The shipping industry is as cyclical as they come. When economic winds change direction, it can create quite a storm for shipping lines to navigate. Companies that are ill-prepared for these storms can sink under the weight of too much debt, which is what's starting to happen in the containership sector right now. Shippers seeking a lifeline, however, won't find one by reaching out to Seaspan Corporation (NYSE:SSW), which is making it clear that it won't renegotiate its contracts just to cut its customers some slack.
Times are tough in the containership market right now. Average box freight rates are at record lows, while sinking volumes and load factors are eerily similar to what happened during the financial crisis. This is causing shipping companies to operate in the red, forcing many to seek ways to cut costs, including charter rates.
This desire to seek charter-rate relief is a concern that containership leasing company Danaos Corporation (NYSE:DAC) brought up last quarter. CEO Dr. John Coustas said in the company's earnings press release release that:
Several liner companies, including Hyundai Merchant Marine and Hanjin Shipping, two of our largest customers, have publicly announced their intentions to restructure their balance sheets and seek concessions from charter owners in an effort to reduce their operating costs. These events are still unfolding and have not come to any resolution and we cannot speculate now how they will conclude. Needless to say, these developments have our full attention, and we are very focused on approaching these discussions with the goal of maintaining the value of our charter contracts.
Not only have these shippers reached out to Danaos seeking charter-rate concessions, but Hanjin Shipping also reached out to Seaspan Corporation with the same request, proposing a 30% cut in charter rates. Seaspan Corporation, however, wasn't even willing to talk. According to an interview CEO Gerry Wang gave to Bloomberg, his company will "not accept any rate cut." He further noted that "we have never done it," and that his company "won't tolerate a contract renegotiation." In his opinion, a signed contract is a signed contract.
Cracks in the foundation?
Seaspan Corporation's complete unwillingness to renegotiate these charters stems from their importance to sustaining its operating model. The company's foundation is built upon the stable cash flow it expects to generate from long-term time charters; the company's fleet is currently backed by $5.7 billion in contracted revenue, with an average remaining charter length of five years. It's the long-term cash flow security of these charters that allows Seaspan Corporation to finance its vessel acquisitions.
Seaspan Corporation is reluctant to renegotiate its charters with Hanjin because that could open the door for other shippers to ask for charter relief. That in turn could erode its revenue backlog, making it harder not only to finance future fleet acquisitions, but also to maintain its dividend.
What remains to be seen is whether Seaspan Corporation can indeed continue to take a hard-line stance, especially given what has happened to the contracts of other sectors over the past few years. The offshore drilling sector, for example, had been similarly backed by long-term, fee-based contracts that were seen as non-negotiable. However, given the depth of that sector's downturn, offshore drillers have been more than willing to renegotiate.
Offshore drillers have been using what are called "blend-and-extend" contracts to provide rate relief to their customers. Seadrill (NYSE:SDRL), for example, was recently awarded an 18-month contract extension for one of its drillships, commencing in April of 2018 and concluding the following October. That extension was worth $164 million to the company's backlog. However, as part of that agreement Seadrill also agreed to reduce the day rate on the current contract, which brought down its value to the backlog by $132 million. The net result was a $32 million increase to Seadrill's backlog. In other words, the company traded a lot of near-term cash flow in exchange for keeping this rig working for another year and a half.
Seaspan Corporation doesn't want to go down that same path because of the potential impact it would have not just on its cash flows, but on the value of its entire fleet. With that fleet being heavily financed, it's a risk the company isn't willing to take.
Seaspan Corporation's business model is built upon the security of the long-term time charters it has with its customers. It doesn't want to see that security breached, which is why it isn't willing to cut Hanjin's charter rates. What remains to be seen is if peers like Danaos will also take a hard-line approach, or whether they'll follow the offshore drilling sector's lead in order to keep customers happy. If that happens, Seaspan Corporation might be forced back to the negotiating table.