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Shipping companies, largely viewed as barometers of global trade have registered strong returns in 2022 as the world economy bounces back towards the pre-Covid era. I am invested in Ardmore Shipping Corp (ASC) which has risen⁓ 303% (YTD), Eagle Bulk Shipping (EGLE) is up 22% (YoY) while Star Bulk Carriers Corp (SBLK) has lost 18% (YTD). Most importantly, investors are reaping dividend gains from some of the top marine companies. ZIM Integrated Shipping Services (ZIM) declared a Q3 2022 dividend of $2.95 per share representing a yield of 102% (TTM), EGLE has a yield of 16.29% (TTM) while SBLK is at 33.60% (TTM).
Thesis
Despite facing lower year-over-year freight demand, ocean transportation powerhouse Matson, Inc (NYSE:MATX) expects overall earnings growth from an extended capital investment including vessel constructions. The company intends to increase the China Long beach express (CLX) service by at least 500 containers of capacity per vessel to provide a significant net income contributor through 2027. However, the company announced the closure of the China-California Express (CCX) loop due to declining demand for its expedited Asian services with more capacity withdrawals expected in 2023.
Lower Earnings and CCX cancellation
Q3 2022 saw Matson’s revenue hit $1.11 billion up 4.03% (YoY) beating estimates by $62.55 billion. The company’s EPS stood at $6.89 above estimates by $0.15. However, EPS had declined 27.4% (QoQ) after hitting a high of $9.49 in Q2 2022. Lower earnings at the beginning of the 2H 2022 indicated decreasing profitability. Gross profit into the quarter fell 29.3% at $376.4 million even as net income hit $266 million (-30.13%, QoQ).
The lower earnings as seen above partly contributed to the company’s termination of its temporary CCX service in September 2022. This cancellation was done earlier than expected and it caused an income shock to the niche carrier. In essence, it removed approximately 25% of Matson’s trans-Pacific capacity seeing the demand for the premium services was on a decline.
In my view, the termination of the CCX was somewhat premature seeing that the CEO Matt Cox was bullish about the company’s support for the service after its launch in Q3 2021. The company was optimistic that demand (at the time) would be adequate for the CCX loop to proceed into 2023. With the lower revenue margins, I am convinced the company will not shy away from more capacity reductions and schedule changes into Q1 2023 to meet the declining consumer demand in the expedited market. This decline should, however, be commensurate with the decline in air cargo as well as ocean market rates.
From the management’s understanding, it appears that the Asia-US West Coast is not as lucrative as it once was to marine companies. As early as September 2022 the route’s rates fell below $3,500 per forty-foot equivalent unit (FEU). In contrast, the Trans-Atlantic route has outpaced the Trans-Pacific one (with Rotterdam to New York rates) ranging from $6,700 and $8,350 per FEU. On its part, Matson indicated in Q3 2022 indicated that it realized premium rates over the Shanghai Containerized Freight Index (SCFI). The market is in transition and with reduced revenues for Matson, it only means that the company’s rates were pulled down in tandem with the reduction in the SCFI.
Matson saw its Hawaii container volume decline by 7.1% (YoY) even as its Alaska volume increased by 10.6%. The decrease in Hawaii was due to low retail volume while in Alaska, the increase was attributed to a higher volume of exported seafood to Asia dubbed (AAX), dry-docking demand, and high domestic seafood volume. The Alaskan economy is set to grow from increased exploration of energy resources, and high oil prices. The only challenge here will be the high inflationary pressures, high-interest rates, and lower personal income that may lead to uncertainty and demand shock.
New Vessel Construction
Matson announced at the beginning of November 2022 that through its MatNav subsidiary, it had entered a significant vessel construction agreement with Philly Shipyard. This contract will see the latter construct 3 new 3,600 twenty-foot equivalents (TEU) Aloha Class dual-fuel capable containership with delivery timelines set for Q4 2027.
The new vessel program is set to cost Matson about $1 billion by adding almost 500 containers of capacity per vessel. In its Q3 2022 earnings call, CFO Joel Wine intimated that they had already deposited $565 million to the capital construction fund expecting a refund of up to $242 million in cash taxes paid in 2021. This new build is also expected to add Matson’s trade-lane capacity, and increase the income levels (both net and operating) and EBITDA after the vessels become operational.
To accompany the fleet upgrade, Matson is set for a dual fuel installation program that will see its engines running on LSFO or LNG. The company has set aside about $100 million for LNG installations. A breakdown of this investment shows that the company wills spend roughly $35 million to make its first Aloha class ship, the Daniel K. Inouye- LNG ready and enter dry-docking in Q1 2023. The next investment is the re-engineering of the Manukai ship to make it a dual fuel LNG and conventional fuel engine at $60 million. The Manukai ship is set to enter dry-docking by mid-2023. Matson is working to achieve its 2030 GHGs emissions goal of reducing its fleet emissions by 40%
On quarterly analysis, Matson’s capital expenditures are at record highs considering the cash used in Q3 2022 sat at $613.9 million indicating an increase of 1783.13% (QoQ) from $32.6 million in Q2 2022.
Risks to the Downside
Matson’s capital expenditure on both the new vessel constructions and LNG installations is now at its peak. Any delay to the projects’ deliveries and other supply-chain congestion-related issues may not only lead to the incurrence of additional costs but an adverse effect on the share price in the long run. The new vessels also require maintenance which may attract unforeseen complications and affect revenue generation. Transition to LNG fuel may not result in a 40% GHG emissions reduction by 2030.
Lower demand for ocean carriers has continued to eat into company profits leading to a reduction of capacity in tradelanes. There has also been a decrease in short-term rates with the entry of digital platforms further slowing down the spot rates. Low bookings from China to North Europe/ US is a matter of concern as it means companies such as Matson will not meet annual revenue targets. It was reported that rates from the Asian cities of Shanghai, Tianjin, and Shenzhen to the European hubs of Le Havre- in Hamburg fell to $1,000 per TEU and $1,800 per FEU.
Bottom Line
MATX is trending at ⁓ 4% above its 52-week low of $60.35. We may see the continual downside as the company struggles to regain its revenue footing especially after the CCX loop cancellation. Still, Matson’s management is determined to make good on its capital investment in vessel constructions and LNG installations. The main challenge here is that ocean market rates are reeling from recession bites that have not only affected competition but also lowered returns for carriers. For these reasons, we propose a hold rating for the stock.
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