Container shipping 2016 – Stock prices discounting the worst

• In 2015, stocks of container shipping companies under our coverage performed poorly, with average negative returns of 22% during the year. The downward slide intensified as the year progressed with falling freight and macro headwinds kept investors ducking for cover. The broad-based sell off in container shipping stocks wiped out USD 17bn of cumulative market capitalisation of our coverage universe.

Operators facing prisoner’s dilemma.

• Container shipping operators face prisoner's dilemma: Prisoner’s dilemma is a theory that shows how two prisoners drop the best choice for the worst one because they cannot trust each other. We believe container shipping operators are facing a similar dilemma while trying to outdo their rivals by ordering ultra-large ships. They are procuring larger vessels to help increase their market share through their cost superiority, while being fully aware that the need of the hour is capacity rationalisation. This strategy is not only fuelling the never-ending competition for large ships but also leading to mistrust among operators, entangling them in the prisoner’s dilemma. The year 2015 saw several carriers – Evergreen, CMA CGM, MSC, Maersk, CSCL and UASC – ordering ultra-large ships. Drewry estimates that fleet growth of 8.5% for 2015 will be the biggest since 2010.

Is consolidation a solution?

• Investor sentiment seems pessimistic: While the container shipping industry anticipates a bout of M&A activity, investors do not seem to be too enthused about it. In fact, share prices of all companies under our coverage, with the exception of NOL, continued falling during the month of December when the NOL deal was announced, suggesting the deal had no positive influence on the sector. Further, share prices of the parties involved in the COSCO/CSCL merger slumped immediately after the four-month suspension on trading was lifted. Such lack of enthusiasm from investors indicates that the current M&A decision appears to be based more on opportunity than immediate financial rationale

Recovery pushed back by three years

• Tread with caution: We believe share prices of container shipping operators will remain under pressure in 2016. Excluding OOIL and Hapag Lloyd, no other ship operators under our coverage offer attractive valuations, given our current outlook. We have given an Attractive rating to OOIL which we view as a best-in-class operator, trading at a ~40% discount to the group average based on our 2016e P/B. We have also rated Hapag Lloyd as Attractive as we believe it’s a compelling combination of scale of operations, increasing diversification with less reliance on the volatile intra-Asia market, and seasoned management. Our top two picks for 2016 are: Orient Overseas and Hapag-Lloyd.