It was common knowledge that the company was in financial trouble; from 2010 to the first-half 2016 the company’s operating loss amounted to approximately $580 million with most of the damage emanating from the container division (see Figure 1). Since 2013, Drewry Financial Research Services has warned that Hanjin was dangerously leveraged and living on borrowed time.

Figure 1
Hanjin Shipping operating income/losses (US$m)

Source: Drewry Maritime Research (www.drewry.co.uk)

The container industry is hardly in rude health but Hanjin, along with compatriot Hyundai Merchant Marine (HMM), stood out as being in particularly bad shape. Both carriers have occupied the lower reaches of Drewry’s Z-score freight operators’ financial stress index for some time (see Figure 2) and as of the mid-way point of this year had readings well below 1.8, indicating a higher risk of bankruptcy.

Figure 2
End-year Z-score of Hanjin Shipping versus rest of container sector

Source: Drewry Maritime Research (www.drewry.co.uk); Sea & Air Shipper Insight report

Since then, HMM has successfully negotiated a huge debt restructuring plan, including obtaining reduced charter rates from ship-owners that eventually saw its main creditor, the Korea Development Bank (KDB), become its largest shareholder. The sale of non-core assets also helped HMM report a net income of $185m in the second quarter, ending a sequence of six quarterly losses. It will join 2M carriers Maersk Line and MSC in a new alliance next April, assuming regulatory approval.

The KDB is also Hanjin’s main creditor, but its self-rescue plan has not proceeded as smoothly as over at HMM. Vessel charterers, most publically Seaspan, refused to lower their rates and despite selling a number of assets the plan to sell two tranches of new shares to sister company Korean Air fell short of raising the sum’s expected by creditors.

Table 2
Hanjin Shipping volumes, revenue by trade 2015

Note: *Includes South Asia and Middle East
Source: Hanjin Shipping

The lack of progress led to Hanjin’s directors calling for court receivership on Wednesday 31 August. While the company is not technically bankrupt during administration it is difficult to see how the company will be able to continue trading as customers are now desperately trying to locate and find alternative ways for their goods to be delivered. It’s unlikely any would entrust their cargoes to Hanjin again.

The immediate collateral damage of Hanjin’s situation will be widespread. Ports and terminals that have recently accepted Hanjin ships and containers will not only lose a customer but might not get paid for work carried out; the same applies to container lessors, and charter shipowners, particularly Seaspan and Danaos, which were Hanjin’s biggest suppliers of non-owned ships. Given the parlous state of the time-charter market at present those companies will struggle to fix those ex-Hanjin rented ships at anything like the same rate.

For Danaos, Hanjin’s charter of eight ships (3 x 10,100 teu units + 5 x 3,400 teu) accounts for about $560 million of its $2.8 billion contracted revenue, so the Korean firm’s demise would be a serious dent in its income stream. “We are disappointed that the Korean Development Bank has failed to support an important participant in the global containership business,” said Danaos CEO Dr. John Coustas. “Danaos actively supported Hanjin in its efforts to restructure its operations and we are hopeful that Hanjin will be able to achieve a restructuring of its business and emerge from court receivership as a financially stronger company.”

Table 3
Hanjin’s biggest trades by share of trade-wide nominal capacity

Source: Drewry Maritime Research (www.drewry.co.uk)

Even shippers unaffected by Hanjin’s situation will feel a short-term shock as the reduction of capacity will inflate freight rates. Table 3 shows the trades in which Hanjin had the largest presence. Notwithstanding the general rate increases (GRIs) already in-place freight rates out of Asia surged the day after Hanjin’s announcement. The World Container Index, a joint venture between Drewry and Cleartrade Exchange, reported that spot rates from Shanghai to Los Angeles in the US and Rotterdam in Europe, increased by 42% and 39% respectively on 1 September against the previous week.

Then there are the various service partners with slots onboard Hanjin ships. The carriers facing the biggest disruption are Hanjin’s partners in the CKYHE Alliance – Cosco, K Line, Yang Ming and Evergreen – who operate a number of services in the East-West container trades. However, such is the intertwined nature of the industry whereby carriers swap space freely in order to expand their network offering that many more lines will be affected. Many shippers will be unaware that when they book with carrier Y that their container will actually have been moved on a Hanjin-operated vessel. Table 4 displays all of the deep-sea (ie excluding regional) services of Hanjin along with its various service partners.

Table 4
Hanjin ship deployment and service partners, as of August 2016*

Note: Does not include regional services
Source: Drewry Maritime Research (www.drewry.co.uk)

Now that the unthinkable has happened the immediate attention has to go on how to clean up the mess.  Hanjin’s service partners will have already started efforts to arrange alternative shipments but there will be inevitable delays, especially for containers stuck on ships denied entry to ports. What will happen to containers with Hanjin Bills of Lading is harder to predict, although there are reports that HMM might step in to fulfil those obligations. Shippers moving boxes away from Hanjin B/L this week to other carriers will bear additional costs, while terminals will have issues moving boxes to meet a different vessel and uncertainty over who will pay the handling fees. This will all be very messy and an additional burden.

There are also longer-term implications. The CKYHE Alliance will have to fill in the gaps caused by Hanjin’s exit, which is likely to disrupt their network scheduling for some months. Also, Hanjin was due to leave the CKYHE Alliance next year as part of thereshuffling of carriers into new groups and form a new pact with Hapag-Lloyd, K Line, MOL, NYK and Yang Ming called THE Alliance. Hanjin’s impending exit immediately puts this grouping on the back foot, erasing any pre-planning and meaning that it will be diminished in size in comparison to 2M + HMM and the Ocean Alliance (CMA CGM, Cosco, Evergreen and OOCL).

Perhaps the most far-reaching consequence of Hanjin’s situation, alongside the recent defensive M&A activity, will be that all stakeholders will now finally understand that carriers cannot survive on a diet of ultra-low freight rates if they want to see healthy competition. Soon, shippers will only have 13 carriers that could genuinely be called “global” in scope. Drewry will run on Monday 26 September a free webinar for shippers and exporters called “Code Red” for ocean transport. Click on this link for registration.

Our view

The impending bankruptcy of Hanjin should serve as a warning that carriers do have breaking points and that they will not always be rescued. Unless shippers make the altruistic decision to pay more to save carriers (unlikely) they will need to pay more attention to the warning signs.