Risks and Opportunities

Strategic Environment

Infrastructure

HHLA’s competitiveness largely depends on Hamburg’s infrastructure as a port and logistics hub. Hamburg’s offshore, onshore and regional transport networks must be able to cope with the flows of goods and their carriers. Infrastructural deficits could make it impossible to handle peak loads in ship handling – arising from the ongoing trend towards a growing number of ever-larger vessels – with the same level of reliability for all carriers.

Following the European Court of Justice’s ruling regarding the interpretation of the Water Framework Directive, the final decision on dredging the lower and outer stretches of the river Elbe now lies with the Federal Administrative Court. The planning supplement decision is expected to be submitted to the court in the first quarter of 2016. There have been no concrete statements made by either the court or those involved with the proceedings thus far about when a decision can be expected. As a result, shipping companies may reschedule their mega-ship liner services and traffic could bypass the Port of Hamburg – possibly permanently. This would result in a corresponding loss in earnings.

As well as swiftly dredging the navigation channel, the regional road and rail infrastructure must be modernised and expanded if the Port of Hamburg wants to retain and enhance its competitiveness and optimise its processes for the in- and outbound flows of goods in its hinterland. The rising volume of replacement investments and maintenance work resulting from the rail infrastructure modernisation drive will continue to affect the availability of routes in the medium term. Projects of special significance for HHLA include constructing the transversal port highway and upgrading the Kiel canal, including its locks.

As an infrastructure-related operator, HHLA and its subsidiaries depend on prompt provision of the scheduled volume of public investments and services which are frequently necessary to support their own investments. Otherwise, HHLA’s investment plans themselves or the expected economic results could also be delayed. This in turn could cause throughput and transport volumes to bypass HHLA’s sites. Moreover, the risk to HHLA of having to fund the costs of individual projects cannot be excluded.

For this reason, HHLA closely cooperates with the relevant public institutions for these projects. It also safeguards its interests by participating in relevant committees and through lobbying and active public relations activities.

Market Environment

Developments in Container Throughput, Transport Volume and Logistics Services

The pace of growth in those economies whose goods flows HHLA serves is a key precondition for the development of container throughput, transport volumes and logistics services. If demand for HHLA’s services fails to materialise as expected, the high level of fixed costs associated with this business model means that it might not be possible to compensate fully for negative divergences in earnings in the short and medium term. An economic trend which falls short of expectations may also lead to write-downs on assets (mainly property, plant and equipment and financial assets). HHLA regularly checks for any impairment of its assets and makes adjustments where necessary.

Global economic growth slowed over the course of the year. While the advanced economies continue to chart low but stable growth, structural changes in economic growth, particularly in China, led to a decline in global trade. Following a marked decline in economic output, market research institutes now forecast moderate growth for Ukraine based on reforms. Sanctions against the Russian Federation and persistently low oil prices are having a decidedly negative impact on transit traffic in the Baltic region. On the other hand, there are opportunities for a stronger volume trend in connection with the growth potential of Central and Eastern European economies such as Poland, the Czech Republic, Slovakia and Hungary, which use the Port of Hamburg for a large proportion of their transcontinental trade. Should the economic trend exceed expectations, prompting stronger volume growth, this could present an opportunity to profit from higher earnings by achieving economies of scale in handling and boosting volumes in downstream transport systems.

Following the decline in container volumes in Northern Europe and along the Asia–Northern Europe trade route in 2015, the market research institute Drewry anticipates a slight recovery in 2016. However, volume and capacity risks remain relevant to HHLA.

Throughput and transport volumes in the markets of relevance for HHLA, as well as the growth in ship sizes, are monitored closely to ensure trends are recognised at an early stage. Where they are scalable, controllable costs and investments – e.g. for the further expansion of the container terminals – are adjusted flexibly in line with the foreseeable level of demand.

Competitive Environment

In the area of container handling, HHLA competes directly with other terminal operators in Northern Europe. Primary competitive factors – apart from pricing – are the reliability and quayside productivity as well as the scope and quality of container handling services. Other factors affecting the terminal operators’ competitive position are the ports’ geographical position, the scope and quality of their hinterland links and their accessibility from the sea.

The development of additional handling capacity in the Northern European ports, coupled with current economic developments, have led to a significant increase in competition. Risks associated with a shift in volumes have partially emerged for freight volume with greater geographical flexibility, such as transshipment services. Due to fierce competition for container transport by rail, HHLA’s Intermodal subsidiaries also face the risk of volumes being re-routed with a resulting risk for revenue.

HHLA constantly improves its competitiveness by further enhancing its service quality and technological capabilities. Its ship handling activities focus primarily on increasing the efficiency of its handling services and addressing the increasing number of peak loads prompted by the handling of container mega-ships. HHLA is working on innovating its systems and optimising processes to further strengthen its position in handling technology. HHLA’s rail companies also connect the European seaports with the Central and Eastern European hinterland via a growing number of highly frequent shuttle services and direct links. Investments in its own hub terminals, such as the one currently under construction in Hungary, are intended to further increase the service quality and performance of HHLA’s hinterland network.

Customer Structure

HHLA’s shipping company customers operate in a tough competitive environment for container liner shipping. Reasons for this include high idle capacities due in particular to new mega-ships entering the market and low freight rates, twinned with weak growth in the global container transport industry. The cost pressure on shipping companies will therefore remain high in future. HHLA’s clients are responding to this situation with mergers and acquisitions, as well as by restructuring and reducing their services. These developments present both risks and opportunities for HHLA in connection with the temporary or structural re-routing of services between the North Range ports. Furthermore, shipping company customers could become even more price-sensitive, especially for transshipment loads.

In the field of ship handling, HHLA cooperates with many shipping companies on a neutral basis (“multi-user principle”). In the 2015 financial year, HHLA’s customer base included all of the top 20 container shipping companies. This enables HHLA to respond flexibly to changes in the container liner shipping sector. In addition, HHLA aims to enhance added value for its customers by expanding its mega-ship handling activities, continuing to develop the quality of its services and its technological capabilities, and optimising client-specific processes.

Intermodal Services and Services Procurement

The HHLA companies operating in the Intermodal segment pay track fees to the national railway companies or network operators for their rail network usage and also purchase traction services in some cases.

As the rail infrastructure in Germany is largely publicly owned, various authorities guard against discrimination in access and track fees. These authorities include the Federal Network Agency and the Federal Railway Authority in Germany and corresponding bodies abroad at EU level. Nevertheless, as the national rail network owners and operators have a monopoly, the profitability of rail firms may be impaired by a track pricing policy which does not take a neutral approach to carriers and distorts competition.

To reduce the level of dependency on national railway companies for traction services and to enhance production quality, HHLA is expanding its own facilities, rolling stock and locomotives in line with demand. As part of this strategy, it also purchases services from private suppliers. Providing end-to-end transport services using the company’s own operating assets guarantees high quality along the process chain. HHLA’s objective is to offer its customers a logistics chain of unparalleled quality and reliability. This will further strengthen Hamburg’s appeal: high-performance seaport terminals promote higher volumes in the hinterland, while intelligent transport systems with low-cost structures boost container flows at the port.

Finance

Currency

The bulk of HHLA’s services are rendered within the eurozone, so the majority of its invoices are issued in euros. The Logistics and Intermodal segments operate internationally, and a container terminal is operated in the Ukraine. Invoicing here is based primarily on euros or dollars. Currency or transfer risks therefore result primarily from exchange rate fluctuations affecting Central and Eastern European currencies. Due to the political situation in Ukraine in the first half of 2015, the Ukrainian currency, the hryvnia, fell strongly in value. The risk of a further devaluation remains. It remains to be seen whether the political situation will stabilise in the short term.

All HHLA companies that operate with foreign currencies reduce the risk of exchange rate fluctuations by monitoring rates regularly and, where possible, transferring free liquidity in local currency to hard-currency accounts .

Bad Debt Losses

The continuing idle vessel capacity means that freight rates are low. The liquidity and earnings position of shipping companies is thus expected to remain strained. The risk of bad debt losses cannot therefore be ruled out.

HHLA uses credit checks to reduce del credere collection risks. Active receivables management is used to enable the precise monitoring of receivables and payment patterns. HHLA has also taken out loan loss insurance to minimise default risks. Should the financial position of specific debtors change significantly, the insurer may limit the amount of cover it offers for new receivables payable by these debtors and/or no longer be able to provide coverage.

Pension Obligations

The reference interest rate for measuring the necessary provisions for company pensions recovered slightly over the course of the year. The actuarial losses carried in equity have fallen as a result. A reduction in interest rates would prompt an additional increase in pension provisions. This would result in a fall in the equity ratio Due to the volatility of the interest rate, this risk remains. HHLA monitors interest trends so that it can adjust its provisions as necessary.

Please see the reporting on financial instruments in the Notes to the Consolidated Financial Statements for further details of downstream default risks, liquidity risks, interest and exchange rate risks, including risk mitigation measures and the management of these risks.

Legal Risks

Compliance Incidents

Well-trained, motivated employees are the foundation for responsible business activities. The Group’s relationship with its employees is dominated by its sense of social responsibility. Staff representatives are closely and actively involved in Group decision-making and take their responsibilities seriously. This paves the way for a successful working relationship.

However, it is impossible to completely rule out the risk of employees committing fraudulent acts or legal and competitive violations in the course of their work. see also Note 47 in the Notes to the Consolidated Financial Statements, Management of Financial Risks

To reduce these risks, HHLA has introduced guidelines, manuals and double-checking, embedded controls in its processes and established spot checks as part of its compliance management system. Furthermore, the Group has issued a code of conduct which applies to all Group managers and staff. Training sessions are held regularly on the contents of this code of conduct. New employees and apprentices also receive training on the code. Regular induction and training sessions focusing on special topics – such as occupational health and safety, environmental protection, conduct in the competitive environment, preventing corruption and insider trading rules – are also held for those staff affected by these issues. All of these activities are supported by additional communication measures, for example via the HHLA intranet and staff newsletter.

Provision of Services

Failure of Technical Equipment

In the case of equipment-based companies, there is a risk that a failure of central technical equipment may restrict the ability of these companies to render their services. Depending on the length of the downtime, unavailable equipment leads to additional costs for providing services. Preventive maintenance, contingency plans/repair services, regular inspections and tests are performed in order to identify possible faults before they happen.

As part of the expansion of terminal capacity, major investments have been made in hardware and software components. Ever-greater process automation, the increasing integration of customers and service providers into organisational processes and the related growth of data transfer mean that the availability of IT systems is becoming increasingly important. Redundant copies of key IT components such as data centres, computer networks and telecommunications systems substantially reduce the probability of downtime and data loss.

Other Risk and Opportunity Factors

Risk of Storm Surges

As a result of the existing structural situation and the fact that HHLA’s port facilities and buildings necessarily operate close to water, there is a fundamental risk of storm surges. Flood protection work undertaken by HHLA and the Free and Hanseatic City of Hamburg in previous years has reduced this risk considerably, however.

Should this risk ever become reality, comprehensive emergency programmes have been put in place by public authorities and companies operating in the port to minimise the potential damage. In addition, the risk of damage to property is sufficiently covered by insurance policies.

Investment Options

In addition to organic growth, HHLA regularly examines opportunities for acquisitions. Potential equity investments focus on port projects in attractive growth markets. In addition to strategic aspects and synergies with HHLA’s existing activities, key decision-making criteria include growth prospects, the anticipated return on capital employed, and the extent to which entrepreneurial risks can be justified.

HHLA is in a sound financial position. This means that the company has the financial means to take advantage of strategically beneficial acquisition opportunities.