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 workloads 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.

The Federal Administrative Court reached a decision regarding the dredging of the river Elbe on 9 February 2017. It does not revoke planning approval for the dredging of the river Elbe. According to the court’s ruling, however, the latter is unlawful in part due to violations of habitat conservation law and is therefore not initially enforceable. Two points (a review of potential harm to the Elbe water dropwort due to a project-related increase in salt levels and provisions on coherence measures) that the Federal Administrative Court explicitly classifies as remediable must be revised. An approximate timeline for the practical and procedural implementation of the required remedial measures is not yet available. As such, no reliable forecasts of a possible starting date for construction can be made. 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. Projects of special significance for HHLA include constructing the port crossing 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 that 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 flows of goods HHLA serves is a key precondition for the future development of container throughput, transport volumes and logistics services. If demand for these 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 divergences in earnings caused by underutilised capacity in the short and medium term. An economic trend that falls short of expectations may also require adjustments to the valuation of assets (mainly property, plant and equipment and financial assets). HHLA regularly checks for any impairment of its assets and makes adjustments where necessary.

Research institutes forecast moderate global economic growth for 2017 after a difficult year in 2016, which was dominated by largely stagnating global trade and political uncertainty, among other things. Although the advanced economies are expected to continue their stable but modest growth, uncertainty surrounds the possible consequences of Brexit in Europe and the further development of the US economy following the change of president. In China, economic growth is expected to slow slightly but remain at a high level. Planned protectionist measures, as recently resolved by decree in the USA, will impose strict limits on global growth. 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. A gradual lifting of the economic sanctions imposed on the Russian Federation could also have a positive impact on the volume trend.

For 2017, the market research institute Drewry expects slight growth in global container throughput and the Northern Europe–Asia trade route, which is particularly important to HHLA. The correlation factor between relevant GDP and containerised trading volumes is expected to remain unchanged at less than 1. In other words, the partial decoupling of economic growth and growth in container traffic is set to continue. The anticipated growth in the Northern Europe–Asia trade route is therefore expected to fall short of economic growth in the eurozone in 2017. Consequently, volume and capacity risks remain relevant to HHLA.

Throughput and transport volumes in the markets of relevance for HHLA 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 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 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.

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. However, these risks are countered by taking appropriate measures.

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 further strengthen the performance of HHLA’s hinterland network.

Customer Structure

HHLA’s shipping company customers have operated in a tough competitive environment for container liner shipping for several years now. Reasons for this primarily include structurally related idle capacities and low freight rates, twinned with weak growth in the global container transport industry. This resulted in many shipping customers posting operating losses once again in the course of 2016. Moreover, Hanjin was forced to file for insolvency. The cost pressure on shipping customers will remain high in future. However, the initial outlook for 2017 indicates an increase in freight rates and an upturn in demand. HHLA’s shipping customers are responding to the changed market situation with mergers, as well as by restructuring and reducing their services. One consequence of this ongoing process is a fundamental reorganisation of shipping company alliances and services, especially in the Asia–Europe shipping region. The temporary or structural re-routing of services between the North Range ports presents both risks and opportunities for HHLA. 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 2016 financial year, HHLA’s customer base included all major 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.

Market Concentration in Procurement

Some of the handling equipment used by HHLA is highly specialised and this may result in a reliance on suppliers for maintenance or the procurement of replacement parts. Under certain circumstances, this may lead to operational restrictions. The corresponding risks are reduced to some extent by involving suppliers at a strategic and collaborative level and optimising the supplier base. This will be aided by the planned introduction of an IT-based supplier management system in 2017.

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 and repair, contingency plans and breakdown services, regular inspections and tests are performed to help identify possible faults before they happen and thus reduce risks.

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 monitor non-discriminatory access and carrier-neutral 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 that 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.

Financial Risks

Currency Risks

As the bulk of HHLA’s services are rendered within the eurozone, 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. The value of the Ukrainian currency, the hryvnia, continued to fall in the first quarter of 2016 due to the ongoing crisis in Ukraine. Despite stabilizing somewhat over the rest of the year, the risk of further devaluation cannot be ruled out. 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

Freight rates remain low due to the ongoing disequilibrium between trading volumes and ship space. The liquidity and earnings position of shipping companies is thus expected to remain strained.

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. This insurance cover is not extended to certain shipping customers. Moreover, Hanjin has filed for insolvency and will be liquidated in 2017.

Pension Obligations

The reference interest rate for measuring the necessary provisions for company pensions fell to a historically low level due to the continuation of the European Central Bank’s (ECB) expansionary monetary policy. Any further reduction in interest rates would prompt another increase in pension provisions. Lower volatility is assumed than in the past financial year based on the interest rate levels. 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. see also Note 47 of the Notes to the Consolidated Financial Statements, Management of Financial 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.

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 that 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. Should compliance violations occur, specific process adjustments may be undertaken to prevent them in future.

New Regulatory Requirements

Changes to legislation, regulatory reforms or amended requirements may necessitate changes to HHLA’s internal processes or existing equipment. By ensuring a steady flow of information and cooperating closely with the relevant authorities, HHLA is able to make timely internal preparations and forward-looking investments aimed at reducing the associated costs.

Other Risk and Opportunity Factors

Flooding

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. However, flood protection work undertaken by HHLA and the Free and Hanseatic City of Hamburg in previous years has reduced this risk considerably.

Should this risk ever materialise, 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 and evaluates acquisition opportunities. 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 assessment of commercial opportunities and risks. HHLA is in a sound financial position. It therefore has the financial means to make acquisitions.