Is China’s largest line robust enough to keep pace with its competitors?
Analysis by Eric Johnson
It’s safe to say that 2011 wasn’t the smoothest of years for China’s largest ocean carrier, the COSCO Group.
This past summer the company fought accusations that it failed to pay charter payments on some of its leased bulk vessels, while the group sustained a $430 million first half loss. Then longtime group chief executive officer Wei Jiafu stepped down from his post in August, though he’ll remain chairman.
COSCO is the parent company of COSCO Container Lines, which has risen to become the fifth largest liner carrier in the world by fleet capacity as of mid-January, a major feat for a line that wasn’t even in the top 20 less than a decade ago.
But by analysts’ estimates, the container line sustained about $150 million in operating losses in the first half. With revenue levels in east-west container trades deteriorating significantly in the second half, it’s likely the container business suffered sizable losses for the year.
COSCO’s topsy-turvy year was aided in large part by sluggish container growth on the transpacific and too much capacity on the Asia-Europe trade. The maritime analyst SeaIntel has projected that the liner carrier industry saw revenue decline by about $300 per TEU in 2011.
And COSCO struggled to match the better performing lines in the industry in terms of profit per TEU in 2009 and 2010, the last two full years for which financial data was available at the time of this writing. According to American Shipper research of carrier financials last year, COSCO’s profit per TEU was $88 in 2010, barely half that of Hapag-Lloyd ($157 per TEU) and roughly the same as that of APL (also $88) and Evergreen Line ($78), all similarly sized Asia-based lines. Industry leaders with profit per TEU in 2010 were Hyundai Merchant Marine ($206 per TEU), Maersk Line ($193) and OOCL ($188).
In 2009, a year in which every line lost money, COSCO lost $215 for every TEU it carried, fourth worst among the 15 lines analyzed by American Shipper.
Most lines will succumb to a loss in 2011, but the prevailing question about COSCO is just what its long-term strategy will be. Its fleet size suggests a diversified, global carrier, but network gaps and an over-reliance on service partnerships might prevent it from chasing down the major three European lines ahead of it, or even fending off its similarly sized rivals.
COSCO turned down an opportunity to comment for this analysis.
In 2011, COSCO had bigger capacity growth, by percentage, than any other line outside of compatriot line China Shipping. The line is the biggest partner in the CKYH Alliance, which in late December tied up a deal with Evergreen to jointly operate 12 loops on the Asia-Europe trade from April. A day later, COSCO announced it would also swap slots with China Shipping on the Asia-Europe trade.
The CKYH Alliance, with COSCO at the forefront, has a market-leading capacity share on the transpacific. So by any measure, COSCO is a major east-west carrier, with the added benefit of being a sizable player in the intra-Asia and China domestic liner market. Lloyd’s List Intelligence pegged the carrier as the fourth largest in the intra-Asia trade, and second largest in that trade among the world’s top 15 lines (only Evergreen has a bigger share).
But COSCO’s share of the growing, but highly fragmented intra-Asia trade isn’t so large as to put it light years ahead of European majors Maersk Line and CMA CGM, which operate sizable intra-Asia subsidiary carriers that are between 70 and 80 percent the size of COSCO’s intra-Asia operations. In other words, COSCO’s advantage in its home market isn’t as big as it may seem. It trails Evergreen by the same margin that Maersk trails it.
COSCO does have an intra-Asia advantage over APL, whose presence on the trade is a third that of COSCO, and Hapag-Lloyd, which has little dedicated intra-Asia presence outside of capacity on longer routes.
American Shipper liner research affiliate ComPair Data shows that more than 30 percent of COSCO’s international allocated capacity is tied to the intra-Asia trade (and this doesn’t even reflect COSCO’s China domestic capacity).
For comparison, APL has around 27 percent of its capacity dedicated to intra-Asia moves, and that doesn’t even factor in COSCO’s larger reliance on China domestic capacity. Hapag-Lloyd’s capacity allocation to the intra-Asia trade is around 10 percent.
Intra-Asia Enough? But is the robustness of the intra-Asia trade enough to buoy COSCO as it wades through a difficult 2012 on its two key east-west trades? The maritime analyst Alphaliner projects containership capacity will expand by 8.3 percent this year after scrapping and delivery delays are factored in. That’s higher than what was seen in 2011 and will very likely surpass demand growth, which is projected to be 6 to 8 percent.
The latest mega-alliances to emerge on the Asia-Europe trade don’t bode well for COSCO’s ability to react quickly to the market.
“I do not see the CKYH-China Shipping-Evergreen (partnerships) competing efficiently,” said SeaIntel Chief Executive Lars Jensen. “On paper they will get a fantastic network, however, they need to make compromises across many carriers, which inevitably will result in a lower degree of efficiency as well as make it more difficult to quickly change if market conditions change.”
Yet COSCO’s fleet and order book composition, heavily skewed towards big ships, points to further expansion in the Asia-Europe trade, said Simon Heaney, consultant with the London-based analyst Drewry.
“In the first half of 2010, COSCO’s volume growth in that trade was well above average at 22 percent, whereas it flat-lined in the transpacific (in line with numbers indicating Asia-Europe demand was stronger than the transpacific),” Heaney said. “Although COSCO’s (liner division) lost about $150 million in the first half across all of its business, it probably didn’t lose as much as others in the Asia-Europe trade thanks to the size of ships it operates. Crucially, all of the COSCO-operated ships in the trade are over 8,000 TEUs, with about half over the 10,000-TEU break-even threshold.”
ComPair Data confirms COSCO’s big-ship emphasis on the trade. COSCO’s average size ship on the trade as of Jan. 8 was 8,849 TEUs, compared to 7,964 TEUs for the trade as a whole. The carriers with the largest average-size ship on the trade are MSC (10,325 TEUs) and Maersk (9,411 TEUs). COSCO’s average Asia-Europe vessel was larger than CMA CGM (8,823 TEUs).
Notably, COSCO’s average Asia-Europe ships are far larger than APL’s (7,866 TEUs) or Hapag-Lloyd’s (6,997 TEUs), though both those lines have larger ships on order.
What’s more, COSCO significantly increased its deployed capacity in the trade over the course of 2011, particularly in the first half. Asia-Europe deployed capacity rose 34 percent from the start of 2011 to the end of June, to 227,590 TEUs, and rose 36 percent for the year, to 230,093 TEUs.
In this light, the partnerships with Evergreen and China Shipping can be seen as a temporary measure to combat the growing influence of Maersk, Mediterranean Shipping Co., and CMA CGM over the Asia-Europe trade.
Bear in mind as well that the CKYH Alliance’s leading share of the transpacific doesn’t measure up to the dominant share Europe’s big lines enjoy on the Asia-Europe trade, never mind that COSCO’s share within the alliance is diluted by its partners.
But where COSCO is lagging is in trades outside of the transpacific, Asia-Europe, and intra-Asia.
Becoming Global. “Where it does differ from the leading trio of carriers is that it cannot be considered to be a truly ‘global’ carrier,” Heaney said. “Just over half of its business comes from the intra-Asia and Chinese domestic markets and it pretty much has all of its deep-sea eggs in just two baskets, Asia-Europe and transpacific, both of which have been difficult financially of late.”
In comparison, the European lines (including Hapag-Lloyd) have made deep forays into potentially lucrative emerging market trades in Africa and South America. That puts an extreme emphasis on out-and-back loops where rates are suffering.
“Neither COSCO nor China Shipping are yet achieving their potential,” Francis Phillips, chief analyst for ComPair Data, wrote in an early October commentary on China’s two shipping lines. “Even if they were to combine their separate rival services in every deep-sea trade and bought a worldwide string of container terminals, they barely have a single strong cross-trade between them. All their routes radiate outwards from China, leaving them little scope to triangulate boxes back home again.”
Phillips wrote that COSCO’s strategy to build its network through partnerships has placed a ceiling on its development.
“It is noticeable that each time one of the Chinese pair contemplated entering a new trade they tended to separately partner with non-Chinese lines prepared to let them provide one or two ships in a loop trading to China, in exchange for slots on all the others,” he said. “They usually assumed a junior role, minimizing their start-up investments and enabling them to enter more trades more quickly.”
Jensen, of SeaIntel, sees COSCO trying to address those gaps soon.
“Clearly the emerging markets are key,” he said. “I suspect they will be ramping up their presence in these trades in the coming year, with particular focus on South America and Africa.”
Heaney noted, however, that COSCO’s order book doesn’t look suited to driving hard into the emerging regions. In comparison, dominant lines in those trades like Maersk, MSC, and Hamburg Süd have ordered large shallow-draft, high-reefer-capacity vessels.
Growth, With Partners. In the last decade, COSCO has risen in prominence through an ambitious fleet building program that has seen it steadily rise up the table of global carriers in terms of fleet size. It is now firmly ensconced in the top five and is one of only seven lines to operate vessels in excess of 10,700 TEUs (compatriot line China Shipping is another).
It also has room to grow, with 32 ships, representing nearly a quarter of a million TEUs of capacity, on order.
“What has always made both Chinese carriers interesting is their potential to rapidly become global industry players,” Phillips said. “This is based on legitimate aspirations to share in China’s vast and ever-growing trade volumes and the advantage they enjoy compared to other major players of direct government ownership and financial backing.
“Looking back over their shoulders now, privately-controlled Maersk and MSC might well agree that of all the pack behind them, it is the Chinese they are most hoping to have left well behind. It is particularly interesting that none of the open doors were provided by Maersk or MSC themselves. COSCO was welcomed into the powerful Asia-based CKYH alliance, and trade after trade, by Hanjin and ‘K’ Line.”
Phillips noted that 31 out of COSCO’s 44 non intra-Asian loops involve one or more of its CKYH partners.
“However, it is partnered by Evergreen in the trades from Asia to South Africa, east coast South America and west coast South America, and also to the Red Sea. Zim subsidiary Gold Star is a partner to Australia. COSCO’s two minor cross-trade ventures both involve CKYH partner Hanjin. In North Europe-ECSA COSCO provides two out of six very small ships alongside two from Hanjin and one each from CCNI and UASC, and in the North Atlantic COSCO provides one small ship alongside two from Hanjin and one from Evergreen.”
COSCO Container Lines Managing Director Wan Min, who took the helm of the container division in June, said the liner carrier is focused on pumping up its links to emerging markets in Africa and South America, but has only introduced new services with the help of partners, while the largest carriers serving those trades provide mostly standalone or single partner loops.
In addition, the dominant carriers in the Africa and South America trades are introducing larger-capacity vessels specifically designed for the demand and port infrastructure in those two regions, with excess capacity already a problem.
Group Issues. That comfort of size and scale belie some vulnerability on the group level for COSCO. Weakening rates in virtually all shipping sectors has provided the COSCO Group with no true safe haven among its portfolio of businesses (save the healthy profit margins from its terminal operating unit, which is predominantly reliant on terminals in China).
Hong Kong-based Macquarie Capital analyst Janet Lewis said in a note to clients in September that she expects the group to post losses the next two years, with the only potential silver lining being a small profit from container activities in 2012.
“We believe it will be at least 2013 before the company can generate a profit again,” Lewis wrote. “Capital needs are rising just as its profits are under pressure.”
While neither of the ratings agencies have downgraded COSCO in recent times, other carriers, including the diversified Japanese lines, have seen their ratings hit. There is a general sense of unease about the state of the shipping industry that will affect all constituent lines.
In an email to American Shipper, Charles de Trenck, founder of Hong Kong-based Transport Trackers, said the COSCO Group has a number of issues to hash out, including operational style differences between its divisions, strategy and deployment in its container division, and its accounting practices and consolidation of results.
At a group level, some analysts have raised concerns about how accurately COSCO has reported its financials. Those concerns threw more light on COSCO’s bulk vessel charter troubles this year.
Bulk Payments. The carrier had a handful of chartered bulk ships detained at various ports last summer as shipowners accused COSCO of non-payment on hire rates. Reports suggested COSCO was attempting to renegotiate long-term charter terms on vessels it hired during the high rate boom in 2008.
“Many of the shipping contracts under renegotiation were struck during the 2008 boom when the industry’s largest capesize vessels were being rented by COSCO and others for more than $100,000 a day,” Reuters reported in early September. “The dry bulk freight market has since plummeted due to the economic downturn and an oversupply of vessels, leaving COSCO paying 2008 prices for ships that now rent for less than $25,000 a day.”
The détente mellowed by late summer though, when COSCO said it had reached agreement with shipowners on 18 vessels. Reuters reported further that COSCO was looking to consolidate its three bulk shipping units to increase its bargaining power with shipowners.
At the height of the bulk charter dispute, the company announced that Wei, its longtime chief executive, was leaving, to be replaced by former China Shipping Group vice president Ma Zehua. The move was due to Wei’s age, not COSCO’s business performance, and was normal in state-owned enterprises, the company said at the time.
Still more transition occurred when Min replaced Sun Jiaking as head of the container division last year. Jiaking was also promoted to group vice president.
Wei was a galvanizing figure not just for COSCO, but for the industry, and it’s difficult to predict what effect his departure from day-to-day operations will have on the line. But its container division will likely continue to be hampered by a lack of true global standalone connections outside of the main east-west trades with China. That places COSCO not just at a disadvantage against the European titans of the industry, but also some of its similarly-sized brethren in Asia.
Jensen noted COSCO does have one advantage some of its closest rivals don’t — unstinted state support.
“The impact is significant,” he said. “Especially in these times, COSCO will have the reassurance that almost irrespective of poor market developments, they will be able to access capital, allowing them to stay in the game.”
But Phillips reiterated that COSCO’s network is too China-centric.
“By concentrating on providing separate services to as wide a spread of destinations as possible, almost all directly to and from China, COSCO has achieved the illusion in China of a secure global strategic position,” Phillips said. “Unfortunately, by allowing itself to be enticed into so many junior partnership roles with a very small group of key partners, the opposite now appears to be the case.”
Is China’s largest line robust enough to keep pace with its competitors?