Earnings Call: Q1 2017

May 3, 2017

Good day, ladies and gentlemen, and welcome to the Matson First Quarter 2017 Financial Results Conference Call. At this time, all participants are on a listen-only mode. Later, we will conduct a question and answer session, and instructions will follow at that time. If anyone should require operator assistance during the conference, please press star then zero on your touchtone telephone. As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Mr. Jerome Holland, Director of Investor Relations. You may begin. Thanks, Vicky. Matt Cox, Chairman and Chief Executive Officer, and Joel Wine, Senior Vice President and Chief Financial Officer, are joining the call today. Slides from this presentation are available for download at our website, www.matson.com, under the Investor Relations 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 are more fully detailed under the caption Risk Factors on pages 11 to 18 of our 2016 Form 10-K, filed on February 21, 2017, and in our subsequent filings with the SEC. Please also note that the date of this conference call is May 3, 2017, 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. With that, I will turn the call over to Matt. Thanks, Jerome, and thanks to those on the call today. Matson's core ocean transportation businesses performed in line with our expectations in the first quarter, with operating income of less than half the prior year level as our fuel surcharge collections continued to lag the impact of bunker fuel price increases that occurred in late 2016. We have announced four fuel surcharge increases in response, the latest of which was March 16, that went into effect in April. As we have explained before, it is not uncommon for fuel to have this kind of timing impact on our quarterly results, but over the course of a year, we expect this timing impact to be neutralized. At Matson Logistics, our first quarter results were impacted by market softness in both our Alaska freight forwarding business and our transportation brokerage business. While results were lower than expected, we remain confident in our outlook for logistics. Looking ahead, we are affirming our full year 2017 outlook for EBITDA and operating income, as we expect to see modest improvement in each of our core trade lanes, with the exception of Guam, where we expect further competitive losses due to the launch of a competitor's second ship. As a result, we expect Matson's 2017 operating income to be lower than it was in 2016, and expect EBITDA to approximate the $288.6 million last year. Before moving on, I would like to highlight some changes last week upon the retirement of our Chairman, Walter Dods. Walter announced that I would succeed him as Chairman of the Board, and that board member Jeff Watanabe has been designated Lead Independent Director. In light of my new responsibilities as Chairman, we are expanding the roles of Ron Forest and John Lauer, who are proven leaders and have been integral to managing Matson's growth over the past decade. Ron Forest has been promoted to President of Matson, with continued responsibility for all the company's operations, including vessels, terminals, equipment, labor relations, purchasing, and engineering, as well as overseeing Matson's investment in SSA Terminals. John Lauer has been promoted to Chief Commercial Officer of Matson with continued responsibility for sales, marketing, customer service, pricing, and government services for Matson's Ocean Transportation division. Slide 4 highlights our financial metrics, which Joel Wine will describe in more detail later on. In the first quarter 2017, we earned net income of $7 million or $0.16 per share and generated EBITDA of $52.3 million. I would also note that the first quarter is historically our lowest in terms of earnings and cash flow, and that was more pronounced this year by the timing of our fuel surcharge collections lagging fuel expenditures. Turning to our Hawaii service on slide 5. The Hawaii trade experienced modest westbound market growth in the first quarter of 2017. But as expected, Matson's container volume was lower than the first quarter 2016, which benefited from volume gains when Pasha Hawaii was struggling with service changes and other issues. With this challenging year-over-year comparison behind us, we continue to expect our Hawaii volume to approximate the level achieved in 2016, excluding the 53rd week that benefited 2016. In addition, we are expecting higher than normal operating expenses in 2017 as we undertake once every five-year dry docking of our neighbor island barges. Our Hawaii fleet renewal program is well underway, with two of our four new ships already in production at Philly Shipyard in Philadelphia. These will be the largest container ships ever built in the U.S. Our second pair of vessels will be a Con-Ro design. These vessels will provide substantial container capability and capacity, as well as conventional roll-on, roll-off service and will be built by NASSCO in San Diego. Throughout this fleet renewal period, we will continue to evaluate our deployment in Hawaii and look for opportunities to improve utilization and lower operating costs while maintaining our leading service. We expect to move between a 10 and 11 ship fleet over the next several months as we navigate through a heavy dry docking schedule, retire older vessels, and progress towards our long-term deployment with the most modern vessels in this trade. Moving on to slide 6. For the latest economic stats and forecast from UHERO, or the University of Hawaii's Economic Research Organization. The Hawaii economy continues to perform well with visitor arrivals up, unemployment down, and steady construction activity. Growth in the current construction cycle has been fueled by high-rise condominium construction in the Kaka'ako Ala Moana area of Honolulu, where we've seen the first wave of projects reach completion and expect to see a second wave of project near completion over the next couple of years. As this condo development tails off, there is an expected gradual buildup in residential home construction, most notably at two large single-family and townhouse projects called Ho'opili and Koa Ridge in suburban Oahu, where building is expected to continue for the next 10-12 years. Building on the neighbor islands, which has lagged well behind Oahu, has also begun to show signs of life and is expected to show further expansion, but the pace is expected to remain well below the mid-2000s boom. While the multi-year ramp-up of construction has eased, UHERO expects enough new activity in the pipeline to maintain employment near the current level for the next several years, generating smaller net gains in jobs next year, followed by a gradual decline on the downside of the building cycle. Moving to our China service on Slide 7. Matson's volume in the first quarter 2017 was over 23% higher year-over-year, primarily due to stronger demand for our expedited service offering during the lead-up to and recovery from Lunar New Year, which fell earlier in the first quarter this year. We also had an additional voyage in the first quarter this year as we were able to load one of our vessels with eastbound cargo on its return voyage from dry docking in China. Matson continued to realize a sizable rate premium for our expedited service in the first quarter, and our average freight rates were modestly higher than last year. We recently completed our annual contract renewals, which represent approximately half of our China volume over the course of a year. This year's renewal shaped up about as expected, with modest increases across the board, but we remain cautious about the spot market in 2017 as liners continue to add capacity to what is already an oversupplied market. For the balance of 2017, we continue to expect our proven service to be highly differentiated with a service advantage over the international carriers in the TransPacific. Matson's advantage results from several factors, including our industry-leading transit times, efficient cargo offloading at our dedicated terminal in Long Beach, and superior on-time performance. Longer term, we view the consolidation of international carriers and launch of new alliances in April as potential sources for longer-term market improvement. Turning to Slide 8. As expected, Matson's Guam volume in the first quarter declined year-over-year due to competitive losses to APL's U.S. flag container ship service that increased frequency to weekly in December 2016. While this increased capacity and service frequency make it reasonable to expect further volume losses, we plan to fight to retain every container of our customer's business. Having a long history in Guam with strong customer ties and a 5-8 day service advantage from Oakland and L.A. Long Beach, we expect to retain significant market share. In fact, our goal this year will be to limit any competitive losses beyond a modest amount. As we expect this to be a highly competitive market situation, we will not be providing any more specific market guidance share or market share specifics beyond that goal. Moving now to slide 9. In Alaska, Matson's container volume for the first quarter of 2017 was 4.2% lower year-over-year, primarily the result of the continuing energy sector-related economic contraction. For the full year 2017, we continue to expect modestly lower volume based on declining northbound freight due to ongoing contraction of Alaska's energy-based economy, partially offset by improved southbound seafood volume. In addition, with the installation of exhaust gas scrubbers on our three diesel vessels serving Alaska now complete, we don't expect to regularly deploy our less efficient steamship reserve vessel in 2017, resulting in lower expected vessel operating and dry docking relief expenses. Turning next to slide 10. Our terminal joint venture, SSA Terminals, contributed $4.9 million in the first quarter of 2017, compared to $2.6 million in the first quarter 2016. The year-over-year increase was primarily due to improved lift volume. For the full year 2017, we expect SSA Terminals to approximate the contribution to our ocean transportation operating income it made in 2016 as continued industry consolidation and the launch of new global shipping alliances may create some puts and takes as container flows and supply chains are adjusted between West Coast terminals. Recently, we announced plans to expand our relationship with SSA Terminals to include Matson's Tacoma Terminal before the end of this year. SSA Terminals will be replacing APM Terminals as the operator of our Tacoma terminal serving our Alaska vessels. APM Terminals has been a high-quality operator, and we thank them for their many years of service. Turning now to logistics on slide 11. While the first quarter 2017 benefited from a full quarter of freight forwarding operation results from Span Alaska, that business faced the same headwinds that impacted our Alaska container shipping results. Further, our transportation brokerage business trended lower year-over-year as it was impacted by the well-reported margin compression due to excess capacity and a more competitive pricing environment. Even with this weaker than expected first quarter, we're affirming our full year 2017 outlook for logistics operating income to approximate $20 million. While the inclusion of Span Alaska's freight forwarding business for the full year is expected to be the main driver of the significant year-over-year increase, we do have other revenue and cost-saving initiatives underway to help offset the margin pressure in our brokerage business. I will now turn the call over to Joel for a review of our financial performance and our outlook. Joel? Thanks, Matt. As shown on slide 12, ocean transportation operating income declined year-over-year in the first quarter, primarily due to the unfavorable timing of fuel surcharge collections, lower container volume in Hawaii and Guam, higher vessel operating expense, primarily related to the deployment of an additional vessel in Hawaii, and higher dry docking amortization. Partially offsetting these unfavorable year-over-year comparisons was higher container volume in China due to stronger demand and an additional sailing during the first quarter of this year. The company's SSA Terminals joint venture investment contribution increased year-over-year, mainly due to improved lift volume. Logistics operating income increased by $300,000 year-over-year in the first quarter, primarily due to the inclusion of Span Alaska's freight forwarding operations, but that was largely offset by the lower domestic intermodal and highway brokerage yields that Matt referenced earlier. Slide 13 shows a summary of the balanced manner in which we allocate our cash flow generation. For the last 12 months ended March 13, 2017, we generated cash flow from operations of $142 million and undertook net borrowings of $297.9 million, from which we used $194.5 million to close our acquisition of Span Alaska, made net CCF deposits of $18.7 million, spent $77.2 million on maintenance CapEx and $95.8 million towards the progress payments on the Aloha Class vessels and initial deposits on the Kanaloa Class vessels. Lastly, we also returned just over $50 million to shareholders via dividends and share repurchases. As a reminder, our LTM maintenance CapEx has been higher than our normal range of $40 million to $50 million per year. This was as expected and is primarily due to the completion of the scrubber installation program on our Alaska vessels and other capital projects related to what has been a relatively heavy dry docking last 12 months for us. In addition, we took advantage of highly attractive container prices to accelerate our purchases of selected container equipment at near record low levels. With that, let me now turn to slide 14 to affirm our outlook for the full year and provide our thoughts on the second quarter 2017. To start with, we continue to expect full year 2017 consolidated EBITDA to approximate the $288.6 million achieved in 2016. Based on our increased capital and dry docking spending, we expect depreciation and amortization to increase by about $15 million this year to $150 million in total, inclusive of approximately $50 million of dry docking amortization, which would lead 2017 consolidated operating income of approximately $140 million. Of that total, as Matt mentioned earlier, we continue to expect logistics operating income to be approximately $20 million. From those items, it follows that we expect ocean transportation operating income for 2017 to be lower than the $141.3 million achieved in 2016. We expect interest expense for the full year 2017 to be approximately $25 million and our effective tax rate for the full year to be approximately 39%. In the second quarter 2017, we expect ocean transportation operating income to approximate the $33.9 million achieved in the second quarter 2016. We expect logistics operating income in the second quarter 2017 to approximately double the $2.2 million achieved in the second quarter 2016. I'll now turn the call back over to Joel for his final remarks. Thanks, Joel. Looking ahead, I remain confident in the long-term prospects and strong cash flow generation of Matson's core businesses, which will provide the foundation for our fleet renewal investments and continued value creation for our shareholders. With that, I will turn the call back to the operator and ask for your questions. Thank you. Ladies and gentlemen, if you have a question or comment at this time, please press the star then the number 1 key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Our first question comes from the line of Kevin Sterling with Seaport Global Securities. Your line is now open. Thank you. Good afternoon, Matt and Joel. Hi, Kevin. Hi, Kevin. Yes. Good to talk with you all again. Matt, you talked a little bit about your cautious outlook in the China trade lane, but lately, we've seen an improvement in international rates in that trade lane. But are you of the opinion that you don't think these current rates are sustainable since it sounds like you have a little bit more cautious view for the rest of the year? I think, Kevin, it's somewhere in between. Clearly last year was, we were at an all-time low in freight rates. I think that we have seen rates in the general market around the BCO contract renewal up a few hundred bucks in the general broader market from all-time lows. So I think it's true that we will see year-over-year improvement. And we're seeing international carriers report lower losses than they had in the previous year, or will report lower losses. But the caution is really from our view that while we're improved from the previous year, there continues to be a surplus of capacity in the trade, that I think has yet to play out in the spot market. Again, we're going to continue to be full, and there continues to be a significant advantage in premium rate environment for us. We have continued with the new deployments to see no carrier within five days of our current transit. We are in pretty good shape, but we just note that the overall surplus of capacity continues to overhang the market. Okay. I got you. Let me phrase it another way, too. We have seen air freight volumes really pick up here say the last month or so, and have air freight rates out of China spike, and since you guys offer an expedited service, obviously slower than air, but much cheaper, historically, could you see a pickup maybe in your business if we do see a spike in air rates? Could you see maybe some modal shift from air to your ocean service? Yeah, we have observed that over the last 10 years. We have seen more and more of our book of business are people that used to ship a portion of their product or all of it air, and now they reserve a portion for our expedited service. If there is a problem in the air freight market, that certainly could positively impact our results. I also note that we plan to be effectively full all year. On the spot market, would we take advantage of that? Sure, we could. As these new alliances get up and running, if there are service disruptions, that could be good. But again, we just want to be cautious because we cannot predict those kinds of things, but those could be positive factors in our market for the rest of the year. I got you. Okay. Let me move on to Guam real quick. In Guam, you obviously offer a faster service and you have a long history of serving that market, which should give you a competitive advantage. But are you seeing your competitor come into the market with real aggressive price concessions in order to win market share? Are your customers kind of asking you to obviously come down on those price concessions? I am just curious to what you are seeing in the market, maybe in terms of price now with a new weekly sailing from a new competitor. Yeah, I think the way you've asked that question is right. I think APL has a significantly inferior service. What they have to offer is a lower freight rate for that cargo, which is not time sensitive. We are seeing them offering lower rates given their inferior service. Matson is evaluating that dynamic without getting too specific and reacting to it where we feel it's in our interest to do so. Those are the competitive dynamics at work. Okay. Well, that's all I had for this evening. Thanks for your time and best of luck to you. Okay. Thank you, Kevin. Thanks, Kevin. No problem. Our next question comes from the line of Ben Nolan with Stifel. Your line is now open. Yeah, thanks. Hey, guys. I wanted to follow on real quickly to Kevin's first question as it relates to China. As you're looking across all of your various businesses, is that maybe the one where you would say it has the potential to surprise you the most to the upside? Is it maybe even where you're the most hopeful in terms of upward momentum? I guess, let me answer it slightly different than the way you phrased the question. Clearly, it has historically proven to be the most volatile, both upwards and downwards. If I were to guess, I would guess that this trade has historically been the most difficult to predict and has changed the most. I would also say, though, that since our ship is full, and a portion of our cargo, half or approximately half, is committed to annual contracting, the upside is not, I wouldn't say limited, but it is steadied by the fact that both on the upside and downside, we choose to put half of our cargo under annual contract, and we're full most of the time. So our upside is limited. Our downside is also limited by the fact that our service is so differentiated. I think I would answer your question, yes, China has proven to be the most volatile and could surprise us to the upside. I think we're through the worst of the cycle. We called the bottom last year. We were cautious in trying to call a market recovery, and we remain cautious, but that certainly could happen. Okay. Here's a little bit. Obviously you're playing catch up on the fuel surcharges. Are we now at the point where that should be, I know that there's been a number of incremental upticks in that surcharge lately. Are we now at a point where second quarter is the right run rate, and if oil prices don't move much, which is a lot to ask I know, but that sort of the timing issues will be resolved? Yeah, I think that's fair to say. I think I would also say, we remain very confident that our fuel surcharge mechanism in the domestic trades remains very effective over time. Absent of an oil price shock, we believe we're going to start to make Start to make a recovery in the commentary around the first quarter, and those comments are reflected in Joel's second quarter and full-year estimates of earnings and EBITDA that we've just affirmed. Okay, perfect. Then quickly for you, Joel, you guys were a touch under 31% on the tax rate in the first quarter, and I realize it was off a relatively lower number than what you're guiding for the back half of the year. But you still stuck to that 39% annual rate. How should I think through that bump in rates relative to where it was in the first quarter? Well, the way to think through that is that the first quarter's got such a low amount of pre-tax income that a little adjustment to our tax rate ends up being a bigger percentage difference. When you look at the contribution of the second, third, and fourth quarter, those are much larger to pre-tax income. The reason that we had this in the first quarter was the adoption of the new stock-based accounting changes, investing of shares, which you've seen that across the whole most corporate complex. It's a very small number for us, pretty immaterial, so it's not going to be that material to our whole annual number. We left our annual number outlook where it's at. Okay. That's what I thought. All right. Last one from me, and I'll turn it over. You guys are now integrating, or SSA Terminals is integrating Tacoma Terminal. Is that going to impact the numbers at all, or how does it impact operations? Is this just sort of a small part of the regular operations or something more significant? Yeah, I would say you've got it about right. I do think that over time First of all, this won't happen till towards the end of the year. The timing isn't exactly clear, but it'll happen later in the year. We expect it to be an absolute non-event for our customers who will be basically swapping out the stevedores at the same terminal in our main processes around that. Over time, we could see a small contribution coming from that terminal, which would be reflected in SSA Terminals' results. But again, it's certainly not a needle mover for this year, and it could be a very small positive longer term for us. Okay, great. Great. I really appreciate Okay. Thanks, Ben. Our next question comes from the line of Stephen O'Hara with Sidoti & Company. Your line is now open. Hi, good afternoon. Hi, Steve. Hi, Steve. Just curious, on the outlook, it sounds like it's unchanged for the year. I guess, just relative to where you were at the end of the fourth quarter, just qualitatively, do you feel any better now than you did then? Or what's kind of changed internally for you guys? Anything. Yeah, not a lot has changed, Steve. We're basically affirming our full year guidance. I think that we, again, as was asked before, remain cautious on the China trade. What's happening in each of our markets is shaping up more or less the way we expected. We've fallen a little more behind in fuel, but we do expect that to be recovered. We got off to a little bit of a slower start in Matson Logistics, but again, looking at it closely, we feel pretty good about it. Not a lot different at this point. I don't know, Joel, do you have any commentary about it? No, it's exactly that. Some of our businesses are doing a little better than we thought several months ago. Some are doing slightly worse, but overall, it's really in line, and that's why we haven't changed our outlook, Steve. Okay. All right. Thanks. I know you mentioned it, I missed it, though. What was the year-over-year dry dock differential in terms of maybe increased depreciation and so forth? Did you say what the impact was on 1Q from the fuel surcharge? We did not say what the impact was on the fuel surcharge. The year-over-year dry docking difference, in terms of dry docking amortization, was about $3 million. $3 million in the quarter, okay. $3 million. And for the full- Yeah, $3 million in the quarter. First quarter last year versus first quarter this year. And for the full year? Well, you mean for the LTM? No, no, I'm sorry. For 2017, what's the expectation for the increase? The full increase is going to be $15 million for dry docking and depreciation. I'll need to get back to you on the specific amount for the dry docking piece. Okay. The differential between operating income for ocean transportation is about $21 million, give or take. Is that the expectation for the full year, down about $21 million? Yeah, that's right. Because when you add up the EBITDA of the two businesses and track down, that's the right ballpark. Okay. The fuel surcharge is kind of on top of that. I think originally you'd said about half was the first quarter impact from fuel, but was that correct? No, we never said that. We said it's been the biggest year-over-year impact to operating income this quarter. That's why we highlighted it first, but we never said it was half. Okay. All right, I apologize. Steve, just to clarify, the recovery of fuel, while we didn't disclose the specific amount, are embedded in our second quarter outlook and our full year guidance. Okay. You under-collected in the first quarter. You're expecting to over-collect the balance of the year until that's made up, essentially? Well, you can't say over or under necessarily, because all you're doing is comparing to last year. As an example, you could have under-collected last year and also under-collect this year, but under-collect by less, and therefore it could be a positive year-over-year. We're not saying anything about over or under. All we're saying is on a year-over-year basis. Okay. No, that's helpful. Thank you. Okay. Thanks, Steve. Thanks, Steve. Our next question comes from the line of Jack Atkins with Stephens. Your line is now open. Jack, just a couple from us. Matt, on the logistics guidance, Okay looking at that. Just given where you are after the first quarter and then the headwinds you called out, Alaska plus the domestic brokerage and intermodal markets, which I think we expect to see further margin compression over at least the next couple quarters. What are you guys seeing in that business that gives you confidence to be able to hit that guidance this year? Yeah. First of all, I would answer the Span Alaska question, which obviously is a large part of the overall outlook. I would make the same point that Joel Wine made for a different question, which is the Alaska trade is a very first quarter and fourth quarters are very small. While we're expecting some reduction year-over-year, we still are very confident that the earnings are going to show up in Span Alaska, and that the first quarter traditionally is a very modest quarter. So in some ways it amplifies the seasonality of our overall business and certainly of the logistics business. Secondly, without commenting specifically about other carriers who have announced that are talking about a continued soft environment, we are not saying a different thing than the rest of the market is expecting. What we're expecting is, from new activities within our logistics unit and cost reduction initiatives, that we are going to be able to approximate our $20 million outlook guidance through other things rather than have a different view of the market. Got you. Okay. I think you mentioned in your prepared remarks that you'd be shifting between the 10 and 11 ship deployment over the next few months. Maybe if you could provide some color on what's driving this transition. I think you called out dry docking or the timing of dry docking. Yeah. Then maybe in terms of what to expect around the timing of when this happens. Yeah. What I will say generally is that, we have been in an 11 ship fleet. Three of our largest ships today are the C9 class vessels, and when they go into dry docking, we typically have to deploy two vessels in their place, two of our older steamships in their place, in order to be able to carry the cargo package. But once those dry docks are completed of the C9 vessels, given their greater capacity, it allows us to operate with one fewer ship, we think, and still carry our cargo package. As we looked for the completion of the C9 dry dockings during those windows of time when those vessels are in our operation, it allows us to operate one fewer vessel. That is the general story behind it without talking about specifics. I would say our thinking about shifting into a 10 ship deployment, the economic results of those are embedded in our second quarter and full year outlook. I would say that. Okay. But those are the general thoughts about how we approach that. Okay. Thanks for that. Joel, just one housekeeping question. How much is left this year in terms of progress payments on the new ships? This year. Give me a second and I'll get that number for you. It's approximately 200. Okay, perfect. Thanks, guys. Okay, thank you. Okay, thanks. I am showing no further questions at this time. I would now like to turn the call back over to Mr. Matt Cox for closing remarks. Thank you, operator. Well, thanks for your interest in the call. We look forward to catching up with everyone at the end of the second quarter. Thank you. Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone, have a great day.