Industrials

Chris Bryant is a Bloomberg Gadfly columnist covering industrial companies. He previously worked for the Financial Times.

In "normal" times, AP Moeller Maersk's oil production assets should provide a natural fuel-price hedge for its container shipping business, the world's largest. But these aren't normal times.

An 84 percent drop in Maersk's 2015 profit revealed that its hedge isn't working right now and the company's big bet on oil and shipping has come unstuck.

CEO Nils Andersen has sold assets outside its core oil and shipping business -- including stakes in Danske bank and Denmark's largest supermarket group. The company's left with mainly container shipping and freight terminals on the one hand, and oil production and drilling services on the other.

Vanishing Hedge
Oil prices and shipping costs are now moving in lockstep, and that's bad news for Maersk
Source: Bloomberg data, normalized

But that much tighter focus on oil and shipping currently looks unwise -- the shares have slumped by more than half since March, suggesting investors agree.

Maersk's hedge normally works like this: oil prices fall, depressing oil production earnings but boosting the profitability of shipping goods by sea, which requires lots of fuel.

One would also normally expect a slump in oil prices to accelerate global demand and therefore stimulate trade.

But neither of these things is happening right now, contributing to what Maersk called a "perfect storm" for the group.

"The low global economic growth with resulting low container freight rates and oil price has fundamentally changed the short term outlook of almost all of our businesses," Maersk said.

What's gone wrong? Container shipping companies ordered far too many large ships a couple of years ago, when global growth projections were rosier.

The global container fleet grew by around 8 percent last year but container demand was more or less flat. At Maersk, capacity increased by 0.5 percent year on year. Its cuts have already started, with a 2 percent decline in the fourth quarter from the third as it trimmed charter capacity.  

That wasn't enough to salvage its financials, though. Freight rates have tumbled and Maersk was forced to pass on fuel price savings to customers, contributing to a 15 percent slump in revenues last year.

Maersk is seen as a barometer of global trade so investors should be relieved that it does not see freight demand falling off a cliff: it expects global demand for seaborne container transportation to increase 1-3 percent in 2016. But due to overcapacity that won't give the company as much of a boost as it would like.

Maersk can't force rivals to remove surplus capacity from their fleets (although some are doing so). Losses and debts may eventually wheedle out some of the weaker players in container shipping but that process of attrition takes time given the natural reluctance of banks to recognize losses from financing unneeded ships. Meanwhile, there is also little hope that oil prices will recovery quickly.

Maersk's Missing Revenues
As returns on invested capital cooled last year, revenues slumped
Source: Company reports

Maersk's cash generation and balance sheet looks solid and it is doing the right thing by cutting costs and capex. But its goal to deliver a return on invested capital of above 10 percent over the cycle is starting to look ambitious (it achieved a 2.9 percent ROIC in 2015).

Andersen said the company was in an "excellent position" to continue to invest during the downturn, as that's "the way companies operating in cyclical businesses do make money." Those acquisitions would have to be pretty lucrative for Maersk to hit its target, given current market conditions.

In addition, the company said it would need an oil price of $45-55 a barrel to break even. But prices are now currently stuck around $30 a barrel. 

With global growth muted, interest rates near zero and oil and freight rates in the doldrums, it is hard to see how Maerk can drive returns much. What it really needs is for that oil hedge to start working again. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Chris Bryant in Frankfurt at cbryant32@bloomberg.net

To contact the editor responsible for this story:
Jennifer Ryan at jryan13@bloomberg.net