AMKBF - Orient Overseas Limited: Record Profits But Faces An Uncertain Future

2023-05-01 16:37:18 ET

Summary

• OOCL is part of COSCO Shipping but with a separate listing in Hong Kong.
• They delivered excellent net profit in 2022.
• Excess earnings have been wisely allocated to improve the balance sheet and also reward shareholders with dividends.
• Optimism has started to emerge that the container freight market has bottomed out, but we are not convinced.

Investment thesis

The world went through an extremely challenging time during the Covid-19 pandemic.

Supply chains that ensure goods can move from factory floors to consumers were severely disrupted. On top of that, many consumers stuck at home spent money on goods rather than services. All this led to costs of shipping containers going up to levels not seen before.

Companies that make their money from moving container boxes around the world have had a couple of very profitable years.

The largest players in that space are MSC, a Swiss-based private company, followed by A.P. Moller - Maersk ( AMKBY ) from Denmark and COSCO Shipping from China.

Part of COSCO Shipping is Orient Overseas International Limited, based in Hong Kong, which has its main listing in Hong Kong. It can also be bought through the OTC market in the U.S. as ( OROVY ) ( OROVF ), although these have very little liquidity, hence we prefer to potentially buy it in Hong Kong where its stock code is 0316.HK.

This article will look at Orient Overseas International Limited to explore if now is a good time to invest in it.

Background of Orient Overseas International

The shipping and logistics company is usually referred to as just OOCL.

It is a large integrated international container transportation, logistics, and terminal company with offices in 70 countries. OOCL owns 46 vessels of different sizes with a carrying capacity from 2,992 TEU to 21,413 TEU.

A fleet of 68 vessels is also chartered on leases of multi-year periods.

OOCL is a member of the Grand Alliance, which was formed in 1998 between OOCL Hapag-Lloyd in Germany and NYK in Japan.

In the 1970s, the two largest shipowner personalities were the Greek owner Aristotle Onassis and the Hong Kong-based C.Y. Tung which started OOCL but also had a fleet of VLCC and dry bulk vessels.

At one time, OOCL had become the 7th largest liner company in the world, with a fleet of over 150 ships. It also had the bragging right of owning the largest ship ever built, the ULCC "Seawise Giant" which measured 564,763 deadweight tons.

After C. Y. Tung's death in 1982, his son Tung Chee-hwa, who later became the first Chief Executive of the Hong Kong government, took over the helm. It was a very difficult time for shipping companies. I remember because that was the time that I started working in dry bulk shipping in Norway.

By the mid-'80s, OOCL had to declare bankruptcy as it was unable to service its debt and other liabilities. In stepped Hong Kong billionaire Henry Fok who roped in Bank of China and China Merchants, so it could stay afloat.

In July 2017, the parent company, OOIL, received a US$6.3 billion takeover bid from its Chinese rival, COSCO Shipping. The deal was completed in 2018.

At the time the deal was done, it was thought that COSCO overpaid for OOIL, but in hindsight, the timing was good as it was not long before the container shipping market went ballistic.

COSCO Shipping Hong Kong now owns 71% of OROVY.

Let us go through last year's financial results.

2022 FY Financial Results

OROVY set a record last year with a net profit of $9.97 billion. This was an improvement of 40% from 2021.

EPS was $15.09.

We often like to gauge a company's profitability by looking at its ROE. Here ORIVY shined last year with an ROE as high as 86.3%.

Another important factor is their cash flow. They made a net operating cash flow of $11.25 billion. It puts the $6.3 billion COSCO paid for their stake in 2017 in some context.

We all know that this is a capital-intensive industry. There is always a need to renew the fleet of both ships, containers, and land-based equipment for their logistics. That is not cheap. In 2022, their Capex was $1.31 billion, which was in line with what they spent the year before.

With these two fantastic last years, they have done three important things.

Cash on hand has improved greatly, from $3.23 billion at the end of 2020 to $11.21 billion as of the end of December last year. Out of this cash on hand, most of it is held in USD-denominated short-term time deposits. Higher interest on these deposits led to an improvement in interest earned over the year from $34 million to $183 million in 2022.

Secondly, they have reduced their borrowings and lease liabilities to a very comfortable $2.08 billion, which is something they could wipe out entirely based on their cash pile.

Last, but not least, all this strengthening of their balance sheet did not come at the cost of not returning any capital to shareholders.

Over a trailing 24 months period, they have paid out $78.54 per share in dividends.

Shareholders on register will receive $22.80 per share on 24 May 2023.

No shares were bought back over the year 2022.

It is vital to bear in mind that their dividend is likely not safe. The industry has a long history of going through long cycles often delivering poor results where no or minimal dividends are distributed.

Business prospects

It is certainly tempting to jump on board, no put intended, this company's shares as it looks like a "gravy train" with a dividend yield of 33%.

However, financial results are always backward-looking. We invest in the future, not the past.

In our last article on SFL, we investigated how l ower earnings from container ships could impact SFL. It is useful information for anyone who is interested in this segment.

Here is a small extract of what we wrote in the article dated 26th January this year.

When we look at the supply up against the demand, Bimco stated that there is a surplus of supply of roughly 1 million TEU in the coming year. It hits the largest ships the most, as 80% of the newbuildings coming are in that category. That is 50 vessels of 20,000 TEU capacity the market really does not need. Liner companies have already started with blank sailings and slowing the speed of vessels, Time charter rates could fall to levels that only cover the operating costs of a vessel. Not servicing the capital costs."

Over the last month, there has been optimism from some camps that the market is bottoming out for the container freight rates.

We are not convinced that the reversal in freight rates is sustainable since new vessels will keep coming out from shipyards throughout this and next year. The result of this will not happen immediately. There is a time lag. As such, we believe we will see further pressure on pricing power for the liner companies in the second half of this year and the whole next year.

Risk to the thesis and conclusion

On the topic of the cyclicality in the industry, that is its biggest risk.

OROVY informed investors in their latest annual report that its group's revenue will increase/decrease by $181.1 million for every 1% increase/decrease of the average container freight rates, with all other variables held constant.

Our only exposure to the container trade is through a stake in SFL Corporation ( SFL ), which is heavily weighted towards ownership of container ships. It was 54% of their revenue last year. However, due to their long-duration charters on most of their container vessels, they are not that much impacted by what we see in the spot market.

Is now a good time to enter an investment in OROVY?

We tend to lean towards Warren Buffett's wise words of being "greedy when everybody else is fearful, and fearful when everybody is greedy".

Supply and demand projects do not look favorable.

As such, we initiate our coverage of OROVY with a Hold stance.

For further details see: