Hamburg, 17. September 2020
This week we head again to Oslo but not to the bond market; instead, we deviate to what seems to us to be the reopening of another Norwegian specialty market — the project business.
In its latest asset play, Pareto Securities AS successfully established Atlantic Feeder AS, a Norwegian limited tonnage tax company, which acquired two small sister feeder container vessels from two distressed German KGs. The vessels, the Pictor J and the Perseus J, were constructed in 2008/9 at Naval Gijon, Spain. ICE 1A classed, the vessels have a capacity of 925 TEU with 199 reefer slots. The vessels were acquired at a historically low level at a ~68% discount to newbuilding parity and 11% below VesselsValue’s appraisal.
The vessels will be technically managed by Baas Shipping, which is a joint venture between two independent ship managers, Brise Bereederungs GmbH & Co. KG and FL Schifffahrt of Lübeck, who also co-invested in the project.
Founded in 1985, the Brise Group operates a fleet of 17 feeder container ships, self-unloading cement carriers, and multipurpose vessels. FL Schifffahrt emerged from Reederei Eicke, which was established in 1982 and operates two feeder containerships and three MPCs. While awaiting the opportunity for an asset play, the vessels will trade in the recently formed European Feeder Pool, to minimize downside risk on earnings and utilization while retaining full upside potential. The European Feeder Pool is managed by Arkon Allied Container and consists of seven vessels including the Pictor J and the Perseus J.
As most of the time charter contracts in the Pool are denominated in Euros as are most of the ship operating expenses, the project was financed in Euros. Including the purchase price, start-up expenses, fees, costs, and working capital the total project cost was €7.475 million with funding split between equity of €4.200 million and a secured loan from a German bank of €3.275 million. Fully amortizing, the term loan has a term of 6.5 years and a fixed-interest rate.
Values of feeder container ships have been in decline since the financial crisis with values down 70 – 80% from the peaks of last decade. Consequently, in assessing the potential investment opportunities, Pareto determined that feeder container vessels offered an attractive risk/reward profile. Based upon the attractive purchase price, there is significant upside potential from current low values to historical average values. Looking at the five-year average, the 25-year average and newbuilding parity, the upside potential is 35%, 143% and 211% respectively. With the upside potential, there is downside protection with the vessel’s scrap value representing 39% of the purchase price with 13.5 years expected remaining useful life. There is also significant cash yield potential from a rate recovery. The normalized average earnings for a 1,000 TEU vessel are $7,000/day over the last 15 years, which would equate to cash yields of approximately 30% and 40% on a 10- and 15-year-old vessel, respectively. It is that age group which offers the most favorable combination of cash-yield and remaining operating/revenue lifetime. Lastly, the levered structure is operating above break-even in today’s time-charter rate environment with full utilization. And historic data demonstrates profitable operation during 92% of the time despite the various historic downcycles.
The pitch to investors is returns and to demonstrate them Pareto created a six-year IRR matrix. The base case range is constructed assuming the following earnings assumptions: lowest six-year’s earnings since 2000 (November 2008 to November 2014), average T/C earnings over the last 10 years and average T/C earnings over the last 15 years. There are two residual assumptions: depreciated value from the purchase price and depreciated value from broker values. Under these assumptions, the IRR’s range from a low of 18% to a high of 48%, with an estimated dividend yield range of 14-40%.
The market will be the key determinant of the project’s success, which will benefit from the shift in the overall container market towards a two-tier market with large vessels deployed on main long-haul routes and feeder vessels serving transshipment hubs. As core infrastructure bringing cargo to final destination ports, feeders provide last mile tonnage to customers driven by the continued development of large and efficient intraregional transshipment hubs (logistics, inland infrastructure). Transshipment multiplies shipping options and improves connectivity within the network through the creation of regional hub and spoke networks for cargo relay. Feeder trades have a highly different vessel design requirement than main haul trades rendering them core to cargo delivery infrastructure. And finally, a strong and efficient feeder market is vital for the development of smaller market connectivity and restricted areas.
Underlying market conditions is the balance between supply and demand. Like most sectors, fleet growth has slowed recently with limited ordering activity since 2015. In fact, in 2019, the container fleet only grew 3.9%, the lowest level since 2016 which saw growth of 3.5%. In June, the order book represented 10% for the total container segment, which is the lowest ever recorded. For feeders, the order book represented 8.8% of that fleet in TEUs the lowest level since 2015 with new orders stopping completely this year. In assessing the container order book, context is required as it is heavily weighted to the larger sizes — with 82%, in TEU terms, Post-Panamax or larger.
In addition to the slowdown in new orders, the level of scrapping is a key determinant of supply. After the financial crisis, the container fleet experienced massive scrapping, but scrapping leveled off in 2018-19 as the market improved. In the feeder container segment, between 2 – 5% of the fleet has been scrapped yearly over the past 12 years, averaging 0.28 million TEUs annually. Only intermediate (Panamax) and feeder vessels have been scrapped so far and the lowest scrapping age was in 2016 when feeder vessels were scrapped at an average age of 21 years and intermediate container vessels at only 17 years of age. Since 2016, the scrapping age has increased gradually as the container market improved and was 25 years for feeder container vessels and 20+ years for intermediate vessels during the last three years. Scrapping is set to improve substantially going forward as 22% of feeder vessels are today older than 20 years and a massive influx awaits as 42% of the fleet is currently over 15 years of age.
Seaborne container volumes are highly correlated to the world’s GDP growth over the past 25 years with an average multiple of ~1.9x. Recently the multiple has been lower, around 1.4x since 2011 and 1.3x since 2013 which is likely a reflection of the trade war between the U.S. and China. In its latest World Outlook, the IMF forecasts world GDP will decrease by 3% in 2020 followed by a strong rebound of 5.8% in 2021. Global container trade is expected to normalize as countries re-open after lockdowns and stimulus packages have their effect. As the market returns to balance, the limited supply growth will be a major contributor. The ships have been delivered and are now trading. As is always the case with shipping, it is simply a matter of waiting for the rebound. Structured to achieve low cash break-evens, Atlantic Feeder’s vessels are well-positioned to wait it out.