oWe expect CMA CGM S.A. will report a significantly higher EBITDA in 2020, due to a less severe decline in global trade volumes than we previously forecast, stringent capacity deployment by container liners, lower-than-expected bunker fuel prices, and CMA CGM's effective measures to steadily reduce costs.
oCMA CGM's improved cash flow generation, combined with lower debt, will result in stronger credit metrics than we previously expected. In addition, the company might achieve less-volatile earnings, further reduce debt, and increase headroom under the improved credit measures for potential operational underperformance and unforeseen setbacks. We view such headroom as critical for a rating upgrade.
oWe are therefore revising our outlook on CMA CGM to positive from negative, and affirming our 'B+' long-term issuer credit rating on CMA CGM and our 'B-' issue rating on the company's senior unsecured debt.
oThe positive outlook indicates that CMA CGM could maintain S&P Global Ratings-adjusted funds from operations (FFO) to debt of more than 16%, which is our threshold for a 'BB-' rating, if a rebound in trade volumes and the container shipping industry's pricing discipline enables the company to maintain its solid EBITDA performance, and if CMA CGM keeps allocating excess cash flow to net debt reduction.
FRANKFURT (S&P Global Ratings) --S&P Global Ratings today took the rating actions listed above.
We revised our base case following the most recent quarterly reporting by the leading industry players--signifying a steeper-than-expected demand recovery and firm freight rates--and incorporating the positive industry fundamentals continuing into the third quarter of 2020. The movement of essential goods, strong pickup in e-commerce, and shift of consumer spending from services to tangible goods have supported the shipping volume recovery from June. As a result, we now forecast a lower drop in shipped volumes by 5%-10% in 2020 compared with 2019, versus our previous forecast of up to 15%. In our view, containership supply growth will continue to be muted in the next several quarters, which is particularly important in times of weak demand. With no incentive to place new large orders amid subdued contracting activity since late 2015, the containership order book is at a historical low: currently 9% of the total global fleet. Combined with funding constraints, more stringent regulation on sulfur emissions (permitting only 0.5% from January 2020), and COVID-19-related disruptions (such as delays in new-build ship deliveries, ship maintenance and repair works, and scrubber retrofits owing to staff absences and equipment/spare parts shortages in Chinese yards, in particular during the February-April period), this translates into tighter supply conditions, better utilization rates, and healthy freight rates. The COVID-19 outbreak was followed by a quick withdrawal of sailings from China, and container liners continue to adjust capacities in a timely manner, idle ships, or travel longer routes during the typical slack seasons. These measures signify the reactive supply management by container liners, which we would normally expect from an industry that has been through several rounds of consolidation in recent years. Notably, the five largest container shipping companies together have a market share of about 65%, up from 30% around 15 years ago. In the first six months of 2020, CMA CGM reported EBITDA of $2.18 billion, which represents a marked improvement compared with $1.73 billion in the first six months of 2019. Under our base case, we expect this positive trend will accelerate toward year-end 2020, with S&P Global Ratings-adjusted EBITDA of about $5 billion for the full year. This is well above the $3.8 billion that CMA CGM achieved in 2019, and our April 2020 forecast of 3.1 billion-$3.2 billion. Higher-than-expected trade volumes and freight rates, lower-than-forecast bunker fuel prices, and trimming of other operating expenses, combined with a gradual operational recovery at CEVA Logistics (currently undergoing a major transformation), support CMA CGM's earnings improvement. Furthermore, CMA CGM's reduced debt--thanks to asset disposals and the deconsolidation of terminals (sold to Terminal Link, CMA CGM's joint venture with China Merchants Port Holdings Co., in early 2020)--combined with better cash flow generation will result in much stronger credit metrics than we previously expected. Under our base case, adjusted FFO to debt will improve to 18%-20% in 2020, as compared with about 13% in 2019 and our April forecast of 10%-11%. The container liner industry is tied to cyclical supply-and-demand conditions and the EBITDA growth rate we forecast for CMA CGM in 2020 is unlikely to be sustainable, in our view. In addition, there is high uncertainty regarding the pandemic and economic recession, their impact on global trade demand, and the sustainability of CMA CGM's earnings and financial performance. As such, a key challenge for CMA CGM will be turning EBITDA strength into lasting value of $4.5 billion-$5.0 billion. This will depend on industry players' stringent capacity management and tariff-setting discipline, CMA CGM's ability to continue lowering cost per container shipped (as demonstrated by a strong track record of overachieving cost-reduction targets in the past few years), and recovering bunker price inflation to counterbalance the industry's cyclicality. Furthermore, given the inherent volatility of the container shipping industry and associated swings in earnings and cash flow, we consider that maintaining a prudent financial policy underpinned by balanced investment decisions and deployment of excess cash flow to gradual debt reduction are critical and stabilizing factors of credit quality. Under our base case, CMA CGM could achieve adjusted FFO to debt of 18%-20% over 2020-2021, which is consistent with the higher 'BB-' rating, but points to a relatively limited financial flexibility in the context of the cyclical industry. We believe that CMA CGM's operating cash flows could outpace capital expenditure (capex) requirements in 2021 and 2022, creating scope for a further gradual net debt reduction. This would provide CMA CGM with more financial leeway under its improved credit measures for potential operational underperformance and unforeseen setbacks, while maintaining adjusted FFO to debt above 16% over the next two years. Although this ratio is within our thresholds for the 'BB-' rating, we would view such structural debt reduction and increased financial flexibility as critical for a rating upgrade.
oHealth and safety
The positive outlook reflects a one-in-three likelihood that we could upgrade CMA CGM over the next 12 months.
We could raise the rating if we believed that CMA CGM would maintain adjusted FFO to debt of more than 16%, which is our threshold for a 'BB-' rating. This would be contingent on the generally sustained pricing discipline by the industry players, allowing CMA CGM to offset the likely sluggish (albeit recovering) trade volumes and recover fuel cost inflation, and the company's continued allocation of discretionary cash flow to debt reduction. Given the industry's inherent volatility, an upgrade would also depend on CMA CGM's ability to structurally reduce debt and achieve an ample cushion under the credit measures for potential fluctuations in EBITDA, combined with stronger liquidity and regained access to capital markets.
Furthermore, we would need to be convinced that management's financial policy does not allow for significant increases in leverage compared with lowered levels. This means that the company will not embark on any unexpected significant debt-financed fleet expansion or mergers and acquisitions, and that shareholder remuneration will remain prudent.
We would revise the outlook to stable if CMA CGM's earnings weakened; for example, due to much lower trade volumes than we anticipate, deteriorated freight rate conditions, and the inability to offset fuel-cost inflation because of ineffective pass through efforts or a failure to realize cost efficiencies. This would mean adjusted FFO to debt deteriorating to less than 16%, with limited prospects of improvement.
An outlook revision to stable would also be likely if we noted any unexpected deviations in terms of financial policy that would prevent credit measures remaining consistent with a higher rating.
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