Morningstar - Q4 2021 - 50

Strategies
market, where passing on costs to price-sensitive
customers is difficult.
Valuations in the fashion segment are generally
high, with the buoyant market elevating the
prices of almost all the mainstream names we
cover. We do see value in a handful of stocks,
almost all of which are " special situations. " The
lack of a strong online presence of Europe-listed
watchmaker Swatch Group SWGAY, combined
with its nearly 50% exposure to China, is enough
to discourage some investors but has created
a rare opportunity to purchase an established
luxury goods stock at a significant discount to its
fair value. In the U.S., activewear and basic
apparel producer Hanesbrands HBI is expected to
return to profitability in 2022. (For more on
Hanesbrands, see " A Rare Bargain, " Page 65.)
Shipping/Logistics: Opportunities Have Sailed
Shipping and logistics companies have been the
clear supply chain winners. For shippers, the story
is straightforward. Demand fell sharply in the
early months of the pandemic but quickly rebounded,
returning to growth in the third quarter of 2020.
The spike in demand drove freight rates higher.
So, while transported volumes remain below
2019 levels as of September 2021, excess demand
for container capacity has caused a bidding
war. The increase in freight rates was particularly
pronounced on east-west routes, as Chinese
manufacturers attempted to satisfy the demand
from Western consumers. Meanwhile, fuel costs
have actually fallen moderately from 2019 levels.
Higher freight rates and lower fuel costs have
allowed carriers such as Maersk MAERSK B to
generate outsize profits, with EBITDA margins
doubling year over year in the second quarter of
2021. With profits comes big share price movements.
Maersk's price was cut in half at the onset of
the crisis, but it has risen threefold since. As things
stand, we see little upside to our DKK 18,200
fair value estimate, which is predicated on freight
rates falling back to more normal levels in 2022.
Should the current situation persist, however,
an opportunity in Maersk may again present itself.
For the logistics industry, the situation is more
nuanced. In normal times, logistics firms
simply pass on the freight cost to the shipper.
50
Morningstar Q4 2021
In theory, then, higher freight rates shouldn't
make a difference to their gross profit. However,
many large logistics firms have been able to
capitalize on capacity issues to attract new clients
and upsell additional services amid increased
border restrictions during the pandemic. This
financial opportunity, albeit temporary, has already
been reflected in the share prices, with shares of
the likes of DSV DSDVY and Kuehne + Nagel
KHNGF more than doubling in price since January
2020. Clearly, the current situation cannot
persist, and rates will eventually revert to normal
levels, eroding much of the opportunity for
logistics firms to maximize their profits.
Fixes Are Coming
The good news for the global supply chain is that
we are through the worst of the crisis. That is
not to say that the problems in the shipping
networks are solved, nor does it mean that ports
are not experiencing problems. The ports of Los
Angeles and Long Beach, California, for example,
had about 70 vessels waiting to offload cargo as
recently as September. Normally, they would have
zero or one ship waiting. Exports from China and
other Asian countries remain at record highs,
stretching the shipping network to near breaking
point. Aggressive furloughs have left many
countries with a shortage of labor. In addition, the
delta variant is causing scattered COVID-19
outbreaks, resulting in shutdowns of facilities.
Demand for capacity shows no signs of abating
anytime soon. The Bureau for Economic Policy
Analysis in the Netherlands estimates that global
exports of goods and services will increase 6.8% in
2021 and 5.4% in 2022, figures that dovetail with
IHS Markit's estimates of future container shipping
demand. Markit projects that demand will remain
above capacity growth as far as 2026 ( EXHIBIT 1 ).
With demand forecast to outstrip supply, why are
the carriers not adding more capacity? The short
answer is they are, at least to some degree.
Annual vessel orders have risen from 2019 lows of
around 10% of total fleet capacity to closer to 13%
in 2021. But in the last capital cycle in 2007, the
order book hit an all-time high of 54%. In that
context, the latest order is highly conservative. The
reasons for this conservatism come back to
the changes in the shipping industry. In the last
downturn, global carriers got their timing wrong,
placing large vessel orders at the peak of the cycle,
which then arrived in the midst of a downturn,
exacerbating oversupply and downward pressure
on freight rates. The large carriers, more organized
and having learned from the past, are now
reluctant to react to satisfy current demand when
the average three-year lag on the delivery of large
vessels would mean additions to capacity would
come too late to meet today's spikes.
That is not to say carriers are doing nothing to help
alleviate the current situation. First, they are
delaying the scrapping of older vessels to retain as
much capacity as possible. Scrapping levels in
2021 are at record lows, with close to zero capacity
being taken off line. Second, carriers are placing
large orders for shipping containers. There are
180 million containers in use globally, but shipping
delays and wait times at ports have led to lower
circulation for containers. According to shipping
consultants Drewry, container factories,
concentrated almost solely in China, are expected
to produce a record 5.4 million units this year.
Developments from outside the industry should
also help. Worker furloughs are ending, and
as more people are vaccinated against COVID-19
worldwide, workplace restrictions that hinder
efficiency at ports should ease. As Western
economies open and airlines add travel routes, air
shipping capacity should also increase.
Taken together, these fixes should help alleviate
the pressure on supply chains and bring
down freight rates. Market consensus is predicting
a normalization of rates in 2022, falling by
almost 20% from their height at the end of 2021.
While we agree with the premise here, we
believe the risk is to the downside. These fixes
may not have their desired effect until early
or mid-2022, meaning elevated freight rates could
persist for a while longer. And even with
these fixes, it is clear that global supply chains
require structural changes to fully bring shipping
costs and reliability back to normal. K
Michael Field, CFA, is a senior equity analyst at
Morningstar Research Services LLC.
David Whiston, CFA, CPA, CFE, is an equity strategist at
Morningstar Research Services LLC.
https://www.morningstar.com/stocks/pinx/khngf/quote https://www.morningstar.com/stocks/pinx/dsdvf/quote https://www.morningstar.com/stocks/pinx/khngf/quote https://www.morningstar.com/stocks/pinx/swgnf/quote https://www.morningstar.com/stocks/xnys/hbi/quote http://Current issue, page 65 http://Current issue, page 65 https://www.morningstar.com/stocks/pinx/amkaf/quote https://www.morningstar.com/authors/1995/michael-field https://www.morningstar.com/authors/766/david-whiston
Morningstar - Q4 2021

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