In the container shipping industry it isn't only vessels that are roiled by waves. Since 2020, container liners have been buffeted by peaks and troughs in trade volumes starting with a pandemic-driven dip, then an e-commerce-fueled spike, and, latterly, another fall (and persistent weakness) triggered by cost-of-living pressures, sluggish consumer demand, and excess retail inventories.

Now liners face another challenge. The supply of new mega ships, and the capacity they will add, is poised to outstrip demand growth over the coming years, putting huge new pressure on freight rates that recently corrected (possibly to a new post-pandemic normal) from all-time highs both sooner and more precipitously than S&P Global Ratings expected.

That rate correction led to a quicker-than-forecast decline in industry-wide earnings over 2023. And it promises further profitability challenges in 2024, when container liners will have to contend with reduced rates, looming overcapacity, and lingering operating-cost inflation.

Sooner, Faster, And Sharper

A correction had been expected, though its timing, speed, and magnitude surprised. In just a few weeks, in September and October 2022, freight rates tumbled from the unprecedented highs of 2021 and 2022, dragged down by a slump in demand for consumer durables and the rapid decongestion of maritime ports. Since then, rates have remained firmly anchored at levels close to their (challenging) historical norms, not least due to industry overcapacity.

The Shanghai Containerized Freight Index (SCFI) has averaged 980 in 2023, year-to-date. That is down 71% from its average of 3,410 in 2022, and 74% on the average of 3,772 in 2021, but remains about 20% above its pre-pandemic average of 810 in 2019, according to Clarksons Research, a provider of shipping data and intelligence.

The decline in rates has not been homogenous. Container rates plunged most severely on the main lanes of Asia-Europe, Transatlantic, and the Transpacific. Non-main routes such as North-South and regional trade routes such as intra-Asia experienced a varying pace of decline. Even though year-to-date average freight rates remain above their 2019 averages on most routes they are on a downward trend (see chart 1).

Chart 1

Profit Pressures In The New Normal

Container liners' results for the first-nine-months of 2023 reflect the normalization of global supply chains, weaker cargo volumes, and the resulting severe correction in freight rates. During that period, A.P. Moeller Maersk S/A (Maersk), Hapag-Lloyd AG, and CMA CGM S.A. all posted a 47% to 48% year-on-year decline in revenue in their container shipping segments (see table 1). This reflects a low-single-digit drop in transport volumes for all liners and, more importantly, falls of 50%, 45%, and 46% in Maersk's, Hapag-Lloyd's and CMA CGM's respective average year-on-year freight rate/revenue per TEU (twenty-foot equivalent unit). The freight rate decline has been spread over 2023 but accelerated in the third quarter. Strict cost management has only marginally helped to offset declining revenue, leading to a significant plunge in reported EBITDA (see table 1). We expect this trend to persist in the coming months when consumer demand is likely to remain subdued and contracted freight rates are renegotiated based on considerably lower spot levels. Accordingly, our base-case forecast for 2023 includes a significant deterioration in S&P Global Ratings-adjusted EBITDA for all liners compared to the record highs of 2022 and 2021 (see table 1).

Table 1

Trade Volumes On A Slow Path To Recovery

The container shipping sector will enter 2024 weighed down by ongoing weak consumer demand that has persisted since the second half of 2022. Furthermore, industry indicators and container liners' financial reports suggest that there will be little immediate respite, with continued softness in transported volumes expected to maintain pressure on freight rates. We expect macroeconomic risks and geopolitical risks will weigh on global trade next year. Economic issues include cost inflation (headlined by elevated and volatile energy prices), interest rate hikes, and diminishing disposable incomes. Geopolitical uncertainty, which was previously due principally to the ongoing conflict in Ukraine, has increased with the outbreak of the latest war between Israel and Hamas, and could exacerbate already sluggish consumer sentiment and spending.

We incorporate single-digit year-on-year volume growth in third-quarter 2023 and expect a similar scenario through the fourth quarter, based on a favorable comparison against low volumes in late 2022. On that basis, we expect global container shipping demand, as measured by boxes shipped, to increase marginally, if at all, over 2023, and subsequently expand at a low-single-digit rate in 2024-2025. This is in line with our projected global GDP growth of 3.0%-3.3% per year and is comparable with Clarksons Research's outlook (see chart 2). Even modest volume gains would be a significant improvement on 2022, when volumes fell almost 4.0%.

Chart 2

The Capacity Glut Threatens Rates

We expect significant deliveries of new ships will heap further pressure on freight rates. New vessel orderbooks currently equate to 27% of the total global fleet, up from an all-time low of 8% in October 2020, according to Clarksons Research, whose data suggests container liners' total capacity will increase 7%-8% in 2023 and 2024, all else being equal (see chart 3).

Delivery schedules for new vessels indicate that capacity growth will be lumpy. This is notably due to additions of ultra-large containerships, many of which were ordered years ago by ship owners looking for economies of scale and better environmental performance. The timing of large vessel deliveries alongside cumulative supply growth will have a significant bearing on the prospects for a rebound in rates--particularly on the Asia-Europe and Asia-U.S. lanes where mega-containerships tend to find a home.

Chart 3

Capacity Management Could Narrow The Supply-Demand Imbalance

Freight rates have fallen since 2022 to levels that are generally close to their historical averages, and we expect they will remain under pressure.

Liners will have to react to the difficult market conditions if they are to protect their currently robust creditworthiness. Efforts to limit freight rate declines have, so far, been slow, insufficient, and largely failed amid a challenging market backdrop due to a combination of soft demand, the release of tonnage parked at congested ports following the resolution of pandemic-induced supply chain issues, and accelerating deliveries of ultra-large containerships. Inflation, meanwhile, has increased operating expenses.

More rigorous and sustainable capacity management will be required if the industry is to avoid economically unviable rates that consign operators to losses. That is particularly the case given that supply and demand imbalances are on course to widen in 2023-2024, before only moderately narrowing in 2025 (see chart 4). Container liners have a range of tools to manage excess supply, many of which have been tested in recent years. They include cancelling routes (known as loop withdrawals), skipping or cancelling stops (blank sailing), slow steaming, re-routing, swift capacity reallocation, and deferral of new vessel deliveries.

There have been signs that supply management in the container shipping industry is on the right track, and we credit consolidation for much of the possibly newfound discipline that has underpinned this improvement. Mergers and acquisitions, which happened in spurts over several years, have increased the market share of the top five players to about 65% today, up from about 30% in 2000. During that time, about half of the top-20 players have been absorbed through deals or defaulted. The upshot has been a widening of the carrying capacity gap between larger and smaller players and market concentration that has laid the foundation for a more rational and efficient industry. That discipline will be tested in 2024 as supply side challenges soar.

Chart 4

Our Rate Forecast Hinges On Stringent Supply Side Measures

While strict excess capacity management, assuming it occurs, might provide some relief during 2024, it won't completely avert pressure on freight rates given expectations of sluggish demand and accelerating new tonnage deliveries. Moreover, that outlook, combined with the collapse of rates in late 2022, has shifted the balance of power in the industry toward shippers, setting the stage for a difficult round of annual negotiations for container liners.

Our base-case scenario for 2023 includes an average freight rate (incorporating both spot and contract rates) of about half the 2022 record level. The decline in contract rates is proving initially shallow, cushioned by longer-term, fixed-rate agreements that expire with a time lag. Conversely, the speed and magnitude of the decline in spot rates has been more immediate. The combination of those shifts has meant that the pace of decline in revenue (volume to freight rates) for container liners has been slower than the deterioration in market spot rates, in line with our expectations. The extent of the lag for each liner depends on their exposure to fixed-rate contracts agreed at the previously elevated rates.

In our current base case, we assume average freight rates will decrease further in 2024, as contracted rates are renegotiated based on considerably lower spot levels, before firming at still-economically viable levels, i.e., above their 2019 base. That result should enable container liners to (at least) cover operating costs, which have increased significantly since 2019. Many container liners reported average operating cost increases of up to 30% (excluding fuel) over 2022. Our forecast is contingent on industry players implementing more stringent capacity-containment measures and proactively managing excess supply in the upcoming months. That sort of response is not a given but the industry has demonstrated it can positively react to pressure--as it did shortly after the pandemic's outbreak in 2020, when blank sailing and other measures offset a significant and abrupt decline in trade volumes.

Weakening Balance Sheets And Tightening Liquidity

We forecast that the credit metrics of rated container liners will remain well within the thresholds for our current ratings in 2023, and potentially in 2024, but with diminishing headroom for unforeseen operational setbacks or discretionary spending. This is because our base case takes into account a decline in liners' earnings and cash flows over the next few quarters, in line with dwindling rates.

The backdrop to this forecast remains the spectacularly high freight rates over 2021 and 2022, which delivered exceptional free cash flows and strongly improved credit metrics, leading to multi-notch upgrades for many container shipping companies (see table 2). Container liners used that windfall to diversify away from traditional container shipping, via mergers and acquisitions mainly with logistics services and maritime ports, and to fund shareholder returns. Furthermore, many significantly reduced debt, bolstered financial headroom, and found themselves entering 2023 with unprecedented net cash positions (cash exceeding S&P Global Ratings-adjusted debt) and credit metrics that had improved well beyond their pre-pandemic levels. Despite record-high discretionary spending over the year-to-date, recent financial reports suggest that liners' balance sheets and liquidity positions remain solid, providing a still-ample financial cushion for difficult times ahead (see chart 5).

That said we remain relatively cautious in our assumptions. That is because the uncertainty over future normalized freight-rates reduces the predictability of credit-ratio projections and increases the risk that adjusted EBITDA could underperform, or that financial leverage could overshoot what can be reasonably built into our base case.

How much the industry comes to rely on its financial cushion to protect credit quality will be determined by the extent to which rational behavior prevails in 2024 and beyond. Industry players will collectively have to prove their ability to manage the shifting market dynamics if they are to post consistent profits. That will, more particularly, require container liners to demonstrate, in the coming months, that they have the discipline to preserve ample cash reserves and reign in supply excesses. Freight rates will be the ultimate measure of the industry's success, or otherwise, in meeting this challenge. We will closely follow the evolution of rates, while assessing their impact on our base-case forecast and container liners' ability to adhere to our rating thresholds.

Chart 5

Table 2

Table 3