Will COSCO Shipping Holdings' prosperous days return as the 'variant king' sweeps the globe?

Yesterday, the Hang Seng Index plummeted by 1.58%, hitting a new low, while the shipping sector saw a significant rise,COSCO Shipping Holdings, after hitting the daily trading limit two days ago, surged again yesterday by 5.98%.The "Sea Dog" has transformed into the "Sea King."

In terms of news, a new variant of the coronavirus was recently discovered in South Africa and officially named the "Omicron" variant by the World Health Organization. Several European countries have already identified cases infected with the Omicron variant, causing global alarm as the pandemic situation remains tense. According to reports from local health officials in South Africa based on early test results, approximately 1,100 new cases reported in Gauteng Province on the 24th were attributed to this new variant, accounting for 90% of the total.This far exceeds the levels seen during the same period for earlier variants such as Delta.

Proportion of COVID-19 strain genotypes in South Africa

Source: NICD, Guosheng Securities Research Institute

Following the spread of the Omicron variant, several shipping companies in Southeast Asia, facing rising freight rates and capacity shortages, have begun imposing additional charges such as congestion surcharges, peak season surcharges, and container shortages fees. Additionally, it is understood that there have been widespread cancellations of sailings on U.S. routes due to tight vessel space.

So, are COSCO Shipping Holdings' good times really returning?

In 2021, Kweichow Maotai reported a net profit of 39.57 billion yuan in the first three quarters, CATL reported 9.145 billion yuan, and BYD reported 3.297 billion yuan. Can you guess how much COSCO Shipping Holdings made in the first three quarters? 67.59 billion yuan,You read that correctly: COSCO Shipping Holdings’ net profit in the first three quarters of this year was 67.59 billion yuan. The title “Sea King” is well-deserved.

In the first three quarters of 2021, COSCO Shipping Holdings achieved operating revenue of RMB 231.479 billion, representing a year-on-year increase of 96.65%; net profit attributable to shareholders reached RMB 67.59 billion (compared to only RMB 9.9 billion for the whole of 2020). On a quarterly basis, the company's net profits attributable to shareholders in Q1, Q2, and Q3 of 2021 were RMB 15.452 billion, RMB 21.646 billion, and RMB 30.492 billion respectively, outperforming 99% of A-share listed companies and surpassing its own past performance.

Profit growth was driven by both volume and price increases.In terms of volume, COSCO Shipping Holdings' container shipping business completed a freight volume of approximately 20.4471 million TEUs in the first three quarters, reflecting a year-on-year increase of about 8.03%. In terms of pricing, since 2021, the container shipping market has maintained high prosperity with freight rates exceeding expectations. Global goods trade remains robust, driving strong demand for container shipping, while the pandemic and certain unexpected events have continued to constrain effective supply in the container shipping industry (reduced operational efficiency at overseas ports, severe congestion, and decreased turnover rates for container ships and containers). The average value of China's Export Containerized Freight Index (CCFI) for the first three quarters of 2021 was 2,398.80 points, marking a year-on-year increase of 168.50%.

However, what has left shareholders in despair is that the share price of COSCO Shipping Holdings has been continuously falling since July, with a maximum drawdown exceeding 35%, showing a significant divergence between earnings performance and stock price.

Many may argue that COSCO Shipping Holdings is a 'pandemic beneficiary,' implying that its performance will decline once the pandemic subsides, and that the current stock price already reflects future expectations. Others claim that COSCO Shipping Holdings is a cyclical stock, suggesting it should be sold when its PE ratio reaches its lowest point. Based on common sense alone, one might indeed conclude that COSCO Shipping Holdings is not worth long-term investment at present.But can you guarantee that common sense is always right? Could it be that this time is different?

Some market participants believe that the successful development and launch of a COVID-19 therapeutic drug would improve the pandemic control situation, enhance supply chain efficiency, and significantly negatively impact container shipping freight rates.In fact, the pandemic is only one of the factors contributing to the decline in supply chain efficiency.Other factors include shortages of terminal equipment, yard space, and labor, among numerous other issues. The global supply chain involves multiple links, and inefficiency is not isolated to any single link but results from various influencing factors. Since 2021, apart from the Delta variant of the coronavirus, a series of operational incidents have occurred worldwide, such as delays caused by adverse weather conditions, labor disputes, truck capacity shortages, the Suez Canal incident, insufficient rail transport capacity, and shortages of empty containers at key locations, among other challenges.

The reasons for low supply chain efficiency can be summarized as follows:First, reduced operational efficiency due to epidemic prevention and inspection requirements.Quarantine and inspection requirements for employees at docks, warehouses, and yards, along with social distancing measures and crew isolation protocols, have decreased operational efficiency at port facilities. The recurrence of the pandemic has been a major contributing factor in this regard.

Second, cargo volumes exceeding terminal capacity lead to significant backlogs, lowering operational efficiency and disrupting shipping schedules.The surge in cargo transport and vessel deployments has far exceeded the originally designed capacities of many ports, particularly those with outdated equipment in Europe, the Americas, and Southeast Asia. Large-scale cargo backlogs have occupied yard space, complicating container retrieval and storage and significantly reducing terminal operational efficiency. Additionally, disruptions caused by adverse weather conditions have further exacerbated the deterioration in terminal efficiency, even causing severe congestion at more advanced Chinese terminals.

Cumulative year-on-year change in global container shipping volumes by route, January-August 2021

Source: CTS, CITIC Construction Investment

Finally, labor shortages and low surrounding traffic efficiency.Furthermore, terminal clearance capacity has been constrained by factors such as labor shortages, insufficient trucking capacity, limited rail transportation capacity, and issues related to road yard infrastructure. Surrounding traffic efficiency is also low, making it difficult to alleviate terminal congestion in the short term.

From another perspective, improvements in competitive dynamics have led to an oligopolistic structure (a long-term trend).In the first half of 2020, despite stagnant global demand, industry giants maintained profitability by suspending sailings and adjusting rates, demonstrating actual coordination and discipline in competitive dynamics. Furthermore, after 15 years of price wars and overcapacity competition, the industry reached a stalemate where no single player could dominate. The market structure stabilized, with most major players having state backing and three large alliances gradually forming, which was an inevitable trend. Therefore, improvements in competitive dynamics represent one of the key endogenous reasons for the upward cycle.

Regardless of whether COSCO Shipping Holdings is dubbed 'Sea Dog' or 'Sea King,' this company deserves your close attention.

The current factors influencing freight rates primarily revolve around the matching conditions on both the supply and demand sides,On the supply side, the key focus is whether congestion at ports has eased, while on the demand side, attention centers on inventory-to-sales ratios in major importing countries.Additionally, it remains essential to monitor the 2022 U.S. long-term contract signing process and the latest developments regarding the pandemic.

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