German Container Liner Hapag-Lloyd Outlook Revised To Positive On Debt Reduction; Ratings Affirmed

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Research Update:

German Container Liner Hapag-Lloyd Outlook
Revised To Positive On Debt Reduction; Ratings
Affirmed
November 29, 2019

Rating Action Overview
                                                                                                       PRIMARY CREDIT ANALYST
- Hapag-Lloyd's improved EBITDA performance, coupled with debt reduction from free operating           Aliaksandra Vashkevich
  cash flow (FOCF), will result in stronger credit metrics in 2019 than we previously expected.        Frankfurt
                                                                                                       + 49 693 399 9178
- We believe that Hapag-Lloyd's proactive and effective measures to steadily reduce cost per
                                                                                                       Aliaksandra.Vashkevich
  container transported, combined with potential to further cut debt thanks to low capital             @spglobal.com
  expenditure (capex) requirements, could translate to credit metrics commensurate with a
                                                                                                       SECONDARY CONTACT
  higher rating, despite operational headwinds in 2020.
                                                                                                       Izabela Listowska
- We are therefore revising our outlook on Hapag-Lloyd to positive from stable and affirming our       Frankfurt
  'B+' long-term issuer credit rating and 'B-' issue rating on the company's senior unsecured          (49) 69-33-999-127
  debt.                                                                                                izabela.listowska
                                                                                                       @spglobal.com
- The positive outlook reflects our view that Hapag-Lloyd could maintain S&P Global
                                                                                                       ADDITIONAL CONTACT
  Ratings-adjusted funds from operations (FFO) to debt of more than 20%, which is our threshold
                                                                                                       Industrial Ratings Europe
  for a 'BB-' rating, if container shipping industry price discipline enables the company to largely
                                                                                                       Corporate_Admin_London
  pass through higher International Maritime Organization (IMO) 2020 compliance-related fuel           @spglobal.com
  expenses and it keeps allocating discretionary cash flow to debt reduction.

Rating Action Rationale
Hapag-Lloyd will achieve higher EBITDA this year despite sluggish global demand and trade
volumes. In the first nine months of 2019, Hapag-Lloyd reported EBITDA (pre-International
Financial Reporting Standards [IFRS] 16) of €1.17 billion, which represents a significant
improvement compared with €812 million in the first nine months of 2018. Under our base case,
we expect this positive trend will continue toward year-end 2019, with reported EBITDA
(pre-IFRS16) of €1.5 billion-€1.6 billion for the full year. This is well above the €1.14 billion
reported in 2018 and moderately better than our previous forecast of close to €1.5 billion. Two
main factors support the company's earnings improvement. In the first nine months of 2019,

www.spglobal.com/ratingsdirect                                                                                     November 29, 2019   1
Research Update: German Container Liner Hapag-Lloyd Outlook Revised To Positive On Debt Reduction; Ratings Affirmed

Hapag-Lloyd achieved about 4% higher freight rates year on year.This could indicate relatively
healthy pricing discipline among container liners, which is particularly important in times of
sluggish demand. We note that global container trade growth is slowing toward low-single-digit
rates, with Hapag-Lloyd increasing its transported volumes by only 2%-3% compared with 2018
(on a like-for-like basis excluding the effect of the liner's conscious decision to downsize its
intra-Asia footprint this year). The company has also trimmed operating expenses supporting its
profitability.

Hapag-Lloyd's ability to steadily reduce unit costs and recover low-sulfur fuel price inflation
could stabilize earnings in 2020-2021. Hapag-Lloyd's ability to realize operational efficiencies
and steadily reduce unit costs, effectively integrate acquired liners (for example, United Arab
Shipping Co. was integrated five months after the transaction closed), unlock fleet and route
optimization synergies from acquisitions, and achieve slot cost advantages mitigate the
company's earnings' volatility to some extent. We note that Hapag-Lloyd has identified further
cost savings of $350 million-$400 million under its "Strategy 2023" that we believe management
will likely realize, given its successful track record. Factoring into our forecast Hapag-Lloyd's
continued tight rein on cost control, we anticipate relatively stable EBITDA generation over
2020-2021. That said our base case remains susceptible to Hapag-Lloyd's consistent ability to
pass fuel-cost inflation to customers, as the industry shifts to the new regulation under IMO 2020
requiring the use of more expensive compliant fuel.

IMO 2020 regulation setting a 0.5% fuel-sulfur content cap will likely mean fuel bills increase
from January 2020. This means that all container liners must seek to recover cost inflation. The
consolidation that has reshaped the container shipping industry, with the top-five players holding
about 65% market share in 2018 compared with about 30% 15 years ago, should normally lead to
disciplined tariff setting and allow healthy profitability during the transition period and beyond.
Nevertheless, the risk exists that some players might aspire to expand their market share at the
expense of profitable rates, as the industry copes with fuel-cost inflation.

The company has the capacity to deleverage and increase headroom under the improved credit
measures for potential operational underperformance and unforeseen setbacks. Under our
base-case, Hapag-Lloyd's operating cash flows could outpace low capex requirements, which are
thanks to the well-invested and competitive asset base, in 2020. The company's FOCF generation
capacity creates scope for a further net debt reduction, which would provide more financial
leeway under the improved credit measures for potential operational underperformance and
unforeseen setbacks, while maintaining adjusted FFO to debt above 20% over the next two years.
This ratio is within our thresholds for the higher 'BB-' rating. At the same time, we would view such
increased financial flexibility as critical for an upgrade. Under our base-case forecast, we believe
Hapag-Lloyd could achieve adjusted FFO to debt of 20%-23% over 2019-2020, which is at the low
end of the financial profile range consistent with the higher rating.

Rising fuel prices, the inability to recover IMO 2020-related bunker cost inflation, and cooling
economic growth pose risks. We realize that the shipping industry is tied to cyclical
supply-and-demand conditions and that the company's 2019 EBITDA performance might not be
sustainable. We forecast only moderately lower reported EBITDA (pre-IFRS16) of about €1.4 billion
in 2020 and a similar number in 2021, compared with €1.5 billion-€1.6 billion in 2019.
Nevertheless, there are factors that separately or combined pose risks to our base case and
Hapag-Lloyd's ability to sustain improved credit measures. We note that shipping companies face
potential risks including the higher oil prices due to geopolitical tensions; being unable to fully

www.spglobal.com/ratingsdirect                                                                                        November 29, 2019   2
Research Update: German Container Liner Hapag-Lloyd Outlook Revised To Positive On Debt Reduction; Ratings Affirmed

pass through IMO 2020-related bunker cost inflation; and cooling economic growth from ongoing
trade conflicts, which might depress trade volumes more than we forecast. Therefore, we consider
a key challenge for Hapag-Lloyd will be turning the strength of its credit measures into lasting
value. This will depend on the company's ability to continue lowering unit costs to counterbalance
the industry's volatility.

Maintaining prudent financial policy and continuing to lower debt, underpinned by balanced
investment decisions, is a critical and stabilizing factor of credit quality. The company has
stated its intention to maintain its net debt to EBITDA (pre-IFRS16) target below 3.5x, compared
with 3.2x achieved in the 12 months ending Sept. 30, 2019, while coping with operational
headwinds. This compares with our base-case projection of adjusted debt to EBITDA staying at
about 3.5x over the next two years. Given our below 4.0x leverage guideline for an upgrade, our
forecast points to limited debt capacity under the potential higher 'BB-' rating. Our forecast is
based on the assumption that Hapag-Lloyd will continue deleveraging and post S&P Global
Ratings-adjusted debt (including IFRS16 effects and excluding cash) of €6.9 billion in 2019 and
€6.4 billion in 2020, compared with €7.2 billion in 2018.

Hapag-Lloyd's business profile remains constrained by the shipping industry's high risk and
capital intensity. Although we recognize Hapag-Lloyd's enhanced operating efficiency, decreased
unit costs, and improved profitability (defined by absolute EBITDA margin/return on capital levels
and volatility of these measures) over the past few quarters, we do not consider this track record
to be sufficiently long to revise our assessment of the business risk profile upward at this point.
This is most importantly because it does not capture any major cyclical downturn. The company's
profitability remains susceptible to the industry's cyclical swings, high exposure to fluctuations in
running costs, and limited ability to quickly adjust operating base to falling demand and freight
rates. That said, as the fifth-largest player in the industry in terms of capacity, Hapag-Lloyd
benefits from a large, fairly new, and diverse fleet, and strong customer diversification. The
company operates globally through a broad and strategically located route network that helps it
ride out regional downturns. We believe that significant consolidation in the container liner
industry over recent years could help Hapag-Lloyd to achieve consistently less volatile profits
through the industry cycle. We also consider the company's ability to continue reducing the cost
per container transported, demonstrated by a strong track record of outperforming its
cost-reduction targets.

Outlook
The positive outlook reflects a one-in-three likelihood that we could upgrade Hapag-Lloyd over the
next 12 months.

Upside scenario
We could raise the rating if we believed that Hapag-Lloyd would maintain adjusted FFO to debt of
more than 20%, which is our threshold for a 'BB-' rating. This would be contingent on generally
improved pricing discipline in the container shipping industry, allowing Hapag-Lloyd to largely
pass through higher IMO 2020 compliance-related fuel expenses, and the company's continued
allocation of discretionary cash flow to debt reduction. Given the industry's inherent volatility, an
upgrade would also depend on Hapag-Lloyd's ability to structurally reduce debt and achieve an
ample cushion under the credit measures for potential fluctuations in EBITDA, combined with

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Research Update: German Container Liner Hapag-Lloyd Outlook Revised To Positive On Debt Reduction; Ratings Affirmed

stronger liquidity.

Furthermore, we would need to be convinced that management's financial policy does not allow
for significant increases in leverage compared with current lowered levels. This means that the
company will not embark on any unexpected significant debt-financed fleet expansion and that
shareholder remuneration will remain prudent.

Downside scenario
We would revise the outlook to stable if Hapag-Lloyd's earnings weakened, due to, for example,
much lower trade volumes than we anticipate, deteriorated freight rate conditions, and the
inability to offset fuel-cost inflation because of ineffective pass through efforts or a failure to
realize cost efficiencies. This would mean adjusted FFO to debt deteriorated to less than 20%,
with limited prospects of improvement.

An outlook revision to stable would also be likely if we noted any unexpected deviations in terms of
financial policy that would prevent credit measures remaining consistent with a higher rating.

Company Description
Hapag-Lloyd is a leading global container liner, with 231 modern ships, 11.9 million twenty-foot
equivalent units (TEUs) of cargo transported per year, and about 12,950 employees in 392 offices
spanning 129 countries.

The company has a fleet with a total capacity of 1.67 million TEUs, as well as a container stock of
more than 2.5 million TEUs, including one of the world's largest and most modern reefer container
fleets. Its global network provides connections between more than 600 ports on every continent.

Hapag-Lloyd is owned by CSAV (27.8%), Klaus Michael Kühne including Kühne Holding AG and
Kühne Maritime GmbH (29.2%), Qatar Investment Authority (14.5%), HGV Hamburger Gesellschaft
für Vermögens- und Beteiligungsmanagement mbH (13.9%), and Saudi Arabia's Public Investment
Fund (10.2%), with a 4.5% free float.

Our Base-Case Scenario
Our base-case scenario is based on S&P Global Ratings' economic forecasts for GDP growth,
combined with company-specific factors that we believe will allow Hapag-Lloyd to continue
expanding largely in line with the industry at low-single-digit growth rates.

- Worldwide economic growth will remain vital to the shipping industry. Given the global nature of
  shipping sector demand, we consider our economic forecasts for GDP growth of all major
  contributors to global trade volumes. We forecast real GDP growth in the eurozone of 1.2% in
  2019 and 1.1% in 2020 (versus 1.9% in 2018), real GDP growth in the U.S. of 2.3% in 2019 and
  1.7% in 2020 (2.9% in 2018), real GDP growth in China of 6.2% in 2019 and 5.8% in 2020 (6.6%
  in 2018), and continued slower economic growth in Asia-Pacific of 5.0% in 2019 and 2020 (5.5%
  in 2018). We also consider real GDP growth in Latin America of 0.9% in 2019 and 1.8% in 2020
  (1.6% in 2018).

- A shift in overall shipping demand-and-supply conditions toward ocean carriers. With no
  incentive to place new large orders amid muted contracting activity since late 2015, the
  containership order book is at a historical low, currently 10% of the total global fleet. Combined
  with funding constraints and more stringent regulation to cut sulfur emissions to 0.5% as of

www.spglobal.com/ratingsdirect                                                                                        November 29, 2019   4
Research Update: German Container Liner Hapag-Lloyd Outlook Revised To Positive On Debt Reduction; Ratings Affirmed

  January 2020, these factors will likely help restore the demand-and-supply balance in the
  containership segment by 2020. That said, we see a risk of softer demand stemming from the
  ongoing U.S.-China trade tensions.

- Annual growth rates in Hapag-Lloyd's transported volumes of about 3% in 2020-2021 based on
  global GDP growth trends, compared with 1.0%-1.5% we expect in 2019.

- Hapag-Lloyd's deployed capacity to remain flat at 1.6 million TEUs-1.7 million TEUs in
  2020-2021.

- No growth in fixed-bunker freight rate per TEU in 2020 and 2021 after a low-single-digit
  increase this year, constrained by the accelerated delivery of new large ships. We believe
  deliveries of containerships with more than 15,000 TEUs of capacity will constrain freight rates.
  In particular, these will affect the main Asia-Europe and transpacific shipping lanes, despite
  the likely favorable demand-and-supply balance in the industry in general.

- Given supply pressure from the deliveries of ultra-large containerships, freight rates will
  ultimately depend on shipping companies' capacity management and rate-setting decisions,
  especially with higher bunker fuel prices from January 2020 under IMO 2020. The most recent
  supply measures, including blank sailings, to curb industry capacity demonstrate such
  disciplined behavior, in our view.

- A flat crude oil price of $60 per barrel (/bbl) in 2020 and a decline to $55/bbl in 2021, versus
  $60/bbl in 2019. For illustrative purposes, we assume largely stable annual bunker fuel
  expenses in 2019-2021 at about €1.6 billion. This is to capture our view that future bunker cost
  increases or decreases (typically closely linked to crude oil price movements) will either be
  passed through or returned to customers via higher or lower freight rates. We also assume that
  Hapag-Lloyd can largely pass through higher IMO 2020-compliance-related bunker costs.
  Furthermore, we expect increasing fuel efficiency to offset the effect of volume growth, leading
  to lower fuel consumption per TEU.

- Cost per container (excluding bunker expense) to reduce by about 1.0% annually on average
  over 2019-2021, compared with a 4% reduction in 2018. This reflects management's
  demonstrated cost controls, including the realization of further efficiency gains, which will
  counterbalance inflationary pressures.

- Annual capex averaging up to €500 million in 2019-2021, up from €330 million in 2018, mainly
  for new containers, ship retrofits and modifications, and dry docks. There is currently no
  commitment for new containerships, which should help to realize FOCF for deleveraging.

Based on our base-case assumptions, we arrive at the following S&P Global Ratings-adjusted
credit measures:

- FFO to debt of 20%-23% in 2019-2020, compared with 15%-16% in 2018.

- Debt to EBITDA of 3.4x-3.5x in 2019-2020, compared with about 4.7x in 2018.

Liquidity
Hapag-Lloyd's liquidity remains adequate, with source to uses of 1.6x-1.7x including committed
capex only. We nevertheless believe that Hapag-Lloyd's liquidity coverage is susceptible to the
company performing below our aforementioned base-case operating scenario. Our liquidity
assessment also reflects Hapag-Lloyd's proactive and timely treasury management and
uninterrupted access to asset-backed financing, which should support the smooth renewal of

www.spglobal.com/ratingsdirect                                                                                        November 29, 2019   5
Research Update: German Container Liner Hapag-Lloyd Outlook Revised To Positive On Debt Reduction; Ratings Affirmed

existing container revolving credit line (RCF) and asset-backed securities (ABS) that all expire in
2020.

We estimate that Hapag-Lloyd's principal liquidity sources during the 12 months from Sept. 30,
2019, comprise:

- On-balance-sheet available cash of about €272 million, after deducting $350 million of
  minimum cash requirements under a bank covenant.

- Availability of about €500 million under undrawn credit lines maturing beyond 12 months.

- Operating cash flows (after interest paid and dividends received) of €1.0 billion-€1.1 billion, as
  in our base-case forecast.

We estimate that Hapag-Lloyd's principal liquidity uses during the same period comprise:

- Short-term maturities and scheduled amortizations of about €900 million.

- Capex for vessels/containers (only committed), scrubbers, and maintenance of about €200
  million.

Covenants
Hapag-Lloyd passed its financial covenant tests as of Sept. 30, 2019. Maintenance financial
covenants on bank debt stipulate limits such as a minimum ratio of fair-market vessel or
container value to debt, and the higher value of 30% of total assets and equity of €2.75 billion. The
company had about €6.7 billion in equity as of Sept. 30, 2019. Other covenants stipulate minimum
liquid funds of $350 million, with the company holding about €1.1 billion in liquidity reserves
(consisting of cash, cash equivalents, and unused credit facilities) on the test date. We expect the
company will pass the next covenant test in December 2019 and in 2020. There are no
leverage-ratio and interest-coverage covenants.

Ratings Score Snapshot
Issuer Credit Rating: B+/Positive/--

Business risk: Weak

- Country risk: Intermediate

- Industry risk: High

- Competitive position: Fair

Financial risk: Significant

- Cash flow/leverage: Significant

Anchor: bb-

Modifiers

- Diversification/portfolio effect: Neutral (no impact)

- Capital structure: Neutral (no impact)

- Financial policy: Neutral (no impact)

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Research Update: German Container Liner Hapag-Lloyd Outlook Revised To Positive On Debt Reduction; Ratings Affirmed

- Liquidity: Adequate (no impact)

- Management and governance: Satisfactory (no impact)

- Comparable rating analysis: Negative (-1 notch)

Related Criteria
- General Criteria: Group Rating Methodology, July 1, 2019

- Criteria | Corporates | General: Corporate Methodology: Ratios And Adjustments, April 1, 2019

- Criteria | Corporates | General: Recovery Rating Criteria For Speculative-Grade Corporate
  Issuers, Dec. 7, 2016

- Criteria | Corporates | Recovery: Methodology: Jurisdiction Ranking Assessments, Jan. 20, 2016

- Criteria | Corporates | General: Methodology And Assumptions: Liquidity Descriptors For Global
  Corporate Issuers, Dec. 16, 2014

- Criteria | Corporates | Industrials: Key Credit Factors For The Transportation Cyclical Industry,
  Feb. 12, 2014

- General Criteria: Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013

- Criteria | Corporates | General: Corporate Methodology, Nov. 19, 2013

- General Criteria: Methodology: Industry Risk, Nov. 19, 2013

- General Criteria: Methodology: Management And Governance Credit Factors For Corporate
  Entities, Nov. 13, 2012

- General Criteria: Use Of CreditWatch And Outlooks, Sept. 14, 2009

Ratings List

Ratings Affirmed; Outlook Action

                                    To               From

Hapag-Lloyd AG

   Issuer Credit Rating             B+/Positive/-- B+/Stable/--

   Senior Unsecured                 B-

     Recovery Rating                6(0%)

    Certain terms used in this report, particularly certain adjectives used to express our view on rating relevant factors,
    have specific meanings ascribed to them in our criteria, and should therefore be read in conjunction with such
    criteria. Please see Ratings Criteria at www.standardandpoors.com for further information. Complete ratings
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    action can be found on S&P Global Ratings' public website at www.standardandpoors.com. Use the Ratings search
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www.spglobal.com/ratingsdirect                                                                                                November 29, 2019   7
Research Update: German Container Liner Hapag-Lloyd Outlook Revised To Positive On Debt Reduction; Ratings Affirmed

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www.spglobal.com/ratingsdirect                                                                                                  November 29, 2019    8
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