International Maritime Transport

Perspectives

Heather Leggate, James McConville, Alfonso Morvillo

• Publisher: Routledge
• Year: 2004
• ISBN:
  9781134270583
• Edition: 1
• Topic: Business
• Subtopic: Transportation Industry
• Index: Business

The importance of the international maritime transport industry is difficult to overstate. This new book presents an interdisciplinary approach from a wide range of internationally-based experts. International Maritime Transport represents a radical departure from previous works in its structure and approach. The section editors each discuss the state of the art in the opening chapter, before introducing a selection of works providing a wide-ranging analysis of the subject. Wide discretion of approach has provided literary freedom for individual opinion and analysis within the overall framework: this permits a level of innovation which is perhaps stifled by the more standardized model. Whilst each perspective can be seen as exclusive, together they form a comprehensive volume of issues in contemporary maritime transport. Topics covered include: ports as interfaces, logistics, manpower and skills, financial risk and opportunities, the regulatory framework. Each chapter contains an introduction which explains the context of the chapter within the book and the contemporary state of the art. Under the editorship of maritime experts James McConville, Alfonso Morvillo and Heather Leggate, the book is sure to be of interest to students and academics working on maritime studies, as well as being useful to professionals and policy makers in the maritime industry.

Part I
Financial strategy

Edited by Heather Leggate

1
Financial risks and opportunities

Heather Leggate

1 Introduction

The Shipping Industry operates in an environment of uncertainty, with the cyclical and unpredictable nature of freight rates and the changing fortunes of the second-hand market creating a background of instability against which the business must operate.

This level of risk has implications both for the corporate entity and its investors. From the corporate perspective, the level of business risk has to be taken into consideration in appraising future investment, and obtaining appropriate sources of finance for those investments. As far as the investor is concerned, a high level of risk is expected to translate into high return.

Further financial risks are generated by the level of debt finance, whilst the volatility in the exchange rates particularly against the US dollar and fluctuations of interest rates can have a significant impact on performance.

But what of the opportunities? Shipping is an industry steeped in tradition and often it is these traditional attitudes which prevent a more imaginative approach to financial management.

Shipping is generally recognised as being a low margin business. Income is derived from the movement of cargo, which is dictated by the freight rate. Expenses comprise voyage costs, port dues, administrative costs and wages which may be substantial, leading to low operating profit. Given the huge capital requirement in terms of vessels, financing costs in the form of interest can further reduce the overall profitability of the business. Typically, the industry has used substantial amounts of debt to finance its activities and therefore has what is known as high gearing or leverage. This huge financing requirement is a reflection not only of the capital intensity of the industry but also the ageing fleet.

2 Sources of finance

Sources of finance available to companies essentially fall into two categories: debt and equity. Both debt and equity have a cost. Companies strive to minimise this cost in the establishment of their capital structure. Debt theoretically has a lower cost than equity because it carries less risk to the investor. If this is the case, why do companies bother with equity finance? The answer is that the financing decision is based on a number of factors not merely the costs of capital but control of the business, cash flow and access to funds. It could be argued that financing is principally a marketing problem. The company tries to split cash flows generated by its assets into different streams that will appeal to investors with different tastes, wealth and tax profiles.

2.1 Equity

The equity holders or shareholders are the owners of that business and have ultimate control of the company's affairs. In practice, this control is limited to a right to vote on appointments to the board of directors and a number of other matters. They hold the equity interest or residual claim, since they receive whatever assets or earnings are left over in the business after all its debts are paid. However, they have limited liability in that the maximum amount they can lose if the company goes bust is their investment in the shares. None of the other assets of the shareholder is exposed to the company.

The cost of equity to the company is the return derived by the shareholders. This takes the form of dividends and capital gain. Dividends are usually paid annually or semi annually out of earnings or profits and are discretionary. Indeed, a profitable business may decide to retain earnings to reinvest in the business. These retained earnings are in fact a major source of finance for a company. Capital gains or losses may arise from fluctuations in the share price and may be realised if the holder sells his shares. Since both dividends and capital gains are uncertain, shareholders require a high rate of return to compensate them for this risk or uncertainty which can make equity a costly form of finance.

The issue of share capital is also more costly than the issue of debt due mainly to the exacting compliance procedure relating to stock markets, particularly on the established exchanges. There are however, cheaper ways of doing this through the issue of shares to existing shareholders or by the placement of shares to known investors.

Apart from the relatively high cost of equity, another reason why shipping companies have avoided equity finance is that it may mean relinquishing control of the business. This is a particular problem for the smaller companies where the shares are owned by family members. An increased number of shares distributed to new investors will dilute the overall voting power of existing shareholders. One way of avoiding this situation is to make what is known as a ‘rights issue’. Here the shareholders are offered additional shares often at a discount on the market price in proportion to their existing holding. If the ‘rights’ are taken up, the per-centage holding remains unchanged, but the company still manages to raise the required finance.

2.2 Debt

Lenders are not the owners or proprietors of the business and therefore have no voting power. The variety of corporate debt instruments is almost endless. The instruments are classified by maturity, repayment provisions, seniority, security, default risk, interest rates (fixed or floating), and issue procedures. From the investment perspective, debt carries less risk than equity because interest and principal must be paid before there can be any distribution to the shareholders. Debtholders are entitled to a fixed regular payment of interest and repayment of the principal according to an agreed schedule. Interest may be fixed over the period of the loan regardless of what happens to the prevailing rate of interest or may be variable rates often tied to the LIBOR (London Interbank Offer Rate) which is the interest rate at which major international banks in London lend dollars to each other. If the company fails to make these payments, it defaults on the debt and it can file for bankruptcy. The usual result is that debtholders then take over and either sell off the company's assets or continue to operate under new management. Default is therefore the most important risk for lenders or investors in debt instruments.

The risk of default is quantified by rating agencies notably Standard and Poors and Moodys. These ratings are based not only on historical information but an impression of the future. Both these rating agencies see the industry as high risk because of its economic sensitivity, capital intensity and competitive structure. The key factors in the analysis are capital structure, age, size and diversity of the fleet, management ability. Capital structure relates to financial gearing, or the proportion of long-term debt finance. The industry has traditionally relied on loan finance and as such has high levels of gearing, often in excess of 70 per cent. Clearly this factor contributes to the possibility of default in periods of recession. The age of the fleet has already been discussed in terms of capital requirements, but it is also an issue for the investor since, without detailed knowledge, it is an indicator of quality. The running costs are also higher for older vessels, which has a cash flow implication. The size of the fleet affects the rating. Companies with larger fleets tend to achieve a higher grade than those with smaller fleets. Associations with other companies, for example, a high...

Table of contents

• Cover
• Half Title
• Routledge advances in maritime studies
• Full Title
• Copyright
• Contents
• Figures
• Tables
• Acknowledgements
• Biographies of editors
• Introduction
• PART I Financial strategy
• PART II People and skills
• PART III Ports in transition
• PART IV Logistics and ICT
• PART V The regulatory framework
• Index