Zim flew higher in the shipping boom, falls faster when the market falls

At the height of the container shipping boom, ocean freight company Zim outperformed its much larger competitors. It’s still raking in over a billion dollars a quarter, but as the market corrects, it’s falling back to earth faster than others.

On Wednesday, Zim (NYSE: ZIM) announced a decline in quarterly earnings and lowered its full-year guidance. Not only is its spot rate revenue falling, but it is agreeing to lower mid-contract contract rates and handling less volume due to weaker demand and continued congestion at East Coast ports.

Zim reported net income of $1.17 billion for the third quarter of 2022, down 20% year over year and down 13% from the second quarter. Earnings came in at $9.66 per share, below Bloomberg analysts’ consensus of $9.81.

The company lowered its full-year guidance for adjusted earnings before interest, taxes, depreciation and amortization to $7.4 billion to $7.7 billion, a 6% reduction from its previous estimate.

The new outlook implies record earnings for 2022, but Q4 EBITDA fell 41-57% from Q3.

“Over the past few weeks, we’ve seen a sharper drop in freight rates than we previously thought,” Zim CEO Eli Glickman said during a call with analysts on Wednesday. He pointed to “challenging prospects for container shipping, particularly given ship deliveries planned for next year and 2024”.

Zim’s average freight rates are falling

Prices averaged $3,353 per 20-foot unit in Q3 2022. That’s up 4% year over year, but down 7% from the second quarter.

Zim, the 10th largest shipping company in the world, benefited from an increased presence in the exploding market during the boom. Capacity was focused on high yield transpacific trade and strong spot exposure. Now that high operational leverage is pulling Zim down more than airlines with much larger fleets like Maersk and Hapag-Lloyd, which have a broader service footprint and very strong contract coverage.

Zim’s average freight rate (both contract and spot) still exceeds that of Maersk and Hapag-Lloyd. But Zim has peaked earlier and the gap is narrowing. Since the first quarter, Zim’s average freight rate has fallen 13%. During the same period, Maersk and Hapag-Lloyd rose 11% and 12%, respectively. All three expect rates to fall in Q4 versus Q3.

(Graphic: American Shipper based on data from Maersk, Hapag-Lloyd, Zim)

Through the first nine months of this year, 34% of Zim’s volume came from transpacific trading. Xavier Destriau, Zim’s CFO, said spot prices in this market, particularly on the Asia West Coast route, have been particularly hard hit.

“Trade between Asia and Los Angeles was hit the hardest,” he said. When asked if spot prices are at or below breakeven, he said, “We’re not far off on some trades. [For Asia-West Coast] there is not much more scope for a reduction.”

Spot Rate Valuation in $ per 40-foot equivalent unit (Graphic: FreightWaves SONAR)

Zim is renegotiating contract rates

During Maersk and Hapag-Lloyd conference calls, executives said higher contract rates trumped lower spot rates, which could allow average rates to rise further in the third quarter. They also claimed that they generally did not renegotiate annual contracts.

Soren Skou, CEO of Maersk, said: “I know there has been a lot of talk about customer contracting behavior. But the reality is that the vast majority of our contracts stand. Our contract portfolio has developed as expected.”

Hapag-Lloyd CEO Rolf Habben Jansen said: “If you look at Q3, we still had quite decent contract compliance.”

Zim, on the other hand, confirmed that it has renegotiated the existing contract prices. She cited this as one reason why average rates are falling. Zim’s primary contract exposure is in the Transpacific, where 50% of its volume is under annual contracts beginning in May.

Destriau explained, “With the sharp decline in the spot market, spot rates fell below contract rates and exceeded sometime during the quarter. More importantly, from our customers’ point of view, the demand wasn’t there. So we have to live with this new reality.

“Most of our customers are not seasonal customers. They are returning customers with whom we have a long-term relationship. We intend to continue these long-term relationships. As the spread between contract rates and spot rates widened, we had to sit down and agree to reconsider pricing with ours [contract] Customers to protect part of the volume. We had to be pragmatic and make sure we strike the right balance between our clients’ interests and ourselves.”

Stock bulls vs. bears

The stock performance of container shipping stocks like Zim’s is being driven by two opposing forces: downward earnings momentum and a perceived low valuation.

As Deutsche Bank analyst Andy Chu wrote about Hapag-Lloyd in a research note last Thursday: “Right now, there continues to be a two-way pull in the container shipping industry, with bulls pointing to cheap valuation and bears pointing to negative earnings momentum in freight rates and earnings. We’re on the side of the latter – that it’s all about momentum from here on out. We are concerned about the 27% on order of the current fleet and how that might be absorbed in a weaker demand environment.”

Zim’s stock trading is right in the bear camp: It’s down 70% from its 52-week high.

During an interview with American Shipper in October, Jefferies analyst Omar Nokta said many value investors are eyeing container stocks. “Investors don’t want to be involved right now as freight rates are still falling,” he said. “But the moment we start to see some stability in freight rates, I think buyers will flock to this sector because these stocks have value.”

Zim ticks the box for value investors. Not only does it remain highly profitable, but it had $4.47 billion in cash at the end of the third quarter, which translates to over $35 per share. The stock closed at $26.95 on Wednesday.

Nonetheless, spot rates continue to fall, albeit more slowly in October and November than in August and September. Rates have yet to bottom out, so Nokta’s stabilization trigger hasn’t fully materialized yet.

Zim’s new forecast assumes the rate decline isn’t over yet. “We assume that interest rates will continue to fall,” said Destriau. “Ultimately, we believe all trades will find a new equilibrium,” he said, but acknowledged that “there is a lot of uncertainty today as to when rates will stabilize.”

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