September 2016 Matson And Global Container Shipping Quarterly Update

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For U.S. investors, there are three basic ways to gain exposure to container shipping companies. These include owning a direct shipping line, like Matson (NYSE:MATX); owning a container lessor, like Textainer Group Holdings (NYSE:TGH); or owning a charter owner and operator, such as Seaspan Corporation (NYSE:SSW).

There are, of course, other avenues, including direct ownership of larger global shipping lines via American Depository Receipts (ADRs) or through foreign stock exchanges; or industrial companies which provide parts and/or build these ships, containers, or other related equipment.

The global container shipping industry is changing rapidly from consolidation, vessel alliances, and, of course, from the recent Hanjin Shipping bankruptcy. In the midst of this change, investors have an opportunity to own Matson, which predominantly provides U.S. domestic services under the Jones Act maritime law.

Matson also competes within global container shipping lines through the Trans-Pacific trade lane via its China Expedited Service, CLX. This service provides a direct route from China to the Port of Long Beach for the eastbound direction only. Westbound, the services stops at both Hawaii and Guam.

Through the first nine months of 2016, China-based forty-foot equivalent container units (FEUs) reflected 18 percent of all container volume. Nearly 50 percent of the volume was from Hawaii, while another 20 percent was driven from the Alaska business.

As Matson has a significant portion of its business exposed to the Trans-Pacific trade lane, recent volatility for average spot market freight rates have impacted the company’s business results. This has especially been the case when compared to the much higher premiums afforded the company during the U.S. West Coast labor union strikes during the first quarter of 2015.

This factor among others including Matson’s core competitor, Pasha’s service issues for its Hawaii service for the back-half of 2015 and first quarter of 2016, has challenged the market’s perception of where Matson should be valued.

Based upon these challenges, today’s stock price is likely to remain volatile. Upon fundamental and technical review, investors are better suited to consider a position in Matson below $35 per share.

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To date, this value has been perceived to be lower than last year’s closing stock price. For the year, Matson was down 12 percent, substantially underperforming both the S&P 500 and SPDR S&P Transportation indices.

A.P. Moller-Maersk (OTCPK:AMKAF) has witnessed a nearly 25 percent return to date. Nearly 60 percent of the company’s operating revenue was derived from the Maersk Line container shipping segment. The company’s oil and drilling segments reflected 20 percent of operating revenues. The remainder were mostly related to sea shipping activities.

Hapag Lloyd, as a pure-play container shipping line, has witnessed a four percent return to date. Both Maersk and Hapag Lloyd have taken strategic steps to improve their container shipping line operations. For Maersk, the company has separated its container shipping and energy business divisions. Hapag Lloyd has continued to grow its business through acquisitions, the most recent including United Arab Shipping Company, UASC.

Source: Matson Third Quarter 2016 Earnings Conference Call

By scale, the Hawaii business is the most important when comparing FEUs, but Matson’s Hawaii segment also moved over 56,000 automobile units through September 2016. For the transport of goods between Hawaii and the Mainland, management has provided the core indicators related to consumption, travel, employment and building.

The CLX business segment is heavily focused on U.S. GDP growth rates due to the regional distribution location being Southern California. There are likely some cross-border relationships with Matson’s business to Canada and Mexico, but the U.S. economy should be viewed as the primary driver. Some forecasts are looking for U.S. GDP growth just slightly above two percent for 2017, just below the Hawaii estimates.

Alaska is the weakest link among Matson’s core operating revenue generating trade lanes. Alaska will likely witness negative GDP growth for 2016 and possibly could also witness reduced growth during 2017. However, the overall economy has been substantially more resilient than during the 1986-1988 recession, where Alaska lost about 10 percent of total employment and around one percent of population.

Population is expected to remain flat and to be down a little over one percent from the 2013 peak through 2018. Employment is also expected to remain flat through 2018, down around 1.5 percent from the 156,000 peak in 2015. Personal income is anticipated to rise an average of 2.4 percent per year. Air passenger volumes are anticipated to rise two percent per year. Air freight and Port of Anchorage volume is expected to marginally increase. Building permit values are estimated to marginally increase, but still remain nearly 20 percent below 2014 levels through 2018. These estimates are conservative as the impact from the energy sector is anticipated to continue to have a ripple effect on Alaska’s economy.

Source: Company financials and personal database

Fundamentally, Matson has outperformed its global container shipping peers. It should be reiterated here that these companies are obviously not direct competitors, but nonetheless, have been impacted by container freight rates; this is their common ground.

Pasha is Matson’s most closely related peer; however, the company is not public. Matson displays strong fundamental metrics including the company’s profitability and operating ratio. Recently, Matson has undertaken a significant increase in leveraged capital. This has resulted in the company’s leverage ratio increasing from around 1.5 times EBITDA to 2.7 times on a gross basis.

Management expects to further increase its debt obligations to repay near-term due obligations and to swap out the use of the credit facility and operating cash flow which will fund the company’s newbuild program of Hawaii service vessels. Investors should expect to receive marginal dividend increases near the five percent level, and for free cash flow yield to remain low to marginally negative.

Source: Company financials and personal database

The table above is meant to provide further transparency regarding the container freight rate environment and its impacts on operating revenues. For Matson, the company has deviated from the norm for both operating revenues and transported TEUs.

This is a direct result of the company’s higher exposure to U.S. domestic trade lanes versus the Trans-Pacific. However, the impacts from freight rate pricing on the Trans-Pacific trade lane has significantly impacted both Matson’s ocean transportation revenue and profits.

Matson’s ocean transportation revenue has benefited the most from the Hawaii container and automobile volumes which were up nearly three and nine percent through September 2016. The Alaska and CSX business segments witnessed declines of -3 and -10 percent, respectively. Collectively, Matson has witnessed a decline in container volumes of -1 percent for the year.

Matson does not break out the company’s average freight rates by trade lane, but it is clear that the overall decline in TEUs has been offset by some price increases. It is most likely that the Hawaii business has benefited from general rate increases. The combined effect of weaker Trans-Pacific freight rates and reduced fuel surcharges from average bunker prices has been the greatest headwind for ocean transportation revenues.

These are the same factors that have negatively contributed to operating revenues for larger global container shipping lines. All three listed above witnessed average freight rate declines between 18 and 22 percent through September 2016. In the case of Hapag Lloyd, Trans-Pacific freight rates were down 25 percent.

Source: Company financials and personal database

The information above is strictly relative for global container shipping lines. Maersk, in addition to operating its shipping lines, also owns APM Terminals which had 72 terminals worldwide as of September 2016. Measuring terminal units handled is another form of demand; for the year, APM Terminals was up 1.5 percent.

There are correlations to U.S.-based companies for this measure. Over the next few months, APM Terminals is anticipated to begin operating a new terminal at the Port of Lazaro Cardenas. This new terminal will have exclusive access for Kansas City Southern (NYSE:KSU).

Source: Company financials and personal database

All companies whether globally focused or in Matson’s case, more domestically focused have been impacted strongly at the bottom-line. Even with lower bunker fuel costs, the decrease in operating revenues has more than offset any cost savings.

Despite the general correlation for larger global shipping lines versus Matson, Matson’s stock price performance has underperformed these peers. The underperformance is greatly pronounced as one could argue that Matson’s fundamental performance has been stronger. As stated above, this is mostly attributed to the Hawaii business market.

An observation that merits discussion is the disconnect between Matson’s near-term average analyst stock price targets and the company’s perceived valuation by the market today. Matson’s price today trades just shy of 20 times 2016 estimated earnings. Over the previous few years, the stock has tended to trade between 21 and 22 times earnings.

For 2017, Matson is trading 18 times estimated earnings. The market has placed Matson’s value today below the level it has traded in the past. However, analyst average estimates for 2017 place Matson’s value above 22 times earnings.

Source: Yahoo! Finance and personal database

Matson’s stock price from a technical perspective has witnessed a substantial increase in volatility stemming initially from the 2015 labor strike issues on the U.S. West Coast. This led to Matson’s stock price increasing greater than 30 percent versus its 200-day moving averages. Previously, the company had never witnessed performance above 20 percent for any sustained period of time.

During 2016, the opposite has occurred. Matson’s stock price has declined below the 50- and 200-day moving averages by greater than 20 percent. This had never occurred over the past five years. This suggests that the market is having a tougher time gauging Matson’s value.

Assuming today’s valuation multiple of 20 times earnings sticks and that Matson generates close to 2017 earnings estimates, the stock would be valued just below $41 per share, or nine percent higher from today’s price. The dividend yield is currently just below two percent; combined, this equates to a potential 11 percent return through next year.

But Matson has displayed extreme volatility to the down-side as the company has missed earnings estimates and provided revised guidance lower. Over the near term, the headwinds impacting Matson’s business, namely Trans-Pacific trade lane freight rates and fuel surcharges may still persist. The Alaska business segment will also likely continue to face ripple effects from the energy recession. These two segments reflected nearly 40 percent of Matson’s FEU volumes.

For these reasons, investors who are interested in taking an initial position in Matson, or increasing their existing position, may be better suited to look for opportunities below the $35 per share level. As the company has become more volatile lately, prices have hit as low as $29.50 per share, a 21 percent discount from today’s current price.

Disclosure: I am/we are long MATX, KSU.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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