oHapag-Lloyd achieved stronger-than-expected EBITDA in 2020 and we expect it to outperform our October 2020 base-case in the current year.

oStrong free operating cash flow (FOCF) generation allowed Hapag-Lloyd to reduce its adjusted debt and increase its financial headroom, and we expect it to sustain these improvements. This should help to mitigate the likely lower EBITDA from 2022 as freight rates moderate, or unforeseen operational setbacks.

oWe are therefore upgrading Hapag-Lloyd to 'BB' from 'BB-'. At the same time, we are raising our issue rating on the company's senior unsecured debt to 'BB' from 'B' and revising the recovery rating to '3' from '6'. We are also assigning our 'BB' issue and '3' recovery ratings to the proposed EUR300 million senior unsecured notes due 2028.

oThe stable outlook reflects our expectation that freight rates will fall to historical averages (from the current abnormally high levels) in the second half of 2021, resulting in lower EBITDA generation for Hapag-Lloyd, and that Hapag-Lloyd will maintain S&P Global Ratings-adjusted funds from operations (FFO) to debt of at least 25%, our threshold for a 'BB' rating.

FRANKFURT (S&P Global Ratings) --S&P Global Ratings today took the above rating actions.

The COVID-19 pandemic and subsequent multiple national lockdowns across the globe prompted a remarkable shift in consumption, toward tangible goods from services. The combination of accelerated penetration of e-commerce, bottlenecks in air freight logistics from lower availability of belly capacity in passenger aircraft, congested marine ports, and a shortage of containers triggered a surge in container shipping freight rates toward the end of 2020.

Rates continued to strengthen into 2021. In particular, the freight rates on the main container liner trades--Transpacific and Asia-Europe--hit record highs at the end of February 2021. According to Clarksons Research, the Shanghai Containerized Freight Index (SCFI) increased by close to 35% in 2020, compared with 2019, to an average of 1,234 points. In the year to date, it has trended between 2,700-2,900 points, far above its 10-year historical average of 950 points.

Growth in global trade volumes also turned positive from the third quarter of 2020, and has gained momentum in subsequent months. According to estimates by Clarksons Research, the global seaborne container trade shrank by about 1% overall in 2020, but had seen a 7% decline in the first half of 2020. Global trade recovery remained solid into the first quarter of 2021, despite the usual seasonal slowdown. As a result, we now forecast a recovery in shipped volumes consistent with the global GDP growth of about 5% in 2021.

We expect container liners to pursue their disciplined capacity deployment, and that containership supply growth will remain muted over the next several quarters. There has been no incentive to place new large orders by industry players, given the subdued contracting activity since late 2015. Therefore, the containership order book is historically low--12% of the total global fleet. Persistent funding constraints, potential pandemic-related disruptions, more stringent regulation on sulfur emissions (permitting only 0.5% sulfur emission from January 2020), and broader considerations about greenhouse emissions in general--particularly in the context of decarbonization--will likely result in uncertainties over the costs and benefits of various technologies and fuel, and should limit ordering in 2021.

Low levels of new containership orders have translated into much tighter supply conditions. We expect this to continue in 2021, underpinning solid industry trading. Soon after the initial COVID-19 outbreak, there was a withdrawal of sailings from China and container liners continued to adjust capacities to demand trends in a timely manner throughout 2020. These measures demonstrate industry players' reactive supply management, which we consider normal in a sector that has been through several rounds of consolidation in recent years. The five largest container shipping companies now have a combined market share of about 65%, up from 30% around 15 years ago.

In 2020, Hapag-Lloyd achieved S&P Global Ratings-adjusted EBITDA of EUR2.7 billion, which is above EUR2.0 billion in 2019 and our October forecast. Stronger-than-expected operating performance was largely due to a significant increase in freight rates in the fourth quarter and was supported by low bunker fuel prices and successful cost containing measures over the year, despite a slight decline in trade volumes, whose recovery in the second half of the year did not fully offset the drop in the first half. Fueled by the extraordinarily strong first quarter of 2021 on account of the record-high rates, which we expect to moderate as favorable pandemic-related effects ease, and supported by the anticipated low-single-digit growth in trade volumes, our 2021 EBITDA forecast is now EUR3.0 billion-EUR3.5 billion, which is significantly above EUR2.0 billion in our October base-case.

Hapag-Lloyd deployed its 2020 strong free operating cash flows for debt reduction. The company lowered its adjusted debt to EUR4.9 billion as of Dec. 31, 2020, compared to EUR6.7 billion a year ago. This, in combination with EBITDA expansion, led to a significant improvement in our adjusted FFO-to-debt ratio to 49% in 2020, compared to about 23% in 2019 and our October forecast of 26%-27%. We furthermore expect the company to maintain the reduced adjusted debt level in 2021. This is despite Hapag-Lloyd's order for six liquid natural gas (LNG) powered ultra large container vessels in December 2020 for a total of $1 billion, which are scheduled for delivery in 2023. With prepayments already starting in 2021, this should raise Hapag-Lloyd's capital investments beyond the relatively low level of about EUR430 million-EUR530 million in 2019-2020. We also expect the company's discretionary spending to increase with the proposed dividend of EUR3.50 per share for 2020, as compared to EUR1.10 per share for 2019, which translates to about EUR625 million cash outflows in 2021, as well as a recently announced acquisition of a Dutch shipping company with a strong foothold in Africa. That said, we expect the higher cash outflows for capital expenditures (capex) and discretionary spending to be fully absorbed by the anticipated strong operating performance in 2021, which also should be sufficient to cover the annual debt service requirements. This leads to a further improvement in credit measures, with an adjusted FFO to debt forecast of 60%-65% in 2021.

We do not view Hapag-Lloyd's EBITDA in 2020 and expected in 2021 as sustainable. We anticipate that once the pandemic-related effects ease, freight rates, currently extraordinarily high, will moderate later in 2021. We still believe the company will be able to turn its present EBITDA strength into sustainable EBITDA-value of about EUR2.0 billion from 2022, assuming the industry players' stringent capacity management and tariff-setting discipline, as well as Hapag-Lloyd's consistent grip on cost control and ability to recover bunker price inflation. We continue to believe that the container liner industry is tied to cyclical supply-and-demand conditions, which will likely translate to fluctuations in Hapag-Lloyd's EBITDA performance. That said, we still believe because of the industry consolidation and demonstrated more rationale behavior by container liners, the swings in freight rates will be flatter and their peak-to-through periods shorter than in the past.

We view Hapag-Lloyd's financial policy as essential in balancing off the anticipated decrease in free operating cash flow (after lease payments) in 2022. We expect Hapag-Lloyd's EBITDA to moderate to about EUR2.0 billion from 2022 while capital spending rises with an order for six new LNG vessels. This could be complemented by additional capex for new ships and/or containers seeing that the ratio of capex to depreciation remained below 1.0x during the last five years. That said, as demonstrated during the past few years, the company is unlikely to order new ships on a speculative basis or absent favorable demand prospects. We factor into our upgrade Hapag-Lloyd's flexibility and discipline in discretionary spending, which is key to prevent a material build-up in adjusted debt and keep the rating commensurate credit metrics. We also take into account Hapag-Lloyd's stated intention to maintain a ratio of net debt to EBITDA (leverage target) at maximum 3.0x, compared with 1.8x achieved in the 12 months ending Dec. 31, 2020. This compares with our base-case projection of adjusted debt (including pension adjustment) to EBITDA of 2.7x in 2022.

Outlook

The stable outlook reflects our expectations that freight rates will fall to historical averages in the second half of 2021, resulting in Hapag-Lloyds's EBITDA moderating to about EUR2.0 billion and weighted-average adjusted FFO to debt staying above 25%. We think this will be underpinned by the sustained capacity discipline of the industry players and Hapag-Lloyds's balanced financial policy.

Upside scenario

We could raise the rating if our adjusted FFO-to-debt ratio stays above 35% once freight rates moderate. In our view, this will largely depend on Hapag-Lloyd's ability and willingness to keep adjusted debt at around the current lowered level of below EUR5 billion. This would mean shareholder remuneration will remain prudent and Hapag-Lloyd will not unexpectedly embark on any significant debt-financed fleet expansion or mergers and acquisitions not accompanied with an offsetting increase in earnings.

Downside scenario

We could lower the rating if Hapag-Lloyd's EBITDA sustainably plunged below EUR2.0 billion; for example, if trade volumes were much lower than we anticipate and the industry's measures to adjust capacity to sluggish demand were ineffective, resulting in worsened freight rate conditions. Alternatively, we could lower the ratings if Hapag-Lloyd was unable to offset fuel-cost inflation because of unsuccessful pass-through efforts or a failure to realize cost efficiencies. This would mean adjusted FFO to debt deteriorating to less than 25%, with limited prospects of improvement.

A downgrade would also be likely if the company adopted a more-aggressive financial policy, resulting in credit measures falling short of our rating guidelines.

Company Description

Hapag-Lloyd is a leading global container liner, with 237 modern ships, 12 million twenty-foot equivalent units (TEUs) of cargo transported per year, and about 13,100 employees in 395 offices spanning 129 countries. The company has a fleet with a total capacity of approximately 1.7 million TEUs, as well as a container stock of more than 2.7 million TEUs, including one of the world's largest and most modern refrigerated container fleets. Its global network provides connections between more than 600 ports on every continent.

Hapag-Lloyd is owned by CSAV Germany Container Holding GmbH (30.0%), Klaus Michael Kühne (including Kühne Holding AG and Kühne Maritime GmbH) (30.0%), HGV Hamburger Gesellschaft für Vermögens- und Beteiligungsmanagement mbH (13.9%), Qatar Investment Authority (12.3%), and Saudi Arabia's Public Investment Fund (10.2%), with a 3.6% free float.

Ratings Score Snapshot

Issuer Credit Rating: BB/Stable/--

Business risk: Fair

oCountry risk: Intermediate

oIndustry risk: High

oCompetitive position: Satisfactory

Financial risk: Intermediate

oCash flow/leverage: Intermediate

Anchor: bb+

Modifiers

oDiversification/portfolio effect: Neutral (no impact)

oCapital structure: Neutral (no impact)

oFinancial policy: Neutral (no impact)

oLiquidity: Adequate (no impact)

oManagement and governance: Satisfactory (no impact)

oComparable rating analysis: Negative (-1 notch)

Related Criteria

oGeneral Criteria: Group Rating Methodology, July 1, 2019

oCriteria | Corporates | General: Corporate Methodology: Ratios And Adjustments, April 1, 2019

oCriteria | Corporates | General: Recovery Rating Criteria For Speculative-Grade Corporate Issuers, Dec. 7, 2016

oCriteria | Corporates | Recovery: Methodology: Jurisdiction Ranking Assessments, Jan. 20, 2016

oCriteria | Corporates | General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014

oGeneral Criteria: Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013

oCriteria | Corporates | General: Corporate Methodology, Nov. 19, 2013

oGeneral Criteria: Methodology: Industry Risk, Nov. 19, 2013

oGeneral Criteria: Methodology: Management And Governance Credit Factors For Corporate Entities, Nov. 13, 2012

oGeneral Criteria: Principles Of Credit Ratings, Feb. 16, 2011

Related Research

oGerman Container Liner Hapag-Lloyd Upgraded To 'BB-' On Resilient EBITDA And Lower Debt; Outlook Positive, Oct. 5, 2020.

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S&P Global Ratings is a division of S&P Global (NYSE: SPGI), which provides essential intelligence for individuals, companies and governments to make decisions with confidence. For more information, visit www.spglobal.com/ratings.

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