Troubled Waters

Plagued by shrinking profit margins, Hawaii's shipping industry is facing challenging times

February, 2003

In these Hawaiian Islands, where everything from toilet paper to television sets is hauled in on cargo vessels, shouldn’t it be safe to presume that the shipping industry – Hawaii’s lifeline to the rest of the world – is a reasonably profitable one?

Not lately, according to Hawaii’s two largest competing shippers, Matson Navigation Co., which handles approximately 70 percent of all cargo going in and out of the state, and CSX Lines LLC, with the remaining 30 percent market share. Executives from both companies agree: the shipping industry worldwide is suffering, and a multitude of factors has triggered a huge margin squeeze.

Nationally, the industry itself is huge – annually generating 13 million jobs, $1.5 trillion in business sales, and roughly $2 billion in federal, state and local taxes, according to the U. S. Department of Transportation’s Maritime Administration. Yet it faces its share of challenges like any other industry.

“The single most pressing issue that we all face is returns,” says Brian Taylor, Hawaii/Guam division vice president of CSX Lines. “Shipping is an extremely capital-intensive business, and the industry in general is not returning the costs of its capital.”

Paul Stevens, executive vice president of Matson Navigation Co., says the shrinking margins are not exclusive to Hawaii, but constitutes a worldwide trend, as international and domestic carriers alike have watched their profits decline over time. Matson’s own operating profit declined 34 percent, from $94 million in 2000 to $62 million in 2001. While the decrease reflects a fallout in cargo shipping post 9-11, and unresolved productivity issues related to major upgrades at Matson’s Sand Island terminal, 2002 figures will likely decline again. In the first three quarters of 2002, Matson’s operating profit was $35.6 million, or 41 percent less than the first three quarters of 2001.

CSX’s Taylor says that at the end of 2002, CSX was also under pressure and was struggling to bring in the same $650 million to $680 million in gross annual sales (the total for all trade lines serviced by CSX, not just Hawaii) that it had earned in 2001.

One can’t help but wonder if the slip in revenues is what caused CSX Lines’ parent company, CSX Corp., to agree to sell its shipping line to global private equity firm, The Carlyle Group, for $300 million in cash and equities in December last year.

Michael J. Ward, president of CSX Corp., said in a written release, “Completion of this transaction is consistent with our long-stated strategy of becoming a more rail-based organization, strengthens our balance sheet and provides shareholders with significant value.”

Ward was unavailable to comment on whether the sale was actually a reflection of these challenging times, but CSX’s Taylor says the company isn’t the only one charting rough seas. “We aren’t alone,” he says. “All of the global carriers are losing money. So clearly the shipping business in general is going through some really challenging times.”

Several factors are contributing to waning margins, the biggest of which remains the tremendous amounts of capital investment required to run a shipping company. Almost everything, including cargo-handling costs, vessel-operating costs and outside transportation and terminal maintenance costs have steadily increased over the past few years, while Hawaii cargo volumes, which normally tend to offset the rising costs, have remained flat and even tapered off a little.

“In the last couple years, volumes have fallen, and yet the expense of the ships and equipment is still there,” says Taylor, who says the state’s economic forecasts are a good barometer of what the shipping industry will do. “Without any substantial change in economic growth here, the prospect for significant increases in volume is relatively small.”

Sustained Neighbor Island growth has also contributed to declining profits. Both Matson’s and CSX’s cost structures are arranged so that whether a container is shipped to Oahu or a Neighbor Island, it’s the same price. “If you look at where the growth in Hawaii is occurring now, it’s all on the Neighbor Islands,” explains Paul Brewbaker, chief economist for the Bank of Hawaii. “So, as there’s more and more growth of volume that’s inevitably ultimately bound for the Neighbor Islands, the further the ships need to travel and the more the burden of that cost has to be borne by the shipper.”

Another long-term pressure working on the shippers is the evolution of the retail distribution chain from small mom-and-pop shops to the increasingly dominating big-box retailers. Large retailers, such as Wal-Mart and Costco, tend to buy in larger quantities, and on a regular basis, thereby earning bargaining power and reduced shipping rates.

And as if all of this wasn’t enough to spell disaster for the industry, Hawaii’s carriers were thrown another big wrench in the third quarter of last year when West Coast unions underwent sticky labor negotiations, resulting in a West Coast port shutdown. Both Matson and CSX deployed extra ships through the end of last year to cope with the backlog – adding on an additional layer of operating costs.

The good news is it isn’t all gloom and doom for Hawaii’s carriers. They are taking all the appropriate measures to ensure the highest efficiency and productivity levels to get their businesses back on track.

Over the past five years, CSX has invested $6 million to $8 million in various technologies and upgrades. Improvements include: a reconfiguration of its yard layout to increase density; new gate technologies that help move trucks more efficiently in and out of the yard; and new marine stowage technology. Despite the margin crunch, the company has also stepped up its advertising schedule in an effort to increase brand awareness. “A lot of people just aren’t familiar with who we are,” Taylor says. “We’re trying to ensure that we are more recognizable beyond our core group of customers.”

A local shipping company that services just the interisland trade lane, Young Brothers Ltd., which grossed around $55 million last year, has also made a large investment in equipment and vessels. In December, the company was awaiting the arrival of a $500,000 large high-lift, and, according to Glenn Hong, president of Young Brothers, the company will be looking at constructing new barges with extended capacity over the next couple of years.

“Our cost to move a container has not risen along with inflation,” Hong says. “But we do still have the same bottom-line issues as the other large carriers have. Fuel, for example, fluctuates all over the place. And in the 1990s, when we had some very bad years, we had to have some rate increases. So, I would expect that there would again be some nominal rate increases down the road.”

Matson Navigation Co., which has made the most significant capital investment over the past few years, last month implemented a new terminal handling charge of $200 per westbound container and $100 per eastbound freight. “The terminal charge has recognized that cost has been difficult to control, therefore, we need to pass a portion of that onto our customers,” Stevens says.

The move was a last resort of sorts for Matson, which, over the past few years, has taken several proactive steps to streamline operations and improve efficiency and customer service. In 2001, the company completed a $36 million improvement project at its Sand Island terminal, $22 million of which was spent on new container equipment to accommodate projected growth through the next two decades.

The problem was, the implementation was a major change in the way Matson operated, and it did not go as well as expected. “We did spend six to seven months fighting with the implementation of the new technologies, and it caused certain productivity issues,” Stevens says. “So we haven’t fully captured all the benefits of the technology, but it’s our expectation that we will in 2003.”

In fact, Stevens is quite bullish about 2003, and expects Matson’s growth to mirror economic forecasts for the state, which currently call for 2.5 percent to 3 percent growth. He says it may sound optimistic, but that’s factoring in the fall arrival of one of two new ships. Costing $100 million each, the ships comprise the largest element of Matson’s capital cost structure, however, the new ships are being designed for increased fuel and cargo-capacity efficiency, which, in the long run, should save the company a few bucks.

Despite decreasing margins and an unstable economy, Hawaii may soon see another carrier enter the market. Santa Maria Shipping Co., a Santa Rosa-based company, plans to begin container service between Southern California and Oahu’s Barbers Point in 2004.

Santa Maria Shipping is currently building a ship that will sail from California to Hawaii twice a month. The company is hoping to siphon customers based in the Leeward communities by providing direct service to Oahu’s west coast, which is currently not serviced by Matson or CSX.

Price savings will be the company’s biggest selling point. “We’re building brand-new, fuel-efficient, modern vessels, which will help reduce operating costs of the ship. We can pass those savings onto our clients, who will pay on the average of 10 percent to 15 percent less than what they’re paying Matson or CSX,” says Dean Ota, owner of H2O Transportation and consultant to Santa Maria Shipping Co.

While Matson and CSX welcome the competition, both companies intend to vigorously defend their market shares. “In Hawaii today, there are a total of six to seven vessels that call here from the Mainland with a total average weekly volume somewhere in the range of 3,500 to 4,000 containers. That’s an average of 600 containers per vessel,” Taylor calculates.

“All the ships can carry significantly greater volumes of freight than that. So I’d say right now there is clearly enough capacity to carry the freight to come to Hawaii, and there’s probably more capacity than there is cargo volume. I think that Santa Maria, or anyone else that attempts to enter this market, is certainly going to find it very challenging to earn the kinds of returns that are expected to continue investment in their business. They’re going to struggle with all the same things that clearly every other steamship carrier is going through today.”

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Jacy L. Youn