By Alessandro Pasetti
Japan’s Mitsui OSK Lines (MOL) is walking a tightrope. With an enterprise value that trebles its market cap, which implies a huge net debt position, could it be forced to announce the divestment of its core, loss-making, containership unit, which represents 43 per cent of the group’s revenue? Alternatively, it could tap shareholders for $3bn of fresh equity at a steep discount, in order to deleverage its balance sheet and push down net leverage to a more acceptable level of about 6x. Its current market value is $4.2bn.
Either way, what was meant to be a “counter-offensive” year, according to MOL president Koichi Muto, may turn out to be anything but – although the deep ties that traditionally favour MOL in the trade and finance business could help it postpone D-day into 2016 or beyond.
It doesn’t look good
Financially, MOL appears to be on the brink of disaster, although as a Japanese entity it may have more time than if it were a European or a U.S. carrier. It’s a balancing act now: bondholders may push for a dividend cut and large disposals aimed at shoring up MOL’s finances, while shareholders may ask for a more aggressive, debt-financed strategy, hoping that falling bunker rates and a depreciating yen, or a combination of the two, can get MOL out of its misery.
Unfortunately, as MOL scales up and buys the largest vessels available on the market in order to reduce unit costs, its negative free cash flow profile will unlikely help it prevent a significant cash call in the next 24 months, in my view. Based on the structural imbalance between oil supply and demand, the level of inventory in the U.S. and a possible U-turn in OPEC’s strategy, it’s not hard to envisage Brent at between $80 and $90 a barrel, possibly as soon as this year. Low bunker prices, meanwhile, do not always guarantee rising earnings.
MOL’s cash and cash-equivalents at the end 2014 stood at about $1.1bn, a decrease of $425m year-on-year. Total gross debts rose by $741m to $9.8bn, yielding a net debt position of $8.7bn, which implies a net leverage of about 10x, based on its trailing operating cash flow of about $900m. If disposals were on the cards, the most likely outcome would probably entertain some sort of deal with fellow Japanese line NYK, whose financials are not too different from MOL’s.
While it’s hard to envisage interest from a smaller rival such as K Line, which appears to be faring better than its rivals, what seems clear is that one way or another MOL shareholders will have bear the brunt of poor financial management. In fact, interest from foreign suitors should be ruled out. Its debt maturity profile offers some reassurance, and MOL could certainly seek to raise more debt, while implementing a zero dividend policy, but it would then be difficult to keep at bay Moody’s, the credit rating agency, whose judgment on MOL’s financials could make a big difference to its bottom line. In mid-April, Bloomberg reported that MOL, threatened by Moody’s with a cut in its rating to junk, “won breathing room as a decline in fuel costs helped trim its bond risk to a three and a half-year low”. The picture is mixed, though.
“Japan’s three largest shipping companies will see their profitability increase this fiscal year (2014) and next, because the weak crude prices will reduce their fuel costs, all else being equal,” Mariko Semetko of Moody’s said in February – before annual results were announced. However, the analyst also added that although profits for the three carriers would rise, low freight rates would mute the positive impact on total operating profits.
The company’s earnings recovery has been much slower than Moody’s had anticipated, and the credit rating agency has indicated that MOL’s rating could be downgraded “if debt/EBITDA does not fall below 7x by March 2016 or if the company materially deviates from its March 2017 targets set in its medium-term plans”.
Recent trends do not bode well for MOL. According to research from Alphaliner, “carriers’ operating results improved across the board in the first quarter of 2015, boosted mainly by a 49 per cent fall in bunker fuel prices and by foreign exchange gains from the appreciation of the U.S. dollar against most major currencies”, but MOL was the only company to report an operating loss. This could mean that its efficiency measures aren’t working, and the longer it takes to set this right, the more likely divestments and a rights issue will become.
Reprinted courtesy of The Loadstar (www.loadstar.co.uk)