Matson (MATX) Q1 2020 Earnings Call Transcript

Matson (MATX 0.57%)
Q1 2020 Earnings Call
May 05, 2020, 4:30 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the first-quarter 2020 financial results conference call. [Operator instructions] Please be advised that today's conference is being recorded. [Operator instructions] I would now like to hand the conference over to your speaker for today, Lee Fishman, director of investor relations. You may begin.

Lee Fishman -- Director of Investor Relations

Thank you, Towanda. Joining me on the call today are Matt Cox, chairman and chief executive officer; and Joel Wine, senior vice president and chief financial officer. Slides from this presentation are available for download at our website, www.matson.com under the Investors tab. Before we begin, I would like to remind you that during the course of this call, we will make forward-looking statements within the meaning of the federal securities laws regarding expectations, predictions, projections or future events.

We believe that our expectations and assumptions are reasonable. We caution you to consider the risk factors that could cause actual results to differ materially from those in the forward-looking statements in the press release, the presentation slides, and this conference call. These risk factors are described in our press release and presentation and are more fully detailed under the caption Risk Factors on Pages 24 and to 34 of our Form 10-Q filed today, May 5, 2020, and in our subsequent filings with the SEC. Please also note that the date of this conference call is May 5, 2020, and any forward-looking statements that we make today are based on assumptions as of this date.

We undertake no obligation to update these forward-looking statements. I will now turn the call over to Matt.

Matt Cox -- Chairman and Chief Executive Officer

Thanks, Lee, and thanks to those on the call. In light of the unprecedented environment we're in, I wanted to begin the call with our current priorities before recapping our first-quarter results, so please turn to Slide 3. First, we're executing a number of critical objectives to manage the business through this pandemic and period of economic uncertainty. Our company has responded and continues to respond to the reality of operating under COVID-19 pandemic.

There are three areas, in particular, I want to highlight. Our top focus is safeguarding the health and safety of our employees by enhancing processes on the vessels to ensure crew safety, ensuring those working from our warehouses or terminals adhere to Coastguard, CDC, and other government guidelines on PPE, disinfecting, social distancing and requesting those whose job function allow them to do so to work from home. We're also focused on ensuring the consistency of our Ocean Transportation service and making sure cargo is available to our customers as quickly as possible. Messages culture is rooted in providing the highest quality service and best-in-class on-time performance to its customers because we are the lifeline to these remote communities, and this has never been more important than the pandemic environment in which we operate today.

This economic environment is unlike anything we've seen before, but we're no stranger to operating in difficult economic times. As you would expect, we are responding to the new reality and preparing for an extended downturn by managing the operational and financial aspects of the business heading into a downturn. As the COVID-19 situation evolved in early March, it became increasingly apparent that we had to ensure the company had balance sheet liquidity to manage through a sustained period of economic weakness. On March 31, we executed the amendments to our bank facility and private notes to provide additional leverage covenant headroom through the end of 2021.

Joel will go into more details on the amendments later on in the presentation. In early April, we initiated an operating and capital cost reduction plan to address the profitability challenges we expect to encounter as the economy weakens while the recovery remains uncertain. Some of the initiatives include resizing the network to lower freight volumes in our domestic tradelanes and increasing capacity in our CLX tradelane. Reducing operating costs and deferring or eliminating capital projects.

I will go into more detail on the next slide. So please turn to Slide 4. I want to spend a few minutes on these three areas where we are managing the operations for the new reality and preparing for an extended downturn. First, we're evaluating a number of operational initiatives to increase efficiencies and better align capacity to volume demand.

All of the operating initiatives we're evaluating are executing, assume that we'll be in a weaker economic environment for at least the next 9 to 12 months. We've mentioned before that we are evaluating shifting Daniel K. Inouye from the Hawaii service to the CLX. We plan to make this move in late June to better align the CLX capacity with the demand given what we see in the Transpacific Ocean and air cargo markets.

Daniel K. Inouye is one of our fastest and largest vessels and is the sister ship to the Kaimana Hila, which has been operating in the CLX since the third quarter of last year. There are a number of initiatives that we're evaluating or executing to reduce costs, some of which are on this slide. We're evaluating the Hawaii Neighbor Island barge network and the frequency of port calls.

We're also evaluating the number of port calls to Kodiak in our Alaska service. We've reduced operating hours at select terminals and are evaluating other expense reductions at the terminals to increase operating efficiencies. We're evaluating maintenance cost reductions and deferrals, and we're looking to achieve cost reductions from our service providers during this difficult time. Second, we're managing our personnel costs in a number of areas.

We have instituted a hiring freeze across the organization, and we announced today a salary reduction plan. The plan includes a reduction of 10% to 30% for the top highest 100 paid employees. The management team is at the high end of the range. The board of directors and I took a 30% salary and board cash fee reduction.

This plan took effect on May 1st. We're also reducing or eliminating discretionary costs, and we're reducing or eliminating overtime across the company. We expect the fleet repositioning, operating changes, and cost management initiatives to improve operating results by $40 million to $50 million in 2020, of which two-thirds is from fleet repositioning and other operational changes. However, the financial benefits from these actions will only partially offset profit declines in our businesses as a result of the COVID-19 situation and its economic effects.

Please turn to Slide 5. The third and final area of focus is that we are deferring or eliminating all capital spending not considered essential or previously committed. We are at the tail end of a large capital expenditure cycle with three previously announced projects expected to be completed by year end. These committed capital projects include the Hawaii vessel renewal program, where our fourth and final vessels are expected to be delivered in the fourth quarter.

The first phase of the Sand Island terminal upgrade and the six vessel scrubber program. We expect the deferral and elimination of CAPEX to result in approximately $30 million in savings in 2020. While we have a rather limited ability to curtail CAPEX in 2020 due to the committed projects I mentioned, we have more flexibility to contract the capital spending in 2021 and 2022 to the extent the depth or duration of the economic cycle is more pronounced. Without a doubt, this economic downdraft will present a number of challenges for us, but our experience in managing the company through prior recessions puts us on a relatively strong footing to adapt quickly and find opportunities.

I will now briefly recap the first-quarter results, so please turn to Slide 6. While it seems like a long time ago now, our business performed well in the first quarter despite the overhang of the COVID-19 situation. Consolidated operating income came in better than expected led by stronger-than-expected performance in Ocean Transportation, consumption of home food, and essential goods drove increased volume in our Hawaii, Alaska, and Guam tradelanes, and our CLX service returned to normal volume levels, slightly ahead of our expectations. Lastly, SSAT was challenged by canceled sailings, resulting from the COVID-19 situation, which I'll comment on later in the presentation.

Logistics operating income came in slightly below our expectation as some business lines were directly challenged by the COVID-19 situation and transportation brokerage and freight forwarding came in a little softer in March as a result of the shelter in place orders and retail store closures. On April 6, we withdrew our full-year outlook in light of the increasing economic uncertainties regarded the COVID-19 pandemic in the absence of outlook for the tradelanes, SSAT, and logistics. I will provide commentary on the current trends and business activity so far this quarter. And with that, please turn to Slide 7.

Hawaii container volume for the first quarter increased 1.7 year over year primarily due to the consumption of home food and essential goods as a result of shelter in place orders to mitigate the spread of COVID-19. The state of Hawaii announced several orders in March to mitigate the spread of COVID-19 on the islands. These orders have materially affected tourism, which led to a precipitous decline in domestic visitor arrivals mid-March, so we did not see any material impact from this development in our volume in the first quarter. However, we are now seeing the effect of near-zero tourism, as well as the impact from the temporary closure of retail stores, with April westbound container volume down approximately 12% compared to April of last year.

The westbound volume in the first half of April was slightly lower year over year, but then we saw a materially lower volume in the second half of April, with volume declining approximately 19% year over year. Based on the current volume trend, we believe we can see a decline in the mid to high teens percent in the second quarter compared to the prior-year quarter. We expect the loss of tourism to directly and indirectly meaningfully impact the volume in the second quarter and the remainder of this year. Clearly, this economic situation is different from the last two recessions, but we believe history is a reasonable starting point.

The worst quarterly volume declines we saw after 9/11 and during the Great Recession were 23% and 17%, respectively. I'd like to point out that despite the potential large decline in freight, a majority of the volume we carry will continue to flow in the form of recurring sustenance goods and some discretionary items. Please turn to Slide 8. I want to spend a few minutes on the current general state of activity in Hawaii and provide some commentary based on the latest UHERO forecast.

The statewide stay at home order has been extended from the end of April through May 31st. There is virtually no tourism on the island despite some flights on schedule. As you can imagine, hotel occupancy has declined significantly and most hotels have closed temporarily. Like the mainland, big-box retailers, pharmacies, and grocery stores remain open for residents to secure their day-to-day goods, but other essential businesses continue to operate normally.

Some nonessential businesses are beginning to open with limitations. Temporary loss of tourism is going to have a significant impact on Hawaii's economic growth. It will lead to second and third-order effects on the economy, including loss of jobs and discretionary income, lower construction activity, and lower general spending in other industries. UHERO's latest forecast captures the potential integrated effects.

The state has seen a surge in unemployment claims in March and April. Nearly 35% of the workforce in Hawaii has filed for unemployment. UHERO is forecasting a 20% year-over-year decline in non-farm jobs in the second quarter and nearly 14% unemployment rate for 2020, compared to 2.7% in 2019. Following the significant decline in tourism in March, activity is expected to remain near zero for most, if not all, of the second quarter.

UHERO is projecting for the full-year 2020 a nearly 41% decline year over year in both visitor arrivals and real visitor expenditures. The forecast implies improvement in tourist arrivals in Q3 and Q4, but still well below prior-year levels. To put the 41% annual decline in visitor expenditures into perspective, in 2008 and 2009, the worst year-over-year quarter decline in that time frame was roughly 21% and the worst annual decline was 15%. The peak to trough decline from 2007 to 2009 was nearly 30%.

So the COVID-19 economic effects from tourism are forecast to be far worse than what we saw in the last recession. UHERO forecast construction charge to fall by nearly 3% in 2020. Current projects in construction are expected to continue to completion, but those in the planning phases are likely to be postponed. GDP for 2020 is forecast to decline of 7.7% year over year.

This could be the worst GDP growth rate in UHERO's recorded history dating back to the '60s. To put this forecast into perspective, the largest year-over-year quarterly GDP decline in the 2007 to 2009 time frame was approximately 3%. The depth and duration of this economic cycle remain unclear, and the economic effects from the loss of tourism will be significant in the second quarter and the rest of the year. However, again, the majority of our Hawaii service volume consists of highly recurring sustenance goods, and we expect to maintain a good level of demand for this type of volume in this pandemic environment.

Moving on now to our China service on Slide 9. Matson's volume in the first quarter of 2020 was 6.5% lower year over year, but we achieved average freight rates that approximated the level achieved in the year-ago period. China's COVID-19 mitigation efforts elongated our traditional post-Lunar New Year volume low by affecting factory production, factory report infrastructure logistics, and our customers' inventory sourcing to produce goods. The ramp-up in volume from the post-Lunar New Year loads and normal levels in March was slightly ahead of what we expected in our fourth-quarter earnings call.

For the month of April, our CLX service eastbound volume increased by 4% year over year compared to the prior-year period. Demand for the CLX service has been very strong as our differentiated expedited service remains an attractive offering amid the disruption and loss of capacity in the Transpacific air cargo and Ocean freight markets. Historically, the CLX has carried a higher percentage of garments, footwear, and other items in tight supply chains. Apparel and footwear retail volume has declined significantly as a result of shelter in place orders and the temporary closure of U.S.

retail stores. The reduction in retail volume is being infilled by other high demand volumes. For example, our ships have been carrying mass sanitizer and personal protection equipment, as well as other critical supplies including electronics to support growth in the work-at-home environment. We're also seeing much more e-commerce volume at some ocean carriers have canceled sailings and the reduction in air cargo capacity has shifted this type of traffic to our service.

Please turn to Slide 10. I want to spend a few minutes on what we see in the Transpacific tradelane for the balance of the year and how we are positioning our CLX service. We think the disruption in the Transpacific air freight market will continue in the near term and believe our CLX service will experience good demand from this. A substantial loss of capacity from passenger jet belly space is difficult to replace immediately, and it is unknown when this capacity will return to normal.

The loss of air cargo capacity has led to historically -- maybe historically as well, but historically high airfreight rates, almost two to three times previous records. And we've said this before, that our premium expedited service is an attractive alternative to defer air freight, given the significantly lower cost per box with only five-day longer service. We expect unsettled conditions in the Transpacific tradelane to remain for the balance of the year. Already this quarter, there have been a large number of canceled sailings in the tradelane.

As I mentioned earlier, we plan to move one of our fastest and largest vessels, the Daniel K. Inouye, from the Hawaii service to the CLX service in late June. This vessel will add roughly 500 container containers per trip when utilized. For the balance of the year, we expect to infill volume where we can and we know that at some point, retail stores in the U.S.

will open up again, and those volumes turn. We believe that our initiatives will continue to keep the ships full for the rest of the year. Lastly, we will continue to evaluate opportunities to increase capacity in the CLX string in light of the supply/demand dynamics we see. For example, next week, we chartered a vessel for one voyage to sell opposite the smallest of our CLX vessels to supplement our capacity given the extremely strong demand for our expedited service offering.

Turning to Slide 11, in Guam, Matson's container volume in the first-quarter 2020 decreased 3.9% year over year, primarily due to tightening relief related volume in the year-ago period, partially offset by higher volume due to increased demand of essential goods and home food as a result of COVID-19. In April, our westbound container volume declined approximately 4% compared to April 2019. We saw progressively weaker volume throughout the month as the loss of tourism and the temporary closure of retail stores negatively impacted volume. We believe we were in the early innings of volume decline in the tradelane and expect further volume loss in May.

Looking back to westbound volume impact in the Great Recession period of 2008, 2009, the worst quarterly year-over-year decline was nearly 15%. And while the ultimate freight decline will likely be significant, we expect the majority of volume we saw last year to flow in the form of recurring sustenance goods and items. Moving now to Slide 12, in Alaska, Matson's container volume for the first-quarter 2020 increased 11%, primarily due to greater demand from home food, food, and essential goods as residents shelter in place due to COVID-19, as well as volume associated with the dry docking of a competitor's vessel. Approximately one-third of the volume increase in the quarter was attributable to the competitor's vessel dry-dockings on volume in the quarter was modestly lower than the level achieved in the first-quarter 2019.

For April, northbound volume declined approximately 3% compared to April 2019. We saw continued strength in home food and essential good volume in the first half of April, but then we saw materially weaker volume in the last couple of weeks of the month with volume declining at approximately 14% year over year. We believe we'd see volume decline in the mid-teens in the second quarter compared to prior year. Looking back at the northbound volume impact in the Great Recession period of 2008, 2009, and the worst quarterly year-over-year decline was a little over 8%.

So a mid-teens percent volume decline in the second quarter would be nearly twice the percent decline seen in the last recession. Turning next to Slide 13, I want to spend a few moments on the current state of activity in Alaska and provide some commentary based on the latest economic information. Similar to Hawaii, Alaska is under a statewide shelter in place. The state initially mandated the closure of all nonessential businesses but recently allowed select industries to reopen subject to limitation, including restaurants and retail stores.

The state ordered a more aggressive travel ban with no flights into and within the state, and in early April, the major cruise line operators announced they are canceling their summer trips. The precipitous fall in oil prices to extremely low levels prompted some producers to curtail production and reduced rig workers on-site as a result of the COVID-19 mitigation efforts. There are currently a lot of focus on protecting the fishing industry and the surrounding communities during the upcoming salmon season. Protocols on worker safety on the fishing vessels and that the commercial fisheries have been put into place to mitigate the spread of the virus.

The economic toll from COVID-19 and the fall in oil prices is likely to be significant. In a report issued on April 6 by the Alaska Department of Revenues, state revenue for 2020 is forecasted to decline by approximately 40%, which will necessitate budget and possibly other measures to address the shortfall. Unemployment is expected to increase significantly, even with the limited reopening of some nonessential businesses. The Alaska Department of Labor and Workforce Development noted recently that in the last six weeks, over 14% of the half a million working-age population in the state filed for unemployment benefits with accommodation and food services industries hit the hardest.

Although the tourism season in Alaska is short, it's an important contributor to the state's economy. The cancellation of cruise tours will have a negative effect on the economy, and it remains to be seen what will happen with other tourist-related activities. In the oil industry, we expect some production will be deferred due to lower oil prices in the near term and some development projects will likely be delayed. The depth and duration of this economic cycle remain unclear, and the economic effects within the state will be significant in the second quarter and the rest of the year.

However, the majority of our Alaska service northbound consists of highly recurring sustenance goods, and we continue to expect a good level of demand from this type of volume in this pandemic environment. Further, we have little direct exposure to the oil activity in the state, including projects on the North Slope, so we anticipate little to no direct impact from the sector. We also have no direct exposure to the cruise industry and related to tourism activity as most of the cruise lines go to Southeast Alaska, and our operations cater to the rail boat area near Anchorage. We expect southbound volume to remain steady, but we want to remind everyone that this year's summer catch season off-year in the two-year fishing cycle.

Turning to the next slide, 14. Our terminal joint venture SSAT contributed $4 million in the first quarter of 2020, compared to $8.5 million in the prior-year period. The decline year over year was primarily due to the additional expense related to the lease accounting standard adopted in the second-quarter 2019 and lower lift volume due to canceled Transpacific sailings. In April, SSAT experienced volume loss from additional canceled Transpacific sailings.

We expect U.S. West Coast import volumes in the near term, we remain challenged with reduced consumer demand due to ongoing shelter in place orders and canceled Transpacific sailings. We expect the recovery in the volumes at SSAT to be closely tied to the speed and recovery of the U.S. economy, but at this point remain unclear.

Turning now to logistics on Slide 15, operating income in the first quarter came in at $5.1 million or $3 million lower than the result in the year-ago period. The decrease was primarily due to lower contributions from transportation brokerage and freight forwarding. Both of which experienced a softer March as a result of shelter in place orders and retail store closures. COVID-19 had a direct negative impact on our international intermodal and supply chain service businesses.

In April, our transportation brokerage and freight forwarding businesses continued to be negatively impacted by the COVID-19 mitigation efforts and the economic effects. Within transportation brokerage, lower import volume on the U.S. West Coast impacted our intermodal business, and the temporary closure of retail stores negatively impacted our highway business. The temporary closure of retail stores in Alaska, many of which are small to medium-sized businesses that use less than container load forwarding services, negatively impacted our freight forwarding business, and we anticipate the reopening of some nonessential businesses to provide a modest lift to the volume in the near term.

We expect the majority of our logistics businesses to face challenging conditions for the balance of the year. I will now turn the call over to Joel for a review of our financial performance and recent capital structure updates. Joel?

Joel Wine -- Senior Vice President and Chief Financial Officer

Thanks, Matt. Now on to our first-quarter financial results on Slide 16. Ocean Transportation operating income for the first quarter decreased $1.5 million year over year to $7.9 million. The decrease was primarily due to a lower contribution from China and SSAT and higher depreciation, partially offset by lower vessel operating expenses, primarily resulting from one less vessel in the operating in the Hawaii service and the timing of fuel surcharge collections.

The company's SSAT terminal joint venture investment contributed $4 million or $4.5 million less than the prior-year period. The decrease was primarily due to the additional expense related to the new lease accounting standard adopted in the second quarter of 2019 that did not hit the first quarter last year, as well as lower volume due to canceled Transpacific sailings. Logistics operating income for the quarter was $5.1 million or $3 million lower than the prior-year period. The decrease was due primarily to lower contributions from transportation brokerage and freight forwarding.

EBITDA for the quarter decreased $2.8 million year over year to $46.5 million due to a lower consolidated operating income of $4.5 million, partially offset by an increase of $1.7 million in depreciation and amortization which includes dry dock amortization. Interest expense for the quarter was $8.6 million or $3 million higher than the fourth quarter of 2019, primarily due to the higher capitalized interest associated with the lower lean moving into the P&L when the vessel was placed into service in the first week of January. Lastly, the effective tax rate in the quarter was 24%. Slide 17 shows how we allocated our trailing 12 months of cash flow generation.

For the LTM period, we generated cash flow from operations of $284 million, borrowed $56.7 million on a net basis and received $14.3 million from sale-leasebacks, from which we used $103.8 million on maintenance CAPEX, $207.3 million on new vessel CAPEX including capitalized interest and owners' items and $4.9 million on other cash flows while returning $37.6 million to shareholders via dividends. Turn to Slide 18 for a summary of our balance sheet, you will note that our total debt at the end of the quarter was $924.9 million, and our net debt was $905 million. As we indicated on previous earnings calls, we expected our leverage to peak in the first quarter of this year in the mid-threes, and we would begin to deleverage after the first quarter. Unfortunately, the COVID-19-driven economic downturn is expected to have a significant impact on our businesses in the near term and will push the timing of our peak leverage to be later than we originally anticipated.

Please turn to the next slide. So on Slide 19, in light of the evolving COVID-19 situation, we announced on April 6 that we amended our revolving credit facility in private notes at the end of March in order to enhance our liquidity and access to borrowing capacity under our $650 million bank revolving credit facility. These new amendments will provide Matson enhanced financial flexibility until December 30, 2021. The allowable leverage ratio was previously 3.75 times.

And under the new amendments, the allowable leverage ratio will adjust by fiscal quarter up to a maximum of five times as shown on the table on the slide. As of the end of the first-quarter 2020, our leverage ratio under the debt agreement was 3.40 times and the available borrowings to the allowable leverage ratio of four times is approximately $164 million. As a reminder, the EBITDA we report in our press release and in this presentation is different and lower than the EBITDA calculated under our debt agreements. These amendments will increase the effective interest rate on our debt through the amendment period, and the rate on the revolving credit facility in the private notes will be a function of the actual quarterly leverage ratio.

In the event, Matson loses its investment-grade rating either through a downgrade or rating withdrawal, the coupon step-ups on the private notes will increase an additional 100 basis points. Additional details on the amendments can be found in the 8-K filed with the SEC on April 6. Now please turn to Slide 20. On April 30th, Matson announced that it issued a debt instrument under the United States government's Title XI program for gross proceeds of $186 million.

We used the $177 million in net proceeds from the transaction to reduce outstanding debt. The Title XI debt matures in October of 2043 bears a fixed cash coupon of 1.22%, payable semiannually, and is amortized by semiannual payments of approximately $4 million plus interest. Taking into account the up-front guarantee fee paid as part of the Title XI program, the effective interest rate for accounting purposes is approximately 1.60%. Given the attractiveness of this financing rate structure, we are evaluating an additional Title XI debt instrument of approximately $140 million in size to further optimize our balance sheet and reduce our debt cost of capital.

Shifting gears to the CARES Act and other government stimulus measures enacted thus far, we expect to have limited benefits in 2020 from the legislation. Under the CARES Act, we expect to reclaim the remaining $22.9 million in AMT receivable in 2020, of which we previously expected to reclaim half the amount this year and half next year. We also expect to be able to defer approximately $9 million in payroll tax payments for the remainder of this year, with 50% of the deferred amount payable in each of December of 2021 and in December of 2022. Turning to Slide 21 for a review of our new vessel payments.

For the first quarter, we had new vessel cash capital expenditures of $7.2 million and capitalized interest of $1.9 million for total capitalized vessel construction expenditures of $9.1 million. The table on the right-hand side of the slide shows the cumulative and remaining new vessel progress payments. For the remainder of 2020, we expect the last milestone cash payments to be approximately $60.6 million which is net of the $1.2 million of cash already in escrow on the balance sheet. The picture on the slide is at the Matsonia on the building ways in San Diego at NASSCO.

Matsonia is currently 80% complete, and we continue to expect delivery in the fourth quarter of this year. With that, I'll now turn the call back over to Matt.

Matt Cox -- Chairman and Chief Executive Officer

Thanks, Joel. Please turn to Slide 22 for my concluding remarks. Our second quarter is likely to be the worst period in this cycle as tourism is at a near standstill in Hawaii and all of our other U.S. markets face economic headwinds from the shelter in place orders.

However, we strongly believe it is the inherent qualities of our businesses will be a standout throughout the economic cycle. Matson is the lifeline to remote communities of Hawaii, Alaska, and Guam, where we relied upon to deliver sustenance goods week by week. Our culture replacing high priority on-time performance and high quality of service to these remote communities are at the heart of what makes Matson a preeminent transporter of goods, a critical part of domestic supply chains. Our CLX service is a superior product in times like this, where airfreight capacity is challenged and other Transpacific carriers are canceling sailings.

Our logistics businesses thrive when conditions are chaotic and bring high-quality service that is priced during difficult times like these. Our recent debt amendments provide the necessary balance sheet liquidity to manage through the storm and complete our Hawaii fleet renewal phase one of the Sand Island terminal upgrade and our six vessel scrubber program this year despite the challenging circumstances. As we speak today with all of the uncertainty surrounding us, I strongly believe that Matson will come out of this cycle position well with new and stronger customer relationships, new opportunities, and the satisfaction that we met the greatest challenge of managing freight in this unprecedented time. And with that, I will turn the call back to the operator and ask for your questions.

Operator?

Questions & Answers:

Operator

[Operator instructions] Our first question comes from the line of Jack Atkins with Stephens.

Jack Atkins -- Stephens Inc. -- Analyst

Hey, Matt and Joel. Thanks so much for the time. Well, I guess, let me start off by saying that thank you for all the detail that you guys provided. I think that's the most detailed in terms of business trends and outlook that we've heard from a lot of companies.

So kudos on that. I know it's a tough operating environment. I guess let me start with sort of the cost reduction actions. And as you think about that $40 million to $50 million that you guys have targeted, I believe it's for the balance of this year, can you talk about how that gets scaled in? And how much of that is permanent versus just temporary based on current business levels?

Matt Cox -- Chairman and Chief Executive Officer

OK. Yes. Jack, this is Matt. I'll take a crack at it and then I'll ask Joel to comment on some of the sequencing and timing.

So I think basically, the cost reduction efforts, as I mentioned, fall into several buckets. The first is in the category of deploying our largest assets in the market that seems the most active. What's clear is Hawaii will remain muted for the time being at least. And so moving our larger vessels into the CLX where we happen to have this unprecedented level of demand given the relocation of the market will produce some of that benefit.

And then we basically did a bottom-up as most companies are doing, bottom-up look at ways in which we can reduce our operating expenses in line with the lower expected levels of freight volume. And so there are, I would say, over 100 separate initiatives from every terminal, from every location, every one of our locations, which are looking at ways to reduce our operating costs. And then, of course, we're looking at deferring capital and deferring all sorts of discretionary expenditures until we get a better look at this cycle. So I would say with regard to your question about when and how they roll out a number of the initiatives that we're looking at are only get a three-quarter year or eight-month benefit.

So the annual run rate of that $40 million to $50 million is actually higher. And to the extent that the economic cycle remains muted into the future, we'll have a running head start on cost reduction initiatives going into 2021 if that's necessary. So given that it was difficult for us to know exactly what was going to happen, we've decided to take a very strong firm reduction at our recurring operating expenses given the uncertainty. But we're also careful to do nothing that would create permanent damage to our services so that when the cycle ends, our whole goal is to remain effective and to be able to bounce back when that eventual recovery occurs, although, for planning purposes, we're not assuming it happens in the next nine to 12 months.

But what else would you add, Joel, for that?

Joel Wine -- Senior Vice President and Chief Financial Officer

Yes. I think that hits it all. I mean, Jack, and I think the key to your point, a question around timing is a number of these initiatives don't -- you can't just make them go effect one day, you have to phase them in. So a lot of that -- some of them began at the end of April.

A number of other ones, especially the vessel departments will be phased in as we move vessels into these markets through the course of May and June. So if you look at the total $40 million to $50 million, you and investors should wait for more of that to Q3 and Q4. Some of it will definitely benefit Q2, but it won't be proportional equally between Q2 and the latter half of the year. So that's a little bit of sense on the overall timing this year.

And then you also said how many of these will be permanent. And as Matt just articulated, to the extent that we keep our vessels where they are, they'll be permanent. But to the extent that we move them later because market conditions dictate, then it will change, but we'll give updates around the magnitude of that as dictated as those changes occur.

Jack Atkins -- Stephens Inc. -- Analyst

OK. That all makes a lot of sense. And so I guess just sort of following along with that. I mean, given that it seems like the second quarter, hopefully, is the trough from a volume perspective, and it's going to take at least a little bit of time to get to that full $40 million to $50 million run rate, do you expect the business to be able to generate a profit in the second quarter? I know you're not giving guidance.

I'm just trying to think that, trying to figure out, does all this equate to breakeven or maybe even a modest operating loss? Or do you think we're going to be able to generate a profit in the second quarter?

Joel Wine -- Senior Vice President and Chief Financial Officer

Yes. Jack, we believe we'll have a profit in Q2 this year.

Jack Atkins -- Stephens Inc. -- Analyst

OK. That's great. That's great to hear. Last question for me, and I'll turn it over.

On the Title XI financing. Joel, can you just talk for a moment about does that provide you more flexibility around the fleet longer term, less flexibility rather pleased that change the way you kind of think about the capital structure as we sort of look out over the next several years? I know you guys have sort of debated whether or not to take that financing in the past and opted not to now obviously give you a little more flexibility near term. Does that change anything longer term about the business?

Joel Wine -- Senior Vice President and Chief Financial Officer

No. I don't think it does. It will have zero impact on how we deploy the vessels themselves. So it's really just a capital structure financing decision.

And the reason we've been reluctant to do too many of these because it's really important that Matson has access to unsecured long-term capital when and where we need it, and the core foundation of that is being an investment-grade company. And if you just do too much-secured financing, then you lose or maybe inhibit some of your access to unsecured capital. So that's why we've talked about it in the way we have in the past. But if you look at the new world we're in Jack, of course, which we don't think is going to go away in a quarter or two, this is incredibly attractive financing, long-term financing, as I said, 1.6% effective interest rate, 1.22 cash coupon, this is really, really low-cost of capital.

And so from our perspective, it absolutely makes sense to do right now to do it in a judicious way. And we think exploring another tranche of this, around $140 million in size, as I mentioned, is smart for us to do in this environment. So that's why we're looking at it. But no impact to operations or how we deploy the vessels, Jack.

Jack Atkins -- Stephens Inc. -- Analyst

OK. That's great to hear. Thanks again for the time, guys.

Joel Wine -- Senior Vice President and Chief Financial Officer

Thanks, Jack.

Operator

Thank you. Our next question comes from the line of Ben Nolan with Stifel. Your line is open.

Ben Nolan -- Stifel Financial Corp. -- Analyst

Great. Thank you, and a good quarter, guys. And first, let me just come out and say, I appreciate you guys are taking a hit to your own salaries. And I think that's very admirable and good for you for doing that.

But I have a handful of questions. And the first is just as we look at capital allocation in this environment, and I appreciate it's a little bit early, but on early in June, every year, you can set your clock, but you guys increasing your dividend. Have you given any thought to that? Or how do you prioritize dividends in general with respect to where we are in the market? And do you sort of view that as sacred or a tool in a tool chest?

Matt Cox -- Chairman and Chief Executive Officer

Yes. Ben, thanks for the question and for your comment earlier. But basically, we continue to be and believe ourselves to be in a very strong cash flow creator. And while we're at the very end of a large capital program and not to minimize the disruption, but inconveniently timed recession, we don't believe that interrupts our long-term story about cash flow generation, and we equally remain committed to being disciplined in returning capital to shareholders.

So while the board will make the decision with respect to dividends and the approach to dividends, we see ourselves very much committed to that approach of capital if that answers your question.

Ben Nolan -- Stifel Financial Corp. -- Analyst

No. No. That's perfect. And then my next question is sort of around, I mean, you are shifting the more modern larger ships to the CLX service, totally understandable.

Earlier on, you made some comments about maybe changing some of the Neighbor Island port call schedules or Kodiak. Curious if there are any long-term implications of some of those moves. I suppose you can always go back and do them again as demand is required, but does it change the supply chains at all such that maybe there's the unintended consequence?

Matt Cox -- Chairman and Chief Executive Officer

Yes. I mean, I would say the answer to your question specifically is yes, there are adjustments that are required by our customers. So for example, if we were making three calls to a particular day or island, and now we're making two, we have to make sure that we're carrying the cargo a little bit differently the way that our retail store customers would have to order to restock in order for the cargo to be flowed onto their network will require some adjustments. All of that takes some adjustment work by customers, but that can be easily changed volume returns.

And obviously, we're working very closely with our customers to make sure that their core sales and supply chains are not interrupted by this too dramatically but again are all very changeable, we think, with minimal disruption and can be easily changed back when volume returns.

Ben Nolan -- Stifel Financial Corp. -- Analyst

OK. Helpful. And then lastly, again, maybe a bigger kind of a macro, bigger picture question, and in my opinion, you guys think bigger picture. As you look out, and let's say that this is maybe certainly, it's a challenging environment now, and it remains challenging for a little while.

Do you envision any big changes in sort of the competitive landscape that you're offering it? And that certainly is true for the ocean service, but also on the logistics side, I mean, is there -- do you view this as an opportunity to maybe take market share? Or do you think there's going to be some consolidation or shifting of share or any of those kinds of things that might fall out as people grapple with the current environment?

Matt Cox -- Chairman and Chief Executive Officer

Yes. I mean, it's a great question. A little difficult to know for certain. But I mean, if you just look at it trade by trade, it's the easiest way or the way we think about it.

If you look at Hawaii, Hawaii has been a two-carrier trade many decades and decades as has been Alaska, we don't expect the fundamentals of those carrier dynamics to change. If you look at the China market, it continues to be in turmoil. And depending on the depth and duration of this economic cycle, you could expect potentially further international ocean carrier consolidation, whether there's bankruptcies or acquisitions or whether national governments continue to combine their flag carriers. All of that is there's a possibility.

I think as it relates to our Logistics business, for the most part, we see opportunities there. I mean, I think, first of all, it's important for us to have resized our capital projects and in our fleet for the new economic circumstances, and we're going to continue to be working on this. By any means, I don't think we're done as we continue to look at it, but we wanted to make a very early and strong statement about changes to our structure. We do think that there will be some opportunities as other companies who are not as well prepared and Matson has got a long arch of history.

I mean we were mentioning we don't quite remember the Civil War but we do remember World War I and World War II. So we've been around a long time. And often in these downturns, opportunities will present themselves. And I think, first, us resizing our networks and doing what we needed to do.

But secondly, be able to look out for opportunities as they present themselves perhaps in the logistics space or elsewhere, I think it's very much on our minds.

Ben Nolan -- Stifel Financial Corp. -- Analyst

OK. All right. Well, with that, I'll turn it over, but I appreciate the time.

Matt Cox -- Chairman and Chief Executive Officer

Yes. OK. Thank you, Ben.

Operator

[Operator instructions] I'm not showing any further questions at this time. I would like to turn the call over to Matt Cox for closing remarks.

Matt Cox -- Chairman and Chief Executive Officer

OK. Well, thank you, everybody. Please stay safe. We look forward to catching up with everyone at the end of the second quarter call.

Aloha.

Operator

[Operator signoff]

Duration: 54 minutes

Call participants:

Lee Fishman -- Director of Investor Relations

Matt Cox -- Chairman and Chief Executive Officer

Joel Wine -- Senior Vice President and Chief Financial Officer

Jack Atkins -- Stephens Inc. -- Analyst

Ben Nolan -- Stifel Financial Corp. -- Analyst

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